Exam 2 Key

note: this a very brief answers to give you an idea of the solution. I would have expected greater detail on the exam.

 

  1. If the price of Pepsi falls, the demand for Coke will fall. If prices are sticky, that means that there will be a surplus of Coke. Prices may be sticky because of the cost of changing prices on vending machines, fixed period labor contracts, contracts for prices of inputs, etc.
  2. Futures markets allow firms to better plan production plans so as not to accidentally produce too much or too little and have unintended Investment
  3. A
  4. a) increases SRAS and does not change AD

b) This will cause an expansion (GDP will rise above potential)

c) This will decrease unemployment

d) A decrease in G or an increase in T

  1. lower, not change, not change, lower
  2. Because prices are sticky only in the short run. In the long run, prices can adjust up and down.
  3. Below
  4. If the Fed raises the discount rate, other banks will raise their interest rates. If real interest rates rise, Investment falls. If investment falls, then AD falls. If AD falls then in the long run price falls and GDP stays the same. In the short run, GDP falls and prices stay the same.
  5. No. They will get 4% (actually 1% after inflation) return on the investment and they will get 5% real interest from saving the money, so they are better off not investing.
  6. Krugman was right that Singapore had reached the long run equilibrium of the capital deepening process and would need to increase technology if it wanted to keep seeing increases in productivity.
  7. Rising, Falling
  8. They don’t know. They think it may be technology related or maybe oil prices. They do not think it is the effects of diminishing returns due to capital deepening
  9. Savers want small, safe, and liquid investments and Firms need large, unsafe, illiquid funds for investment. Banks allow for diversification across firms so that savers money is collected and becomes large, safe, and liquid.
  10. (If the expansionary gap is $280, then they want to decrease AD to bring GDP down by $280. The two fiscal policy options are: 1) decrease G. Specificaly decrease G such that (G*(1/(1-b+m)))=$280. You know b=.8 and m=.15 so you should decrease G by $97.90 to decrease GDP by $280. option 2) increase Taxes. The tax multiplier is (-b/(1-b+m)), so you will need to increase taxes by $122.50
  1. You would want to compute the value of output using a common currency and a common set of goods, you would then divide it by the number of workers.
  2. C I G NX
  3. Commodity money was used and then banks realized that they could hold the commodity money in the bank and give people IOUs for the commodity. This is the creation of Bank Notes. The bank notes could be traded in at the bank for the commodity. Sometimes bank notes are backed by the power of the government (Fiat Money).
  4. Banks all over the US were issuing bad notes and people would rather use those than better quality money. So more and more bad money is circulating and suddenly no one wants to take the bad money. The monetary system could collapse. The fed stepped in and mandated the use of Federal Reserve Notes which were backed by the US govt.
  5. M1 – it is most liquid, so it is used to buy things more often.
  6. Check out the Solow model appendix from the book, but basically, an increase in the savings rate will shift up the total savings function and so there is greater GDP in the long run capital accumulation equilibrium. Then the innovation described will decrease the depreciation rate, so the line d*K will get a flatter slope, also increasing long run K and GDP.
  1. Small countries import more, so the mpi is bigger, so the multiplier is smaller.
  2. C
  3. Because banks keep more than the RRR and people don’t always deposit money in banks.
  4. Inverse
  5. 23.2 37 16 10.2
  6. Lump Sum Tax – nothing. Marginal Tax  – lowers
  7. This means that X decreases, since Asian markets can't afford US goods. M increases as Asian good prices have fallen. So NX falls. as does AD. 
  1. E
  2. Look at prices. If prices fell, it was the taxes (a decrease in AD) – If prices rose it was a shift back in the LRAS curve.
  3. Stocks are ownership of a company and bonds are IOUs. They are related to investment in that bond provide money for Investment by the firm, BUT NEITHER IS INVESTMENT. 
  1. buy, 1 million
  2. If the Fed changes the RRR, then when people deposit money in a bank, the bank is unable to lend out as much of the money to someone else, so a larger "cut" of the money is kept out of circulation.
  3. 12, 5, 7, 14
  4. False, it depends on inflation

Bonus: Alan Greenspan