Principles of Economics (12th Edition)
12th Edition
ISBN: 9780134078779
Author: Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher: PEARSON
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Question
Chapter 27, Problem 2.2P
Sub part (a):
To determine
Identify the effects of a sharp decline in investments in goods market and
Sub part (b):
To determine
Identify the expansionary policies and rank them.
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The diagram on the right shows the demand for money curve in a hypothetical economy.
Suppose that the economy is initially at point E.
Suppose that due to changes in expectations in the financial markets, the quantity of money
demanded increases because of speculative reasons.
This change would be associated with a movement from E to point EB
C
Interest Rate %
EB
Eo
EA
Quantity of Money
MD (Y,P)
Consider the money market in the accompanying graph.
Initially, the equilibrium interest rate and quantity are
represented by the point, El. Suppose the central bank
reduces the money supply. Adjust the graph of the money
market to illustrate this change and label the new equilibrium
by moving the point, E2.
After this recent change in the money supply, what is
true about the point E1?
The quantity of money demanded is more than the
quantity of money supplied.
The quantity of money demanded is less than the
quantity of money supplied.
The quantity of money supplied is more than the
quantity of money demanded.
Those selling interest-bearing nonmonetary assets
will face market pressure to lower their interest rates.
Interest rate (%)
Incorrect
10
9
8
7
6
5
4
3
2
1
0
0
1
2
E2
Money Market
EI
3 4 5 6
Quantity of money
7
8
MS
MD
9
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What would be the effect of an increase in money supply on aggregate demand, GDP and inflation ? Use appropriate diagram (s) to illustrate and explain your answer.
Chapter 27 Solutions
Principles of Economics (12th Edition)
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- (a) In order to get out of recession, the government chooses to reduce taxes (T) by 250. Find the new equilibrium level of income and interest rates. (b) If instead (i.e. government taxes are back to the original level of 1000), it chooses to increase the money supply (M) by 250. Find the new equilibrium level of income and interest rates.arrow_forwardA country's central bank is engaging in monetary contraction, with M going from M0=40 to M1=20. Its economy is as follows. Goods: slc = 3 MPC = 0.7 G = 10 T = 9 Before the policy, the goods market equilibrium is at Y0 = 54. Financial: I = 18-200r Before the policy, the loans market equilibrium is at r = 4.25% and I = 9.5 Money: M0 = 40 P0 = 2 M/P = 0.02 / (r - Y/5000)^2 and finally, Labor: w = MPL = 0.5 * 4.5 * 16^0.6 / L^0.5 w = EP / P0 * L^0.5 Where workers currently expect the price level of EP=2. There are four endogenous variables that adjust in response to shock/policy: Y, I, r, P. The policy variable of interest is M. Therefore, let's approach our solution by first recognizing that all other letters are just constants and plug them in. For example: Y = 2 + 0.5(Y-6)+7+I becomes Y = 12 + 2*I First, express the goods market as expenditure being a linear function of investment I of the form: Y = a + b*I where a and b are parameters (numbers). 1. How does the monetary…arrow_forwardA country's central bank is engaging in monetary contraction, with M going from M0=40 to M1=20. Its economy is as follows. Goods: slc = 3 MPC = 0.7 G = 10 T = 9 Before the policy, the goods market equilibrium is at Y0 = 54. Financial: I = 18-200r Before the policy, the loans market equilibrium is at r = 4.25% and I = 9.5 Money: M0 = 40 P0 = 2 M/P = 0.02 / (r - Y/5000)^2 and finally, Labor: w = MPL = 0.5 * 4.5 * 16^0.6 / L^0.5 w = EP / P0 * L^0.5 Where workers currently expect the price level of EP=2. - There are four endogenous variables that adjust in response to shock/policy: Y, I, r, P. The policy variable of interest is M. Therefore, let's approach our solution by first recognizing that all other letters are just constants and plug them in. For example: Y = 2 + 0.5(Y-6)+7+I becomes Y = 12 + 2*I First, express the goods market as expenditure being a linear function of investment I of the form: Y = a + b*I 1. How does the monetary contraction directly and immediately affect the…arrow_forward
- Explain the relationship between the effectiveness of monetary policy and the interest elasticity of investment. Will the monetary policy be more or less effective the higher the interest elasticity of investment demand?arrow_forwardDefine the term Liquidity?arrow_forwardExplain how an increase in a price level will affect the demand for money and the aggregate demand. Use relevant graphs to support your answer.arrow_forward
- According to Keynes, increasing the money supply should lower interest rates in the economy. Milton Friedman notes that while it is true that expansionary monetary policy can lower interest rates, it is only part of the story. a. Briefly explain under what conditions an expansionary monetary policy will indeed lower interest rates, both in the short and long run. A graph may help answering this question.b. Briefly explain under what conditions an expansionary monetary policy will increase interest rates. A graph may help answering this question.arrow_forward7 Assume that initially everyone expected the price level to stay the same when the Federal Reserve announces that it will reduce the rate of money growth in one year. People now expect prices to rise less quickly. Use the AS/AD model to explain what happens to prices at the time of the announcement. Use either a graph or equations of the model.arrow_forwardSuppose that expanded credit card availability makes people demand less money at every value of money. a) Using the graph of the money market, show and explain how this change will impact the equilibrium value of money and the equilibrium price level in the economy (do not forget to label the axes). Using the graph of the money market, show and explain the action the Federal Reserve could take to return the economy to its initial price level.arrow_forward
- To https://aplia.apps.ng.cengage.com/ar/serviet/quiz?cx=bkhana-0031&quiz_action=takeQuiz&quiz_probGuid=... The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS₁ to AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion. ? 200 AS 175 AS₁ 150 125 100 75 50 25 0 PRICE LEVEL 0 50 300 200 250 QUANTITY OF OUTPUT 100 150 350 400 Yoarrow_forwardUse the following information for this problem: Goods Market: Asset Market: C = 3+0.5(Y-T) MS = 25/P; assume that the P=1 initially I = 12-50r MD = Y - 50r T = 10 G = 10 Suppose that when the economy is in the Short Run equilibrium (hand draw a new graph starting at the Short Run) the Federal Reserve wants to conduct a stabilization policy. What is the policy they would use called? Show graphically how they would stabilize.arrow_forwardExperimental exercise Argue on the following premises: If the income of the economy increases and the Central Bank does not want to increase the money supply, interest rates must be lowered. Graph. If the money supply increases, the interest rate must rise to balance the money market. Graph. If the money supply were increasing with the interest rate, what would the graph of said curve look like? (Draw it)arrow_forward
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