Economics 576 Macroeconomic Theory and Policy Spring 2015

Question Assume the model: And pay attention to the model in answering the questions Y = C + I + G + X – M C = a + b Yd where a > 0 and 0 < b < 1 I = f (i) but I ? f (Y) ie MPI = 0 G = Go Ms = Mso Ms = money supply/stock Tx = Txo ??..meaning that Tx ? f ( Y ) Md = Mt(Y)+ Ml(i) [Mt = transactions demand; Ml = liquidity preference demand] X = Xo X = exports M = Mo + mY where Mo is autonomous imports and m is the marginal propensity to import In each of the following cases indicate the effect of the given autonomous change (or policy measure) on each of the listed variables. In each case indicate whether the listed variable increases in value decreases or does not change. Note: Answer beside the listed variable. For example if in I an increase in the money supply does not bring about a change interest rates write ?does not change? beside ?interest rates? at I 1. And if an increase in the money supply causes a decrease in the level of income write ?decreases? beside ?level of income? at I 2 I. An increase in the money supply: 1. Interest rates 2. Level of income 3. Imports 4. Investment 5. Government spending II. A decrease in the public?s liquidity preference: 6. Level of income 7. Investment 8. Saving 9. Consumption 10. Exports III. An increase in the marginal propensity to import: 11. Income 12. Amount of money demanded for transactions purposes 13. Bond prices 14. Saving 15. Investment 16. Consumption 17. Money supply 18. Exports IV. An increase in exports: 19. Income 20. Interest rates 21. Imports 22. Money supply V. A simultaneous and equal increase in taxes and government spending: 23. Level of income 24. Interest rates 25. Investment Answer beside the question 26. Expansionary fiscal policy ? taken by itself ? tends to raise interest rates and the level of income. 27. Expansionary monetary policy tends to lower interest rates. 28. The greater the elasticity of the LM curve the greater will be the effectiveness of fiscal policy (in terms of increasing income). 29. The more interest elastic the investment demand function the more effective monetary policy will be. 30. The more interest elastic the investment demand function the stronger will be the ?crowding out? effect associated with a pure fiscal policy measure. 31. For equilibrium in the goods/commodity market (or real sector) the higher the rate of interest the lower the level of income must be. 32. Given a two sector model at any point to the right of the IS curve saving must exceed investment. 33. Using the IS ? LM framework in which model would monetary policy be more effective (in terms of increasing the level of income)? THINK IT THROUGH A. I = f (i) S = f (Y) G = Go B. I = f (i) S = f (Y) G = Go ? g (i) 34. Using the IS ? LM framework in which model would monetary policy produce larger income changes (per unit of monetary stimulus)? THINK IT THROUGH A. Tx = Txo B. Tx = To + tY t > 0 35. Based on the equation of exchange an increase in government spending can increase income if and only if it is financed by an increase in the money supply. 36. At any point to the right of the IS curve total leakages must exceed total injections. 37. If velocity is rising then the demand for money must be falling. 38. The transactions motive for holding/demanding money is related primarily to the fact that money serves as a store of value. 39. The asset (liquidity preference or speculative) motive/demand for money relates primarily to money?s medium of exchange function. 40. A Keynesian would view expansionary monetary policy as having its impact primarily through its effect on interest rates and thus consumption. VI. Generally does the basic Keynesian formula multiplier (regardless of the model) tend to overstate understate or depict accurately the impact of fiscal stimulus packages relative to income (and thus employment)? Why? [Start by first designating whether overstate understate or??.and then explain why it does what you choose] VII. Henry Hazlitt ? Economics in One Lesson: ?The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.? Evaluate and explain!

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