1. Illustrate each of the following situations with a graph showing short-run aggregate supply:
a. A decrease in the size of the labor force.
b. An increase in available capital.
c. An increase in productivity as a result of a technological change.
d. A decrease in the price of oil.
2. On November 9, 2011, the European Central Bank acted to decrease the short-term interest rate in Europe by one fourth of a percentage point, to 1.25 percent, and additional cuts were made over the next three years, to a low rate of 0.05 percent by September 2014. The rate cuts were made because European countries were growing very slowly or were in recession. Whateffect did the bank hope the action would have on the economy? Be specific. What was the hoped-for result on C, I, and Y?
3. The AD curve slopes downward because when the price level is lower, people can afford to buy more and aggregate demand rises. When prices rise, people can afford to buy less and aggregate demand falls. Is this a good explanation of the shape of the AD curve? Why or Why not?
4. What effect will each of the following events have on the current account balance and the exchange rate if the exchange rate is floating?
a) The U.S. government cuts taxes and income rises.
b) The U.S. inflation rate increases and prices in the United States rise faster than those in countries with which the United States trades.
c) The United States adopts an expansionary monetary policy. Interest rates fall (and are now lower than those in other countries) and income rises.
d) The textile companies' "Buy American" campaign is successful, and U.S consumers switch from purchasing imported products to buying products made in the United States.
5. You are given the following model that describes the economy of Hypothetica...
1. Consumption function: C = 80 + 0.75Yd.
2. Planned investment: I = 49
3. Government spending: G = 60
4. Exports: EX = 20
5. Imports: IM = 0.005Yd
6. Disposable income: Yd = Y - T
7. Taxes: T = 20
8. Planned aggregate expenditure: AE = C = I+G+EX - IM
9. Definition of equilibrium income: Y = AE
a. What is the equilibrium income in Hypothetica? What is the government deficit? What is the current account balance?
b. If government spending is increased to G =75, what happens to equilibrium income? Explain using the government spending multiplier. What happens to imports?
c. Now suppose the amount of imports is limited to IM = 25 by quota on imports. If government spending is again increased from 60 to 75, what happens to equilibrium income? Explain why the same increase in G has a bigger effect on income in the second case. What is about the presence of imports that changes the value of the multiplier?
d. If experts are fixed at EX = 20, what must income be to ensure a current account balance of zero? (Hints: Imports depend on income, so what must income be for imports to be equal to exports?) By how much must we cut government spending to balance the current account?( Hint: Use your answer to the first part of the question to determine how much of a decrease in income is needed. Then use the multiplier to calculate the decrease in G needed to reduce income by that amount.)
6. Suppose the exchange between the Danish krone and the U.S. dollars is 7 Dkk = $1 and the exchange rate between the Chilean peso and the U.S. dollar is 650 CLP = $1.
a) Express both of these exchange rates in terms of dollars per unit of the foreign currency.
b) What should the exchange rate be between the Danish krone and the Chilean peso? Express the exchange rate in terms of 1 krone and in terms of 1 peso.
c) Suppose the exchange rate between the krone and the dollar changes to 5 DKK = $1 and the exchange rate between the peso and the dollar changes to 700 CLP = $1. For each of the three currencies, explain whether the currency has appreciated or depreciated against the other two currencies.