Transcript 2005 Macro 1

1.
(i)
Assume that the United States economy is currently in equilibrium
at the full-employment level of real gross domestic product.
AS/AD Model
Output Level
(ii)
Price Level
Price
Level
P1
LRAS1
SRAS1
-------------- E1
AD1
Y1
Real
GDP
(b)
Japan is a major importer of United States
products. Assume that the Japanese economy
goes into a recession.
(i)
Exports to Japan Decrease:
Explain the impact of the Japanese recession
on the U.S. equilibrium output and price
level.
AS/AD Model
NX ↓ => AD ↓ => R-GDP ↓
Price
Level
P1
LRAS1
SRAS1
-------------- E1
AD1
AD2
Y1
Real
GDP
(c )
Assume that the Federal Reserve takes action
to curb the effects of the Japanese recession
on the U.S. economy.
(i)
What open-market operation would the
Federal Reserve undertake?
Buy Gov’t Bonds
Money Market
MS1 MS2
Nominal
Interest
Rate
i1
i2
MD
Q1
Q2
Qty $
(iii) Explain how the change in the nominal interest
rate in part (c ) (ii) will affect aggregate demand
price level, and real output in the U.S.
When nominal interest rates drop =>
Investment ↑ (I) & Consumption ↑ (C) =>
Therefore AD ↑
(d) Define the real interest rate.
real rate = nominal rate – expected
inflation
(e) Indicate the effect of the open-market operation
you identified in part (c ) (i) on the real interest
rate in the United States.
When the nominal rate is going down and
the inflation rate is going up (AD shift), then
the real rate must go down.
Formula: real rate = nominal – expected
inflation