Transcript FRQ Review Answersx

FRQ Review
Questions & Answers
#1
1. Suppose the United
States economy is
experiencing a period of
rapid economic growth.
a. Using a correctly labeled
AD/AS graph, show the
equilibrium price level and
real GDP.
LRAS
SRAS
PL
ePL
AD
Qe
Qn
IG
rGDP
#1…
b. Should Congress choose to “cool
down” the economy, what fiscal
policy options are available? How
would each impact GDP? Use a
graph to support your explanation.
Congress could reduce transfers or
government spending or increase personal
income taxes. Each of these would decrease
aggregate demand and eGDP through the
spending multiplier. The overall effect of a
government spending cut would be GREATER,
however, because consumers will draw on
savings to pay some of their taxes where as
government will reduce spending by the full
amount stated. This mirrors the greater
power of a government spending increase to
later aggregate demand relative to a tax cut
(consumers will save some of their tax rebate,
rather than spending the full amount as the
government would).
LRAS
PL
SRAS
AD2
ePL
AD1
Qe
Qn
IG
rGDP
#1…
c. What would be the impact of
the decisions above on the
government’s national deficit?
•
IRn
The Fed can sell bonds, raise DR or RR
Ms2
Ms1
Contractionary fiscal policies could serve to
reduce the government’s deficit by
increasing revenues even as spending is
reduced.
d. If the Federal Reserve chose to
take action instead, what policy
options are available to them?
How would these policies impact
the Money Market, Investment
Demand, and the AD/AS model?
Use graphs to support your
explanation.
Each of these policies
serves to reduce banks’
excess reserves (loanable
funds), make money
more scarce, raise
interest rates and, in
turn, reduce investment
and overall spending due
to higher borrowing
costs.
Md
Q$
IRn
B
A
LRAS
Q investment
SRAS
PL
AD1
AD2
rGDP
#1…
e. If the government chose to
take no action, how would the
economy ultimately return to
LR equilibrium? Use a graph to
support your explanation.
LRAS
SRAS
PL
SRAS2
ePL
The inflationary gap would ultimately self
correct and close through stagflation. As
producers compete for workers at higher
wages, they will be force to let employees
go even as the price level rises. This
process will take time (prices and wages
are sticky), but will self adjust to close
more efficiently than a recessionary gap.
AD
Qe
Qn
IG
rGDP
#1…
f. Compare how the
actions taken in B and E
would be reflected on the
Phillips curve
While contractionary fiscal policy seen in
B (shifting the AD Left) would be
reflected with movement to the right
along the Phillips Curve (higher
unemployment traded off for lower price
levels), the stagflation evident in e
(shifting AS Left) would be shown as a
rightward shift of the Phillips curve (the
inflation unemployment trade off still
exists, but is worse overall).
B.
Infl.
LRPC
A
B
Qn
E.
Infl.
SRPC
Unemp.
LRPC
SRPC2
SRPC
Qn
Unemp.
#2…
Imagine the Obama
Administration successfully
champions a bill to build
10,000 new schools across
the country. Rather than
increasing taxes to pay for
this investment in
infrastructure, the
government chooses to fund
their efforts through
increased debt. What effect
will this policy have on:
a. The AS/AD model?
AD2
AD1
LRAS
SRAS
#2
b. The loanable funds market
and interest rates?
#2
c. If the Federal Reserve
chooses to adopt a supportive
monetary policy stance in
response to the Obama
Administrations efforts, what
will they do? How will it
impact the loanable fund
market and interest rates?
Monetize the debt—buy bonds
to increase Ms, bring IR back
down
Slf3
#3
Assume that Broudatopia and
Wusslerville are the only 2
countries on the planet Macro.
Broudatopia uses Bs as their
form of currency. Wusslerville
uses Ws as their form of
currency.
a. Assume that real incomes rise
in Wusslerville at a faster pace
than those in Broudatopia. Use
a graph to explain how will this
change affect:
– the supply of Ws
– the international value of
the W
Pw’s
W’s S of
w’s 1
Sw’s 2
B’s D for w’s
Qw’s
The supply of W’s increases as Wusslervillians
bring more currency to the ForEx Mkt to purchase
goods from Broudatopia. This increase in supply
causes the W to depreciate in value.
#3
Assume that Broudatopia and
Wusslerville are the only 2
countries on the planet Macro.
Broudatopia uses Bs as their
form of currency. Wusslerville
uses Ws as their form of
currency.
b. If the Federal Reserve Bank of
Wusslerville engages in the open
market sale of bonds, use graphs
to explain how the following will
be altered:
• the supply of Bs in
international currency markets
• the international value of the
B
Pb’s
B’s S of
b’s 1
Sb’s 2
W’s D for b’s
Qb’s
The supply of B’s increases as Broudatopians
bring more currency to the ForEx Mkt to move
their money to Wusslerville, where interest rates
are higher. This increase in supply causes the B
to depreciate in value.