Question 1
(a)
UR- Philips Curve
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Excalidraw Data
Text Elements
LRPC
SRPC
5%
Unemployment
Inflation rate
4%
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(b)
(i)
AD needs to be reduced by = 500 billion, so government spending needs to be reduced by: 500 billion / 5 = 100 billion.
(ii)
The point on the short-term Phillips curve shifts to the lower right as demand falls, inflation decreases, and unemployment increases.
(iii)
Real interest rates decrease. Demand falls as government spending is reduced and interest rates are lowered to stimulate private investment.
(iv)
Lower real interest rates make U.S. assets less attractive and demand for dollars decreases, so the dollar depreciates.
(c)
Government spending decreases by 500 billion:
(i)
Government spending multiplier = 5 (as calculated earlier)
Taxation multiplier = -MPC / (1 - MPC) = -0.8 / 0.2 = -4
Thus the maximum AD change is:
(ii)
Demand for loans decreases because the demand for funds decreases after government spending decreases.
(d)
In the long run, without policy intervention, the economy will automatically return to potential output and real GDP returns to the level of full employment output. This is because wages and resource prices will eventually adjust, pushing SRAS to the right and eliminating the inflation gap.
Question 2
(a)
Recession ADAS
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Excalidraw Data
Text Elements
GDP
PL
SRAS
AD
LRAS
Y1
PL1
YF
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(b)
In the long run, with no intervention, wages and production costs fall, SRAS moves to the right, and the economy automatically returns to full employment (Y1 returns to Yf).
(c)
(i)
MPC = 0.8, multiplier = 5
Shortfall: 5,400 - 5,000 = 40 billion
Required increase in government spending: 8 billion (increase)
(ii)
Decrease in required tax revenue: 10 billion (decrease in tax revenue)
(d)
Reserve market
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Excalidraw Data
Text Elements
IR
Q
D
S1
S2
IR1
IR2
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(e)
Coolway interest rates fall, dollar assets become less attractive, demand for Coolway dollars decreases, and there is depreciation relative to the Mexican peso.
Question 3
(a) The value of a dollar in a country’s economy declines as a result of the decline in the interest rate of that country.
UR+ Philips Curve 1
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Excalidraw Data
Text Elements
LRPC
SRPC
5%
Unemployment
Inflation rate
7%
B
3%
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(b)
(i)
SRAS shifted right; due to recession, resource costs dropped.
(ii)
The long-run Phillips curve is unchanged because the natural unemployment rate is fixed.
(c)
Expansionary fiscal policy is because of increased government spending or lower taxes.
(d)
The AD curve shifts to the right, real GDP rises, and the price rises.
(e)
Real GDP increases, incomes rise, import demand rises, and money supply increases in the foreign exchange market.
(f)
Country X’s currency depreciates in the foreign exchange market due to an increase in the money supply.
Question 4
(a) The supply of money to country X depreciates in the foreign exchange market due to an increase in the supply of money.
UR++ Philips Curve 2
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Excalidraw Data
Text Elements
LRPC
SRPC
Unemployment
Inflation rate
X
Z
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(b)
An increase in government deficit spending to reach full employment raises the real interest rate because the demand for funds increases.
(c)
Canada attracts increased international capital inflows because of an increase in the real interest rate.
(d)
An increase in the real interest rate in Canada plots the foreign exchange market of the Canadian dollar against the Norwegian krone, foreign capital inflows increase, demand for the Canadian dollar rises, and the Canadian dollar appreciates.
(e)
An appreciating Canadian dollar implies a depreciation of the Norwegian krone.
(f)
If the Norwegian current account was originally zero, a depreciation of the krone will now lead to an increase in Norwegian exports, a decrease in imports, and a current account surplus.
(g)
An appreciation of the Canadian dollar leads to a decrease in exports and a decrease in net exports.
(h)
Question 5
(a) The Canadian dollar has appreciated, resulting in a decrease in net exports.
- Production Possibility Curve
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Excalidraw Data
Text Elements
food
clothing
A
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(b)
(i) Buying bonds (open market operations).
(ii)
S+ Money market
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Excalidraw Data
Text Elements
S1
D
Nominal interest rate
Quantity of money
IR1
IR2
S2
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(iii) Real interest rates fall as a result of an increase in the money supply caused by expansionary policies.
(iv) Falling real interest rates stimulate increased investment, and short-term real GDP rises. This is because increased investment pulls AD up.
(b)
(i) Initial deterioration in current account deficit due to increase in real GDP, increase in income of the population and increase in imports.
(ii) The supply of Rankinland currency bera to the foreign exchange market increases, and bera depreciates because of increased import demand due to real GDP growth.