Macroeconomics Free Response 1. Assume that declining stock market prices in the U.S. cause many U.S. financial investors to sell their stocks and increase their money holdings. Answers for 1. (a) (i) 1. (a) (i) The decline in wealth decreases many investors demand for major purchases and decreases the demand for money. Nominal Interest Rate (a) Draw a correctly labeled graph of the money market and show the impact of the financial investorsвЂ™ actions on each of the following. (i) Demand for money (ii) Nominal interest rate DM MS 1 DM i.r.1 2 i.r.2 Money Market Answers for 1. (a) (ii) 1. (a) (ii) The nominal interest rate would decrease because the demand for money decreases as the DM curve shifts down, as shown above. cause less consumer spending which causes the AD curve to shift left and a decrease in the price level. This decrease in PL will cause the Japanese to want to buy more U.S. goods, increasing the demand for the dollar. Yen Price of Dollar 1. (b) Due to the decline in wealth caused by the change in stock prices, the general price level in the U.S. falls relative to the price level in Japan, a trading partner. Use a correctly labeled graph of the foreign exchange market for the U.S. dollar to show the impact of the change in relative price levels on each of the following. D2$ (i) Demand for the dollar D1$ S$ (ii) Price of the dollar Answers to 1. (b) (i) E2 Y150 1. (b) (i) The decrease in wealth will Y100 E1 Quantity of Dollars Answers to 1. (b) (ii) 1. (b) (ii) Lower prices in the U.S. would cause an increase in demand for the dollar, resulting in the Japanese having to pay more for American goods. Therefore the yen would depreciate as the price of the dollar has increased, and the dollar has appreciated. 1. (c) How will the change in the price of the dollar you indicated in part (b) (ii) affect net exports of the U.S. Explain. Answer to 1. (c) The appreciated dollar would cause American goods to be more expensive for Japan and JapanвЂ™s goods to be less expensive for Americans; therefore, we would export less and import more, resulting in a decrease in net exports. (d) Using a correctly labeled AD/AS graph, show how the change in Xn in part (c) will affect each of the following in the short run. (i) Aggregate Demand (ii) Output and price level Answer to 1. (d) As can be seen on the graph, the decrease in Xn would decrease AD. The decrease in AD would decrease output to Y2 and PL to PL2. (e) Given your answers to part (d), what will happen to unemployment in the short run? Explain. LRAS SRAS PL AD2 AD1 E1 PL1 PL2 E2 Y2 Y1 RGDP Answer to 1. (e) The decrease in Xn in part (d) will result in a decrease in AD and output, which would increase unemployment in the SR. 2. In recent years, the Federal Reserve has made targeting the federal funds rate a main focus of its monetary policy. (a) Define the federal funds rate. Answer: The rate that banks charge one another for overnight loans (b) If the Federal Reserve wants to lower the federal funds rate, what open-market operation would be appropriate? Answer: The Fed would buy bonds from the banks or public. Buying bonds means a bigger supply of money and lower fed funds rate. (c) Assume that the open-market operation that you indicated in part (b) is equal to $10 million. If the RR is 0.2, calculate the maximum change in loans throughout the banking system. Answer: If the Fed buys bonds from banks, DD could increase by the $10 million initially & with a MM of 5, the total money supply could increase to $50 million. If the Fed buys bonds from the public, DD could increase by $10 M initially. With MM of 5, $2 M would be kept in RR & $8 million could be loaned out & increase to $40 million more in DD for a total of $50 million. (d) Indicate the effect of the open-market operation that you indicated in part (b) on the nominal interest rate. Answer: Buying bonds would increase the MS and lower nominal Interest rates. (e) Assume that the FedвЂ™s action results in some inflation. What would be the impact of the open-market operation on the real rate of interest? Explain. Answer: The real interest rate would decrease. Real IR = Nominal вЂ“ Inflation; if we get more inflation, then Real IR = Nominal вЂ“ even more Inflation, so it decreases. 3. Indicate whether each of the following is counted in the U.S. GDP for the year 2006. Explain each of your answers. (a) The value of a used textbook sold through an online auction in 2006 Answer: No, it was counted the year it was produced. Because it was not produced again, it would not be counted. That would be double counting. b. Rent paid in 2006 by residents in an apartment building built in 2000 Answer: Yes, rents consist of the income received by the households and businesses that supply property resources. It is included in the income approach approach to GDP. c. Commissions earned in 2006 by a stockbroker Answer: Yes, payment is being made for productive services of the broker. So the purchase of stocks would not count but his work would. d. The value of autos produced in 2006 entirely in South Korea by a firm fully owned by U.S. citizens Answer: No, GDP measures production inside the U.S. regardless of ownership. These autos were produced in South Korea.