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2007 Macro FRQ

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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 investors’ 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 Japan’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 Fed’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 – Inflation; if we
get more inflation, then Real IR = Nominal – 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.
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