ECON&202.Test3W.Key.Win08 - Name ECON&202 Winter 2008...

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1 Name __________________ ECON&202: Winter 2008 Key Test 3-White Test: Covers Chap 16, 17, 18, 20 & 21 Question 1-5 : Worth 10 points each for a total of 40 points. ONLY ANSWER 4! If you answer 5, I will grade the first 4. Remember explain your answers. 1. In 1939, with the U.S. economy still suffering from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. a. Explain this decision using the model of aggregate demand and aggregate supply. b. Suppose that extending Thanksgiving did not stimulate the economy as much as the President would have liked. What can the Fed do to stimulate the economy? c. The Fed has many critics and just as many supporters. Explain the pros and cons of the Federal Reserve. d. Of the three monetary tools that the Fed can use to influence the economy, which monetary tool is the most common and which is the least? Explain why… Solution: a. Key words for this problem: “…economy still suffering from the Great Depression…” This would mean that the economy is below the Natural Rate of Output (Y 2 ), which would put the economy at Y 1 . Model of Aggregate Supply & Aggregate Demand b. In the short-run, the Fed can stimulate the economy by using one of the monetary tools, namely open market operations (buying 3-month T-bills). By increasing the money supply and thus, decreasing the interest rate (See below for the money market), this action can influence aggregate demand by increasing consumption and increasing investment (Y = C + I + G + NX).
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2 Money Market c. Three functions of the Fed: Regulate banks, lender of last resort and controls monetary policy. Some would argue that the Fed does nothing more than increase price levels. To some extent, this is true. In the LR, changing AD will only change price levels. However, the Federal Reserve can influence aggregate demand in the short-run because of the upward sloping aggregate supply. Others would argue that the Fed plays a vital role in the overall health of our economy. For example, during the sub- prime mortgage mess of 2006-7, the Fed injected millions of dollars into the banking system and acted as a lender of last resort for millions of banks caught in the sub-prime mess. This lender of last resort function plays an instrumental role in times of crisis attempting to smooth out shocks to our economy.
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