PS6key08 - Answer Key for PS6 Professor Shea Spring 2008 1....

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Answer Key for PS6 Professor Shea Spring 2008 1. Use graphs to illustrate the effects of each of the following events on the US Economy in the Keynesian model. Briefly explain your answers. (1) The US dollar depreciates relative to the Euro That the US dollar depreciates means that it takes more dollars to buy one Euro. As a result, US products are more competitive (cheaper) to Europeans, which leads to an increase in US exports. In the meanwhile, a weak dollar also means the prices of European products are higher for US consumers. Therefore, US import decreases. Then US net exports increase, which causes the expenditure schedule to shift upward. As shown in the following graph, we can see that the equilibrium output will increase. (2) The Federal Reserve raises nominal interest rates in the US. Assume that US expected inflation is held constant. Real interest rate = nominal interest rate – inflation rate. Holding the inflation rate constant, the rise in the nominal interest rate results in a rise in the real interest rate. This policy will discourage US investment (including business and households) and the expenditure schedule will shift downward. In the graph below, we can see that the equilibrium output decreases due to this policy. 45 degree AD Y AD
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(3) House prices collapse in the US Household wealth will fall due to collapse of house prices, which leads to a reduction of autonomous consumption. Therefore, the expenditure schedule will shift downward, and the equilibrium output will decrease as shown in the following graph. (4) The stock market crashes in Canada (Hint: figure out what happens to Canada first, then figure out what that does to the US economy) If the stock market crashes in Canada, the wealth owned by Canadian households will shirk and, then, the autonomous consumption of Canadian will decrease. Canada's output will fall as a result of declining autonomous consumption in Canada (the picture is identical to the one in part (c)). One result of this is that Canadian people will buy less US products, which leads to a reduction of US exports. Therefore, the expenditure schedule in the US 45 degree AD Y AD 45 degree AD Y AD
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This note was uploaded on 04/29/2008 for the course ECON 201 taught by Professor Shea during the Spring '08 term at Maryland.

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PS6key08 - Answer Key for PS6 Professor Shea Spring 2008 1....

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