ans_pbset1 - LM curve. Unexpected fall in the interest rate...

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ECON110B Summer Session II 2007 Professor Dong Heon Kim Answer key for the Problem Set #1 1. a. i = 4%; π e = 2% Exact: r = (1+.04)/(1+.02)-1 = 1.96% ; Approximation: r .04-.02 = 2% b. i = 15%; e = 11% Exact: 3.60%; Approximation: 4% c. i = 54%; e = 46% Exact: 5.48%; Approximation: 8% 2. a. The discount rate is the interest rate. So EPDV (Expected present discounted value) are (i) $2,000*(1-.25) under either interest rate and (ii) (1-.2)*$2,000 under either interest rate. b. The interest rate does not enter the calculation. Hence, you prefer (ii) to (i) since 20%<25%. 3. An increase in money growth will cause the LM curve to shift down. This will lower the nominal rate. Assuming expected inflation does not change, the real rate will fall by the same amount. Investment will increase causing an increase in demand and output i LM 1 (M 1 ) LM 2 (M 2 ) by M i A A i A’ A’ r A r A’ IS Y A Y A’ A 4. a) Unexpected shift down of the
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Unformatted text preview: LM curve. Unexpected fall in the interest rate and increase in Y . As the output goes up, the expected profits goes up and thus, the expected dividends increase, causing the price of stock to rise. In addition, as the interest rates fall, the expected present discounted value rises, implying that the price of the stock increases. Hence, both make stock prices unambiguously increase . Please refer to the Graph II 4 in the lecture note. b) If stock market participants fully anticipated the expansionary monetary policy with no change in fiscal policy, then the stock market will not react. Neither its expectations of future dividends nor its expectations of future interest rates are affected by a move it had already anticipated. Thus, stock price will remain the same. No change in stock prices ....
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This note was uploaded on 09/18/2008 for the course ECON 100B taught by Professor Rauch during the Winter '07 term at UCSD.

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