Problem Set 3_Answers

Problem Set 3_Answers - Deskins, Solutions 3 Deskins,...

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Deskins, Solutions 3 1 Deskins, Principles of Macroeconomics Problem Set 3 - Answers Chapter 16 - Questions 3. Aggregate demand could increase by more than $3 billion stimulus due to the multiplier effect. However, the crowding out effect that follows from the interest rate increase associated with an increase in the government budget deficit could wipe away any multiplier effect and result in a smaller overall increase in aggregate demand. 4. If policymakers do nothing, the economy will experience a drop in Real GDP and a drop in the price level. The Fed could potentially prevent the drop in Real GDP, or at least hasten the economic recovery, by increasing the money supply, which will lower interest rates. If the Fed does nothing, Congress has the potential to stabilize the economy by increasing spending or cutting taxes. 5. The federal unemployment insurance program is an example of an automatic stabilizer. As the economy experiences a drop in economic activity and more people become unemployed, the unemployment insurance program brings about an automatic increase in government spending without any action by policymakers. Chapter 16 - Problems 2. a) This will lower interest rates. b) This will increase aggregate demand, thereby increasing output and the price level. c) The price level will increase further. d) The increase in the price level will lead in an increase in money demand, returning the interest rate to its prior level. e) Yes. 3. a) The interest rate will increase following an increase in money demand. This will lead to a decrease in aggregate demand. b) To stabilize aggregate demand, the Fed should increase the money supply to prevent a change in interest rates. c) To increase the money supply, the Fed would conduct open-market purchases. 5. b) An open-market purchase would restore the economy to its natural rate. c) This change would increase the money supply, reducing the interest rate. d) This would increase aggregate, and increase both the price level and Real GDP. The increase in aggregate demand occurs because the lower interest rates make it cheaper for companies to borrow to purchase capital, leading to the purchase of more capital and increasing aggregate demand. 6. a) This would increase money demand since it reduces the opportunity cost of holding. b) This would increase interest rates, leading to a reduction in aggregate demand and output. c) An increase in the money supply would have been necessary to maintain a constant interest rate. In this case there would have been no change in aggregate demand or output.
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Deskins, Solutions 3 2 7. a) Two-thirds b) Larger 10. The effect on aggregate demand would be larger if the Fed were committed to maintaining a fixed interest rate because maintaining a fixed interest rate would prevent crowding out. 13.
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This note was uploaded on 12/27/2011 for the course ECON 205 taught by Professor Johndeskins, during the Fall '11 term at Creighton.

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Problem Set 3_Answers - Deskins, Solutions 3 Deskins,...

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