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home3fall09ans - Econ 434 Professor Ickes Fall 2009...

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Econ 434 Professor Ickes Fall 2009 Homework Assignment #3: Answer Sheet This assignment is due on Thursday, December 10, 2009, at the beginning of class (or sooner). 1. Consider the graphical model of the gold standard. Analyze graphically (be sure to distinguish impact e ff ects from long-run e ff ects. Assume the economy started in full equilibrium) what happens to the price level and the stock of gold if: (a) there is a rise in foreign income. brief answer An increase in foreign income increases exports so the fl ow supply of gold coming into the country will increase. This causes the stock of gold to rise. Given the demand for gold the relative price of gold must fall. Under the gold standard this requires the price level to rise. This makes us less competitive than before. Once the price level rises su ciently the fl ow supply of gold is once again equal to the fl ow demand and the stock of gold stops changing. The gold stock is now higher than before and the relative price of gold is lower. (b) credit cards reduce the need for money in making transactions brief answer This reduces the monetary demand for gold. The same level of transac- tions can be made with the same level of gold. With the demand for gold decreased the relative price of gold must fall. At the lower relative price, the fl ow supply of gold is below demand. The gold stock decreases, and this raises the relative price of gold until we reach equilibrium. Notice that the new equilibrium price level is the same as before as long as the fl ow supply and demand curves do not shift. What happens is that the gold stock is lower than in the initial equilibrium. (c) technological progress in foreign lands increases productivity in the rest of the world brief answer This reduces costs of production elsewhere, so it raises our imports and lowers are exports at the initial price level. Hence, the fl ow supply of gold falls. The price level falls till we are competitive again at a higher relative price of gold. (d) a tari ff on imported goods is imposed. brief answer This increases the fl ow supply of gold as exports exceed imports. But the rise in the stock of gold raises the price level and lowers competitiveness. At the lower relative price of gold trade is again balanced. 1 This is why Adam Smith said that no country, no matter how vigilant, can retain an in fl ow of gold (e) silver is to be coined at a rate of φ per unit of gold (that is one ounce of silver is now worth φ ounces of gold). 1 We ignore any second-order e ff ect such as the tari ff lowering e ciency, making us poorer and reducing income. These are important, but surely second order e ff ects. 1
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brief answer This is the equivalent of increasing the stock of monetary gold. The stock of money in circulation is now: M = λ [ P G ( G + φ S )], where S is the stock of silver.
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