1. Illustrate each of the following situations with a graph showing short-run aggregate supply:
a. A decrease in the size of the labor force.
b. An increase in available capital.
c. An increase in productivity as a result of a technological change.
d. A decrease in the price of oil. 2. On November 9, 2011, the European Central Bank acted to decrease the short-term interest rate
in Europe by one fourth of a percentage point, to 1.25 percent, and additional cuts were made
over the next three years, to a low rate of 0.05 percent by September 2014. The rate cuts were
made because European countries were growing very slowly or were in recession. What effect
did the bank hope the action would have on the economy? Be specific. What was the hoped-for
result on C, I, and Y? 3. The AD curve slopes downward because when the price level is lower, people can afford to buy
more and aggregate demand rises. When prices rise, people can afford to buy less and aggregate
demand falls. Is this a good explanation of the shape of the AD curve? Why or Why not? 4. What effect will each of the following events have on the current account balance and the
exchange rate if the exchange rate is floating?
a) The U.S. government cuts taxes and income rises.
b) The U.S. inflation rate increases and prices in the United States rise faster than those in
countries with which the United States trades.
c) The United States adopts an expansionary monetary policy. Interest rates fall (and are
now lower than those in other countries) and income rises.
d) The textile companies’ “Buy American” campaign is successful, and U.S consumers
switch from purchasing imported products to buying products made in the United
States. 5. You are given the following model that describes the economy of Hypothetica…
1.
2.
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8.
9. Consumption function: C = 80 + 0.75Yd.
Planned investment: I = 49
Government spending: G = 60
Exports: EX = 20
Imports: IM = 0.005Yd
Disposable income: Yd = Y - T
Taxes: T = 20
Planned aggregate expenditure: AE = C = I+G+EX – IM
Definition of equilibrium income: Y = AE
a. What is the equilibrium income in Hypothetica? What is the government deficit?
What is the current account balance?
b. If government spending is increased to G =75, what happens to equilibrium income?
Explain using the government spending multiplier. What happens to imports?
c. Now suppose the amount of imports is limited to IM = 25 by quota on imports. If
government spending is again increased from 60 to 75, what happens to equilibrium
income? Explain why the same increase in G has a bigger effect on income in the
second case. What is about the presence of imports that changes the value of the
multiplier?
d. If experts are fixed at EX = 20, what must income be to ensure a current account
balance of zero? (Hints: Imports depend on income, so what must income be for
imports to be equal to exports?) By how much must we cut government spending to
balance the current account?( Hint: Use your answer to the first part of the question
to determine how much of a decrease in income is needed. Then use the multiplier
to calculate the decrease in G needed to reduce income by that amount.) 6. Suppose the exchange between the Danish krone and the U.S. dollars is 7 Dkk = $1 and the
exchange rate between the Chilean peso and the U.S. dollar is 650 CLP = $1.
a) Express both of these exchange rates in terms of dollars per unit of the foreign currency.
b) What should the exchange rate be between the Danish krone and the Chilean peso?
Express the exchange rate in terms of 1 krone and in terms of 1 peso.
c) Suppose the exchange rate between the krone and the dollar changes to 5 DKK = $1 and
the exchange rate between the peso and the dollar changes to 700 CLP = $1. For each of
the three currencies, explain whether the currency has appreciated or depreciated
against the other two currencies…

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