Econ 304 Summer 2012 Problem Set #5 Due by 11:59 PM MDT July 131. (3 points each)a.Suppose velocity is stable. What would the Federal Reserve need to know in order to keep output at its natural level following a supply shock?b.Assume that velocity is unstable and unpredictable. How would this complicate the Federal Reserve's ability to stabilize the economy following a supply shock.c.Suppose OPEC suddenly collapsed and oil prices plummeted. Indicate what would happen to the short run aggregate supply and aggregate demand curves, output, and the aggregate price level in the short run2.Econ 304 Summer 2012 

Problem Set #5 Due by 11:59 PM MDT July 13

 

1. (3 points each)

a.

Suppose velocity is stable. What would the Federal Reserve need to know in order to keep output at its natural level following a supply shock?

 

b.

Assume that velocity is unstable and unpredictable. How would this complicate the Federal Reserve's ability to stabilize the economy following a supply shock.

 

c.

Suppose OPEC suddenly collapsed and oil prices plummeted. Indicate what would happen to the short run aggregate supply and aggregate demand curves, output, and the aggregate price level in the short run

 

2. ( 2 points each part)

Consider the following model of the economy:

C = 170 + 0.6(Y - T)

I = 250

G = 300

T = 200

a.

What is the value of the marginal propensity to consume?

 

 

b.

Calculate the equilibrium level of GDP

 

c.

What is the value of the government purchase multiplier?

 

d.

Use your answer to Part d to calculate the amount by which government purchases of goods and services would have to rise in order to increase the equilibrium level of GDP by 50

 

3. (3 points each part)

Suppose that the following equations describe an economy (C, I, G, T, and Y are measured in billions of dollars and r is measured in percent)

 

 

 

 

 

 

a.

Derive the equation for the IS curve

b.

Derive the equation for the LM curve

c.

Now express both the IS and LM equations in terms of r

 

d.

Use the equations from Parts a and b to calculate the equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C.

 

e.

At the equilibrium level of real output Y, calculate the value of the government budget surplus

 

f.

Suppose that G increases by 36 to 386. Derive the new IS and LM equations

 

g.

Using the information from Part f, calculate the new equilibrium levels of real output Y, the interest rate r, planned investment I, and consumption C.

 

4. (3 points each part)

Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases.

a.

If investment does not depend on the interest rate, the IS curve is vertical.

 

b.

If money demand does not depend on the interest rate, the LM curve is vertical

 

c.

If money demand does not depend on income, the LM curve is horizontal

 

d.

If money demand is extremely sensitive to the interest rate, the LM curve is horizontal.