Macroeconomics Free Response

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Macroeconomics Free Response
2007
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Macro Free Response 2007

• Assume that declining stock market prices in
  the U.S. cause many U.S.
• financial investors to sell their stocks
  and increase their money holdings.

(a) Draw a correctly labeled graph of the
money market and show the impact of
the financial investors actions on each of the
following. (i) Demand for money
(ii) Nominal interest rate
MS
DM1

• Answers for 1. (a) (i)
• (a) (i) The decline in wealth
• decreases many investors
• demand for major purchases
• and decreases the demand for
• money.

DM2
i.r.1
Nominal Interest Rate
i.r.2
Money Market

• Answers for 1. (a) (ii)
• (a) (ii) The nominal interest rate would
  decrease because the demand
• for money decreases as the DM curve
  shifts down, as shown above.

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1. (b) Due to the decline in wealth caused
by the change in stock prices, the general
price level in the U.S. falls relative to the
price level in Japan, a trading partner. Use a
correctly labeled graph of the foreign exchange
market for the U.S. dollar to show the impact of
the change in relative price levels on each of
the following. (i) Demand for the dollar(ii)
Price of the dollar
FRQ 2007
D2
D1
S

• Answers to 1. (b) (i)
• (b) (i) The decrease in wealth will
• cause less consumer spending
• which causes the AD curve to shift
• left and a decrease in the price level.
• This decrease in PL will cause the
• Japanese to want to buy more U.S.
• goods, increasing the demand for
• the dollar.

Y150
E2
Yen Price of Dollar
Y100
E1
Quantity of Dollars
Answers to 1. (b) (ii) 1. (b) (ii) Lower prices
in the U.S. would cause an increase in demand
for the dollar, resulting in the Japanese
having to pay more for American goods.
Therefore the yen would depreciate as the price
of the dollar has increased, and the dollar
has appreciated.
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1. (c) How will the change in the price
of the dollar you indicated in part (b) (ii)
affect net exports of the U.S. Explain.
FRQ 2007

• Answer to 1. (c) The appreciated dollar
  would cause American goods to be more
  expensive for Japan and Japans goods to
  be less expensive for Americans therefore, we
  would export less and import more, resulting in a
  decrease in net exports.

(d) Using a correctly labeled AD/AS graph,
show how the change in Xn in part (c) will
affect each of the following in the
short run. (i) Aggregate Demand
(ii) Output and price level
LRAS
SRAS
PL
AD1
AD2
E1
PL1
Answer to 1. (d) As can be seen on the graph,
the decrease in Xn would decrease AD. The
decrease in AD would decrease output to Y2 and PL
to PL2.
PL2
E2
RGDP
Y1
Y2
Answer to 1. (e) The decrease in Xn in part (d)
will result in a decrease in AD and output,
which would increase unemployment in the SR.
(e) Given your answers to part (d), what will
happen to unemployment in the short run?
Explain.
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2. In recent years, the Federal Reserve has made
targeting the federal funds
rate a main focus of its monetary policy. (a)
Define the federal funds rate.
FRQ 2007
Answer The rate that banks charge one another
for overnight loans
(b) If the Federal Reserve wants to lower the
federal funds rate, what open-market
operation would be appropriate?
Answer The Fed would buy bonds from the banks or
public. Buying bonds means a bigger supply of
money and lower fed funds rate.
(c) Assume that the open-market operation that
you indicated in part (b) is equal to 10
million. If the RR is 0.2, calculate the maximum
change in loans throughout the banking
system.
Answer If the Fed buys bonds from banks, DD
could increase by the 10 million initially
with a MM of 5, the total money supply could
increase to 50 million. If the Fed buys
bonds from the public, DD could increase by 10
M initially. With MM of 5, 2 M would be kept in
RR 8 million could be loaned out increase to
40 million more in DD for a total of 50
million.
(d) Indicate the effect of the open-market
operation that you indicated in part (b) on
the nominal interest rate.

• Answer Buying bonds would increase the MS and
  lower nominal Interest rates.

(e) Assume that the Feds action results in some
inflation. What would be the impact of the
open-market operation on the real rate of
interest? Explain.
Answer The real interest rate would decrease.
Real IR Nominal Inflation if we get more
inflation, then Real IR Nominal even more
Inflation, so it decreases.
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FRQ 2007

• 3. Indicate whether each of the following is
  counted in the
• U.S. GDP for the year 2006. Explain each of
  your answers.
• (a) The value of a used textbook sold through
  an online auction in 2006

Answer No, it was counted the year it was
produced. Because it was not produced again, it
would not be counted. That would be double
counting.
b. Rent paid in 2006 by residents in an apartment
building built in 2000
Answer Yes, rents consist of the income
received by the households and businesses
that supply property resources. It is included in
the income approach approach to GDP.
c. Commissions earned in 2006 by a stockbroker
Answer Yes, payment is being made for
productive services of the broker. So the
purchase of stocks would not count but his work
would.
d. The value of autos produced in 2006 entirely
in South Korea by a firm fully owned by U.S.
citizens
Answer No, GDP measures production inside the
U.S. regardless of ownership.
These autos were produced in South Korea.