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BECO1001 Principles of Macroeconomics

(Section 001 – 002)

Assignment 2 

Deadline: 5^th Dec. (Thursday)

Submit to: E22 – 4069 (10:00am – 12:30 noon)

Reminder: - hand written format

- A4 size paper (10% deduction for non-A4 size paper)

- no late submission

Please submit the answer of Q4, Q6, and Q8, the others are used for the preparation of exam.

1. Arboc’s central bank (Arbobank) holds 2,000 opeks in government securities. The commercial banks have deposited 200 opeks with Arbobank and hold 100 in vault cash. 700 opeks are held as currency by the public. The required reserve ratio is 20%; banks are loaned up.

A. Calculate the money multiplier.

B. Calculate Arboc’s money supply.

It is felt that the money supply should be increased by 900 opeks. Either an open market operation or a change in the reserve ratio is possible.

C. If the reserve ratio is changed, what should be the new required reserve ratio?

D. If an open market operation is undertaken, what is the value of bonds that central bank should buy/sell?

2. In the economy of Brightland, the commercial banks have deposits of $600 billion. Their reserves are $60 billion. All reserves are in deposits with the Central Bank and the commercial banks hold no excess reserves. There is $120 billion in Central Bank notes outside the banks, and there are no coins.

A. What is the economy's money supply?

B. Calculate the money multiplier.

C. Suppose the Central Bank of Brightland undertakes an open market purchase of securities of so that the M1 increases by $5 billion. By how much will the quantity of money change?

3. Suppose the money demand function is:

Md/P = 1,000 – 100r where r is real interest rate in percent. Money supply is 1,000 and the price level (P) is 2

A. What is the equilibrium interest rate?

B. Draw a graph to show Md and Ms, indicate the equilibrium interest rate and real money balance.

C. Assumed the price level is fixed. If the Fed wishes to raise the interest rate to 7%, what money supply should it set? Show your answers in the same graph of B).

D. Base on the new Ms in C), government would like to restore the interest rate back to the original equilibrium level by changing Md, what should be the new price level? Show your answers in the same graph of B).

4. Suppose that there is an economy with

C = 100 + 0.8Yd t = 25% I = 1,400 G = 2,500

A. Calculate the equilibrium output and the spending multiplier.

B. What are the values of consumption, savings and government tax revenue?

C. Suppose that private investment spending subsequently decreases to 1,000. What, other things being equal, is the change in the national income? If the government expenditure and the tax rate remain unchanged, what is the government budget deficit or surplus?

D. By using the information given in (A), if the government wants to increase the national income to 12,000, calculate how much the government spending should be changed?

5. Suppose that there is a closed economy with

C=300+0.8Y I=100 G=200

A. Calculate the government expenditure multiplier.

B. What is the equilibrium level of output?

C. At the equilibrium level of output in B), what are the values of consumption and savings?

D. Base on the following descriptions of crowding out effect,

 (1) every $10 changes in G leads $5 changes in Md;

 (2) interest rate (r) changes by 1% resulting from every $5 changes in Md;

 (3) interest rate changes by 1%, investment changes by $3;

Find out the final change of equilibrium output if government would like to increase government spending by $100

6. Central bank wishes to have open market purchase of bonds at $2 billion, describe the effect of this increase in the money supply under these conditions:

a. Required reserve ratio is 5%

b. a $40 billion increase in the money supply reduces the interest rate by 1%,

c. a 1% decrease in the interest rate increases investment spending by $60 billion,

d. the spending multiplier is 2.5

Students are required to use at least 4 diagrams and 2 calculations to show and illustrate your answers.

7. Explain what will happen as a result of the following events. In each case, draw an aggregate demand and short-run aggregate supply diagram showing the initial equilibrium output level (Y₀) and price level (P₀). Show any changes and indicate the final equilibrium output level and price level.

A. The economy is operating near full capacity. Now environmental pollution standards are tightened substantially.

B. The economy is operating near full capacity. An import tax (tariff) is imposed on foreign consumer goods, and the central bank tries to maintain the interest rate.

8. Describe the effect of the following cases (A, B, and C), in each case use 2 linked diagrams (AE/Y, AD) to show the effect and indicate the change(s).

A. increase in overall price level

B. increase in autonomous investment (I)

C. increase in Lump-sum tax (T) by the same amount

D. Compare answers of A and B, what is the difference of the effect on AD?

E. Compare answers of B and C, given change in I is the same as change in T, which one has a larger effect on AD and Y? Why?