Economics Assignment on Principles of Macroeconomics

Question

Task:

Economics Assignment Task: Show all necessary steps in your answers.

Question 1: In a certain economy, the components of planned spending are given as:

Cd=600+0.8(Y-T)-350r, Ip=200-450r, G=250, NX=20, T=300

a) Find the relationship between planned aggregate expenditure and the real interest rate, r, and output, Y, in this economy.

b) The real interest rate, r, is set by the Reserve Bank to equal 0.05 (5 per cent). Find the short-run equilibrium output.

c) Suppose potential output (Y*) is 4100. The Reserve Bank has set the real interest rate equal to 5 per cent. At that real interest rate, what is the output gap?What should the Reserve Bank do to eliminate the output gap and restore full employment?

Question 2.

a) The demand for vans in a certain country is given by: D = 2000 ? 20P, Supply by domestic van producers is: S = 1700+ 40 P, where P is the price of a van. a) Assuming that the economy is closed, find the equilibrium price and production of vans.

b) The economy opens to trade. The world price of vans is 4 units. Find the domestic quantities demanded and supplied, and the quantity of imports or exports. Who will favour the opening of the van market to trade, and who will oppose it?

c) The government imposes a tariff of 0.5 unit per van. Find the effects on domestic quantities demanded and supplied, and on the quantity of imports or exports. Also find the revenue raised by the tariff. Who will favour the imposition of the tariff, and who will oppose it?

Question 3. a) Suppose that a country put a billion dollars into circulation, and the banking system has a reserve–deposit ratio of 10 per cent. What is the money supply in the country?

b) If the banks’ desired reserve–deposit ratio is 5 per cent, find deposits and the money supply? If the total amount of currency is 2 billion dollars and the desired reserve–deposit ratio remains at 10 per cent, what is the money supply in the country at this point?

c) Suppose that the people choose to hold a total of 0.5 billion dollars in the form of currency and to deposit the rest of their money in banks. Banks keep reserves equal to 10 per cent of deposits. What is the money supply in the country?

d) Discuss the results you found in part b) and c)

Question 4. Assume that in 2008, 2009 and 2010 a typical family’s monthly household budget consisted of spending on three items: rent on a two-bedroom apartment, hamburgers and movie tickets. In addition, the family had a vacation trip once a month. The family’s average monthly costs were as shown in the table below.

a) Construct the price index (Consumer Price Index) in each year using 2008 as the base year.

b ) Compute the inflation rate for prices from 2009 to 2010.

Answer

Answer to question 1 of economics assignment:
Given that,

Cd=600+0.8(Y-T)-350r

Ip=200-450r

G=250

NX=20

T=300

a.

Planned aggregated expenditure (PAE) = Cd + Ip + G + NX

Hence, PAE = 600+0.8(Y-T)-350r + 200-450r + 250 + 20

PAE = 1070 + .8 (Y – 300) – 800r

PAE = 1070 + .8Y – 240 – 800r

PAE = 830 + .8Y – 800r ----- (i)

Hence, it can be seen that PAE has positive relationship with output (Y) and real interest rate (r).

b.
At equilibrium position,

Y = PAE

Hence, Y = 830 + .8Y – 800r

Considering equation (i), putting the value of r,

Y = 830 + .8Y – 800 * .5

Y - 0.8Y = 830 – 40

.2Y = 790

Y = 790/.2

Y = 3950

Hence, short run equilibrium output is 3950.

c.
Given that,

Potential output (Y*) = 4100

Output gap = Y – Y* = 3950 – 4100 = -150

Hence the output gap at 5% interest rate is -150.

As the output gap is negative in nature, hence it demonstrates that the economy is going through the recession. In order to overcome the situation, government should bring in expansionary monetary policy and reduce the interest rate (Cashin et al. 2018). It will infuse liquidity in market and hence through enhancing the aggregate demand can control the situation.

Answer to question 2:
Given that,

D = 2000 – 20P --- (i)

S = 1700 + 40P --- (ii)

a.
At market equilibrium,

D = S

Hence, 2000 – 20P = 1700 + 40P

Thus, -20P – 40P = 1700 – 2000

Hence, -20P = -300

Hence, P = 15

Putting price in equation (ii),

S = 1700 + 40 * 15 = 1700 + 600 = 2300

Hence, equilibrium price is 15 units and production is 2300 units.

b.
If, the price of the vans is 4 units,

Then, demand is: 2000 – 20 * 4 = 2000 – 80 = 1920

Supply is: 1700 + 40 * 4 = 1700 + 160 = 1800

Hence, difference in demand and supply is: 1920 – 1800 = 120 units

Thus, 120 additional units of vans will be imported from the international market.

Through the analysis it can be seen that there will be fall in demand of domestically produced vans by 120 units. Hence, producers will oppose the decision; however, consumers will be having vans at lower price, thus hey will favour the opening.

c.
If tariff of 0.5 unit per van is imposed, new price will be = 4 + .5 = 4.5

Considering the given demand and supply equation, new demand and supply will be:

D = 2000 – 20 * 4.5 = 2000 – 90 = 1910

S = 1700 + 40 * 4.5 = 1700 + 180 = 1880

Hence, change in difference between demand and supply: 1910 – 1880 = 30 units

Hence, at the revised rate, 30 vans will be imported as the domestic demand changes to 1910 units and supply changes to 1880 units.

Through the tariff revenue raised: 1910 * .5 = 3820 unit

Imposition of tariff will be opposed by the consumers as the price of the products is increased; whereas, suppliers will favour the same as more domestically produced car will be purchased by the consumers.

Answer to question 3:

a.
As the reserve deposit ratio is 10%, hence reserve ratio will be .1

Thus, money multiplier will be = 1/.1 = 10

An increase of $1 Billion in circulation will lead to increase in total money supply by $10 Billion due to the money multiplier effect

b.
As the reserve deposit ratio is 5%, hence reserve ratio will be .05

Thus, money multiplier will be = 1/.05 = 20

Thus, deposits will be .05 and money supply will be (1 - .05) = .95

If 2 billion dollars and the desired reserve–deposit ratio remains at 10 per cent, money supply in the country is: [$20 Billion - $1 Billion] = $19 Billion

c.
If the total money is $2 Billion and people hold .5 Billion and deposits remaining money [2 - .5 = 1.5 Billion], then money supply is: 10 * 1.5 = 15 Billion [As the reserve rate is 10%, hence multiplier is 10]

d.
As per the finding it can be seen that total money supply in market with 5% reserve deposit ratio is $19 billion. whereas, it becomes $15 billion with 10% reserve deposit ratio if the holding in currency is reduced and holding in banks are increased.

Answer to question 4:

a.
For 2008 Cost = ($600 * 1) + ($3 * 50) + ($6 * 10) + ($300 * 1) = $1110

For 2009 Cost = ($620 * 1) + ($4 * 50) + ($7 * 10) + ($320 * 1) = $1185

For 2010 Cost = ($650 * 1) + ($4 * 50) + ($8 * 10) + ($340 * 1) = $1265

CPI in 2008 = (Total cost in 2008/Total cost in base year) *100 = ($1110/$1110) * 100 = 100

CPI in 2009 = (Total cost in 2009/Total cost in base year) *100 = ($1185/$1110) * 100 = 106.75

CPI in 2010 = (Total cost in 2008/Total cost in base year) *100 = ($1265/$1110) * 100 = 113.96

b.
Inflation rate = [(CPI2010 – CPI2009)/CPI2009] * 100 = [(113.96 – 106.75)/106.75] * 100

Hence, inflation rate = 6.75%

Thus, inflation rate from 2009 to 2010 is 6.75%

Reference:
Cashin, D., Lenney, J., Lutz, B. and Peterman, W., 2018. Fiscal policy and aggregate demand in the USA before, during, and following the Great Recession. Economics assignment International Tax and Public Finance, 25(6), pp.1519-1558.