Business, Government, and Global Economy

Raymond Mason School of Business, College of William and Mary, Spring 2018

Problem Set 2, Open Books/Notes, 3 Pages, 6 Questions, 44 Points

Put Answers on Question Sheets, Worksheets May Be Attached, Due at Start of February 23 Class
May Be Worked Collaboratively, Individual Turn In Required

1. Below is a “jumbled” analytical chronology of how fiscal policy works, with blanks. In
the space at below right, provide chronology in correct order with the blanks correctly filled in. To fill in
blanks, choose from Increase, Decrease, offshoots of these words/phrases, or from other words or phrases.

Taxes / Tax Rates are _________

Aggregate Demand and Real GDP________

Interest Rates _______

Budget Deficit / Debt is viewed as too high

Budget Deficit ________

Government Spending is _________

Aggregate Demand Real GDP ________

2. Provided below are graphs for the 4 markets. With one color of pen/pencil, show on all 4 markets how
the curves will shift in response to the initial impacts of an expansionary fiscal policy. Then with
another color of pen/pencil, show on Product and Labor markets how curves will shift in response to secondary
impacts of the expansionary fiscal policy. Assume secondary impacts are as not strong as initial impacts.
Assume exchange rate is flexible, and international capital flows freely in and out of the country. For clarity, do
not draw new equilibriums, just the curve shifts.

Product Labor Domestic Financial International / FX

Infl Wages RIR XR

Real GDP Unemply Loanable Funds BOP Flows

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 3. Based on analysis in (2), for the “final” result – i.e., the new equilibrium associated with
the final shift of the lines, provide:

a. 2 favorable changes to macroeconomic outcomes

b. 2 unfavorable changes to macroeconomic outcomes

4. Provide whether each of following is True or False.

a. In expansionary fiscal policy, crowding out effect is stronger when economy is in recession.

b. The effects of cut in taxes on Aggregate Demand are stronger and quicker (also known as
multiplier effects) for a change in government spending than for a change in taxes / tax rates.

c. To implement contractionary monetary policy, central bank buys securities on open market.

d. When budget deficit gets too large to find sufficient borrowers, the central government can cover
the deficit by printing money.

e. In an expansionary monetary policy, the central bank raises its base lending rate.

f. In its monetary policy, the central bank can control the mix between how much growth changes
and how much inflation changes.

5. Below is “jumbled” analytical chronology of how monetary policy works, with blanks.
In space at below right, provide chronology in correct order with blanks correctly filled in. To fill in blanks,
choose from Increase, Decrease, Too High, Too Low, Bought, Sold, offshoots of these words/phrases, or other
words or phrases.

Aggregate Demand and Real GDP________

Interest Rates _______

Unemployment is viewed as too high

Securities (on the open market) are _______

Unemployment ________

Inflation perhaps __________

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 6. Below is repeat of the table used earlier, with Outcome Indicators across the top and, in this
case, changes in monetary and fiscal policies down the side. For each of the monetary or fiscal policy changes,
provide the impact on each indicator, choosing from Rise (R), Fall (F), Toward Surplus (TS), Toward Deficit
(TD), Appreciate (A), Depreciate (D), Rises Faster (RF), Rises Slower (RS). Assume push back effects on
Fiscal Policy are weaker than initial effects, that international financial account flows respond more quickly and
strongly than current account flows, and that exchange rate is flexible for the Fiscal Policy case and pegged for
the Monetary Policy case.

Real Infl Unemp Real Budget Govt Exch Official

GDP Intrst Balnce Debt Rate Reserves
Rate Level

Expansionary Monetary Policy

Contractionary Fiscal Policy