Unit 9

[AB204 | Macroeconomics]

Final Assignment (due Tuesday at midnight at the end of week 9) Total possible points = 225 General Instructions: 1. Your assignment should have a cover sheet with the following information: a. your name; b. the course number; c. the section number; and, d. the date, 2. You may either copy and paste the questions and the appropriate graphs into your paper, or you may insert your coversheet, your answers and your references into THIS document, renaming it as required in item 5. below. 3. To any graphs, or charts, you may add whatever arrows or other indicators that you feel are necessary to illustrate your analysis. 4. Your answers should follow the APA format by being in double spaced paragraph format, with citations to your sources and, at the bottom of your last page, a list of references). Your answers should also be in Standard English with correct spelling and punctuation, grammar and style. 5. Unless specified differently by your instructor, your completed assignment should be saved with the following file name format: course number, an underscore, Section number, an underscore, your LAST name, underscore, your FIRST name, an underscore, and the word final. It will look like this: BU204_xx _LAST_FIRST_final (where the xx is the section number). 6. Respond to the questions in a thorough manner, providing specific examples of concepts, topics, definitions and other elements asked for in the questions. Your paper should be highly organized, logical and focused. 7. Maximum grade on format (total 15 points): 3 points = correct filename 3 points = correct APA format for answers (coversheet with name, course number, section number, Unit number, date, answers double spaced, in Times Roman black 12 point font) 3 points = correct citations within answers 3 points = Standard English with no spelling or punctuation errors 3 points = correct references at the bottom of the last page.

--------------------------------------------------------------------------------------------------------------------Questions:

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[AB204 | Macroeconomics]

1. Define any key terms that you feel are important in answering the following question as they are defined in the textbook and explain, in your own words what those definitions mean (5 points), and then thoroughly analyze each of the following changes in the market for loanable funds to answer the these questions Use the diagrams below, resizing them as necessary, to illustrate your analysis in explaining what happens to private savings, private investment spending, and the rate of interest if the following events occur. Assume the economy is closed (no transactions are made with foreign countries).

a. The government reduces the size of its deficit to zero (10 points). The aggregate demand curve will shift downward. While the Aggregate supply curve remains constant. Private savings: If government increase tax, they will go down. private investment spending : If government increase tax, it will go down, on the other hand if government spending decrease, it may go up because of reduce of crowding-out. Overall no one knows if it will go up or down. the rate of interest : It will go down because the aggregate demand curve shift downward.

b. At any given interest rate, consumers decide to save more. Assume the budget balance is zero (10 points). No one knows how aggregate demand curve will be like. Because the demand curve of household will go down, but the demand curve of the firms will go up Aggregate supply curve is constant. private savings:They will go up. private investment spending :It will go up because the budget balance is zero.

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[AB204 | Macroeconomics]

c. At any given interest rate, businesses become very optimistic about the future profitability of investment spending. Assume the budget balance is zero (10 points). Aggregate demand curve will go up Aggregate supply curve is constant. private savings:They will go down because people will increase consumption. private investment spending :It will go down because the budget balance is zero.

2. Define any key terms that you feel are important in answering the following question as they are defined in the textbook and explain, in your own words what those definitions mean (5 points), and then thoroughly analyze each situation to answer the following questions.

Using aggregate demand, short-run aggregate supplies, and long-run aggregate supply curves, explain the process and causes by which each of the following economic events will move the economy from one long-run macroeconomic equilibrium to another. Use the diagrams below,

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[AB204 | Macroeconomics]

resizing them as necessary, to illustrate your analysis. In each case, what are the short-run and long-run effects on the aggregate price level and aggregate output?

a. There is a decrease in households wealth due to a decline in the stock market (15 points). The model starts at point 1. Household consumption drops as wealth declines. This decreases spending at any given price level (the AD curve shifts in) and reduces the prices they are willing to pay for goods. The falling price level along with given wages raises the costs of hiring workers and output declines in equilibrium. Equilibrium price and output drop to point 2. The falling price level combined with fixed wages will raise the relative or real wage as the economy goes into a recession. The relatively low demand for labor in the recession will put downward pressure on the nominal wage rate. The falling cost of production reduces the prices that firms demand for their production (i.e the SRAS curve shifts down). Wages will fall until the labor market equilibrium return relative wages to their long-term levels. The new long run equilibrium will be at point 3.

b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases (15 points). The economy begins at point 1. When households have more disposable income, they increase spending. This shifts out demand for goods and increases the prices they are willing to pay for goods. The higher prices of goods reduce the cost of labor. Falling real wages induce firms to increase production. The new equilibrium is at point 2. When firms are producing a lot of output, labor demand is high. Wages feel upward pressure, raising costs. The costs of production are passed along to customers which in turn reduces equilibrium demand. Eventually, wages rise far enough that the excess demand for labor is in equilibrium and real wages return to their equilibrium level and the economy returns to potential output at point 3.

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[AB204 | Macroeconomics]

3. Define any key terms that you feel are important in answering the following question as they are defined in the textbook and explain, in your own words what those definitions mean (5 points), and then thoroughly analyze each situation to answer the following questions.

An economy in a hypothetical country is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gapinflationary or recessionarywill the economy face after the shock, and what type of fiscal policies, giving specific examples, would help move the economy back to potential output? a. A stock market boom increases the value of stocks held by households (10 points). As the stock market booms and the value of stocks held by households increases, there will be an increase in consumer spending; this will shift the aggregate demand curve to the right. The economy will face an inflationary gap. Policy makers could use contractionary fiscal policies to move the economy back to potential output.

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[AB204 | Macroeconomics]

b. Firms come to believe that a recession in the near future is likely (10 points). If firms become concerned about a recession in the near future, they will decrease investment spending and aggregate demand will shift to the left. The economy will face a recessionary gap. Policy makers could use expansionary fiscal policies to move the economy back to potential output.

c. Anticipating the possibility of war, the government increases its purchases of military equipment (10 points). If the government increases its purchases of military equipment, the aggregate demand curve will shift to the right. The economy will face an inflationary gap. Policy makers could use contractionary fiscal policies to move the economy back to potential output. The government would need to reduce its purchases of nondefense goods and services, raise taxes or reduce transfers.

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d. The quantity of money in the economy declines and interest rates increase (10 points). As interest rates rise, investment spending will decrease and the aggregate demand curve will shift to the left. The economy will face a recessionary gap. Policy makers could use expansionary fiscal policies to move the economy back to potential output.

4. The table below shows the United States components of M1 and M2 in billions of dollars for the month of December in the years 1998 to 2007 as published in the 2008 Economic report of the President.
Yea r Currency in circulatio n Traveler' s checks Checkabl e deposits Money marke t funds Time deposits smaller than $100,00 0 Savings deposit s M1 M2 Curren cy in circulat ion as a percent age of M1 Currenc y in circulati on as a percenta ge of M2

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[AB204 | Macroeconomics]

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

460.5 517.8 531.2 581.2 626.3 662.5 697.6 723.9 748.9 759.0

8.5 8.6 8.3 8.0 7.8 7.7 7.5 7.2 6.7 6.3

626.5 596.2 548.0 592.6 585.6 635.9 671.2 643.4 611.4 599.2

728.9 819.7 908.0 962.3 885.3 777.4 697.1 699.9 799.4 976.1

952.4 956.8 1,047.6 976.5 896.0 818.7 829.9 995.8 1,170.4 1,216.8

1,605.0 1,740.3 1,878.8 2,312.8 2,778.2 3,169.1 3,518.3 3,621.4 3,698.6 3,889.8

$1095.50 $1152.90 $1087.50 $1181.80 $1219.70 $1306.10 $1376.30 $1374.50 $1367.00 $1364.50

$4381.80 $3516.80 $3834.40 $4251.60 $4559.50 $4762.20 $5045.30 $5317.10 $5668.40 $6082.70

42.04% 44.91% 48.85% 49.18% 51.35% 50.72% 50.69% 52.67% 54.78% 55.62%

10.51% 14.72% 13.86% 13.67% 13.74% 13.91% 13.83% 13.61% 13.21% 12.48%

For a., b., c., & d., you may insert a completed Excel spreadsheet with your answers, if you wish. a. Complete the table by calculating M1 (5 points), b. Calculating M2 (5 points), c. Calculating currency in circulation as a percentage of M1 (5 points) , and d. Calculating currency in circulation as a percentage of M2 (5 points). e. Examining the following three charts and your completed table, what trends or patterns in: - M1, - M2, - currency in circulation as a percentage of M1, and - currency of circulation as a percentage of M2 do you see (5 points)? f. What might account for these trends (10 points)? In M1 there is no trend that I see in my chart. However in M2 the money is all over the place, up and down through the years. As far as the currency in circulation for M1 as a percentage it went from 42% to the mid 50's from the years of 1998 to year 2007. Now for currency in M2 as a percentage shows slight fluctuation with an up and down effect. From year 2000 to 2006 the circulation stayed at about 13%, thats a 6 year span.

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[AB204 | Macroeconomics]

5. Considering the flow of money throughout a countrys economy and the importance of the proper level of money supply, answer the following questions. a. Discuss how money is created within the banking system (15 points) The process of money creation in the banking system starts with a term called require to hold reserve. This is a required 10% reserve of banks deposits made like from you and I. A required reserve is a reserve ratio which specifies the ratio of reserves to checkable deposits a bank must maintain. Banks can hold more than the required 10% by what is called excess

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[AB204 | Macroeconomics]

reserves. Therefore, excess reserves plus required reserves equal total reserves. Money from the reserves is then loaned out to make a profit for the bank. Banks also use this money for its customers to come in and make a withdrawal. Banks also assume that not everyone that banks with them will draw out all of their money at the same time so this process repeats itself. b. Discuss how in the United States, the Federal Reserve uses monetary policy to control the money supply. (15 points) The Federal Reserve uses three main techniques in regulating the money supply and they are: open-market operations, the discount rate, and reserve requirements. The open-market is the most effective for the economy. When they buy or sell securities, like bonds, then these effect the money supply and interest rates. The purpose of this operation is to ease the availability of credit and to reduce interest rates. This process encourages businesses to invest more and consumers to spend more. The selling of government securities (bonds) by the Federal Reserves has the opposite effect on the money supply and also increases interest rates. The United States sets inflation targets that are meant to maintain a steady inflation of 2% to 3%. 6. Your spouse, or someone else very close to you, has brought you a magazine article on the economy that has the following five graphical depictions of the state of our economy. Knowing that you have just completed an economics course at Kaplan, they ask you what each one means. For each of the following graphs, write a paragraph briefly, but thoroughly, explaining what you would tell that person about what that graph means and why it is important. (Each paragraph is worth a maximum of 6 points, for a total of 30 points.) 1. Gross Domestic Product

Explanation:

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[AB204 | Macroeconomics]

2. Components of Gross Domestic Product

Explanation: 3. Taxes, Surpluses/Deficits & National Debt

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Explanation: 4. Consumer Price Index

Explanation:

5. Unemployment Rate

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Explanation:

References