<p>So have we settled on an answer for number 2 part B and C?</p>
<p>Brahms based on your answers you got part B and C wrong. If interest rate goes down, investment increases (so economic growth increases), but I am fairly sure that supply of loanable funds decreases so interest rate goes down, hence lower growth rate.</p>
<p>also on question 3 b ii. I believe its $400. They already state that $100 is deposited and now they want to know the maximum increase in demand deposits. so the money multiplier would allow $500 to be created. Out of that $100 is already deposited and the remaining $400 can be deposited. </p>
<p>My take on the problem at least.</p>
<p>For qs 3 ii. it asked for the Demand Deposit rate, which is basically the entire deposit ($100) times the multiplier. $400 is for part iii., and I don’t think they would ask the same question twice.</p>
<p>For qs 2. I also shifted supply, but Demand seems to be the one that should shift. If interest rates decrease then foreign investments would also decrease and so would the growth rate of the economy.</p>
<p>I see what you are saying, maybe both ways work. You could really argue demand or supply.</p>
<p>1F explanation please?</p>
<p>For 1F.</p>
<p>In the longrun AS shifts to the right causing the SRPC to shift inward and unemployment rate to revert back to 5% while GDP increases back to its longrun equilibrium rate before the contractionary policy was imposed.</p>
<p>1f is a classical adjustment question, so AS would shift to the right like hipster said.</p>
<p>if a question asks you to state answer and explain.</p>
<p>and u get the answer wrong…but ur explanation is correct with accordance to the wrong answer, would you get 1/2 or 0/2?</p>
<p>I drew a Phillips curve with the Axis’ flipped. ■■■.</p>
<p>Nazzy: usually the points are atomistic and 1/2 can be earnd with the correct reasoning, but very often the reasoning is the key to getting the assertion point. To have the correct reasoning with the wrong conclusion is much less common I think than having a conclusion(up r etc.) for erroneous reasons. You are in a much better position.</p>
<p>1 f is a classical adjustment question, but the orthodox Phillip’s answer probably does not explain through shifting AS. Phillip’s Curve oriented reasoning could be as simple as: </p>
<p>(i)OMO Sale effective in decreasing inflation (the question prompt)</p>
<p>therefore the economy experiences a decrease in inflationary expectations (translation of the prompt into something that moves a curve–explanation) </p>
<p>graphically expressed as a left shift of SRPC.(the “answer”</p>
<p>(ii) LRPC and the natural rate of UE are unaffected by the short run monetary policy as well as the classical adjustment that followed.</p>
<p>brahms - your answers were mostly right, except for 2B, 2C, and your 3C is right but you probably didn’t get full points for it. Here are my answers that I believe to be the correct answers, accounting for our discussion for the last few pages (combination of Brahm’s and mine):</p>
<p>
Y axis: Inflation rate (%). X axis: Unemployment rate (%). SRPC: down-sloping and curved. LRPC: Vertical at natural rate of unemployment, which is 5%. Point A will be at the intersection of the SRPC and the LRPC. Where 5% unemployment meets 6% inflation rate.</p>
<p><a href=“b”>quote</a> Calculate the real interest rate in the long-run equilibrium.
[/quote]
Real interest rate= nominal rate - inflation rate. Thus, 8 - 6 = 2% inflation rate.</p>
<p><a href=“c”>quote</a> Assume now that the Federal Reserve decides to target an inflation rate of 3 percent. What open-market operation should the Federal Reserve undertake?
[/quote]
Sell bonds and government securities (contractionary monetary policy)</p>
<p><a href=“d”>quote</a> Using a correctly labeled graph of the money market, show how the Federal Reserve’s action you identified in part (c) will affect the nominal interest rate.
[/quote]
Vertical axis: Nominal interest rate (%). Horizontal axis: Quantity of money ($). Demand for money is a straight, down-sloping line. Supply of money is vertical. They intersect at (Q1, 6). MS shifts left to intersect MD at (Q2, 3*). Nominal interest rate increases.
*You don’t necessarily have to make the new nominal interest rate be 3%, it could just be “R2” because at this point in time, we’re not sure whether the Fed has succeeded in lowering the inflation rate to 3%. Just a small point, this probably won’t matter for grading.</p>
<p><a href=“e”>quote</a> How will the interest rate change you identified in part (d) affect aggregate demand in the short run?
Explain.
[/quote]
Higher nominal interest rates means firms invest less, aka a decrease in Investment Spending, which is a component of Aggregate Demand. So AD shifts left, decreasing.</p>
<p><a href=“f”>quote</a> Assume that the Federal Reserve action is successful. What will happen to each of the following as the
economy approaches a new long-run equilibrium?<br>
(i) The short-run Phillips curve. Explain.
(ii) The natural rate of unemployment
[/quote]
i) The short run Philips Curve shifts left. Here is the explanation, using an AD-AS analysis:
Before the Fed intervened, the economy was at an equilibrium point (intersecting the long-run Aggregate supply line) at a price level of 6% inflation, at full employment output (5% unemployment). Then the AD curve shifted leftward, causing a recessionary GDP gap as the intersection of AD and Short Run AS did NOT also intersect Long-Run AS. But the economy approaches long-run equilibrium (an intersection of the Long run AS line). This happens because as price levels decrease wages also fall, which means lower input prices for firms. That causes the short run AS curve to shift to the right because firms can produce products more cheaply. This new rightward-shifted short run AS curve meets the leftward-shifted AD curve at a lower price level, but also at long-run equilibrium (it intersections long-run AS). So in conclusion, on the AD-AS graph we have shifted AD left, AS-SR shifted right in response to bring the economy back on the AS-LR line, at the same 5% unemployment rate but at 3% inflation now. So:</p>
<p>i) SR-PC shifts left, because now we can still achieve 5% unemployment, but the price level is 3% (lower than it was before). This can only be achieved by a leftward shift of the SR-PC. But LR-PC stays the same, at 5% unemployment.</p>
<p>
Tara’s currency will depreciate. Investors leave the country and move funds out of Tara’s currency, shifting the Demand for Currency curve leftward. The value of the currency (vertical axis) has dropped.</p>
<p><a href=“b”>quote</a> Using a correctly labeled graph of the loanable funds market in Tara, show the impact of this decision by
investors on the real interest rate in Tara.
[/quote]
Vertical axis: Real interest rate (%). Horizontal axis: Quantity of Loanable Funds. Demand curve is downward sloping. Supply curve is upward sloping. In response to an outflow of foreign investment, the Supply of Loanable Funds decreases. Remember that the demand for loanable funds is by debtors: firms that wish to invest, and simply individuals who go to their banks to get loans (for mortgages, cars, or whatever). The Supply of Credit/loanable funds is provided by lenders, who have money. The foreign investors are not taking out loans, and they are not firms but individual speculators and investors looking for a profit. They make up the supply of credit. So since the supply of credit shifts to the left, real interest rates increase.</p>
<p><a href=“c”>quote</a> Given your answer in part (b), what will happen to Tara’s rate of economic growth? Explain.
[/quote]
Interest rates rose, as investment decreases. Investment is a huge makeup of the Demand for Loanable Funds, and as you can see by drawing out the graph, when the supply of loanable funds shifts to the left, it intersects the Demand for Credit line at a point further left along its line (meaning at less demand). Basically less investment as interest rates rise.
Key point here: less Investment means less capital production, means less future capital production. This means that the rate of economic growth (economic growth defined as a rightward shift of the Long Run AS line, and/or a rightward shift of the Production Possibilities Curve) will be decrease, because quantity of capital is a determinant of long run aggregate supply.
- Mentioning the words “future capital stock” or something like that may be a requisite for a point on this section.</p>
<ol>
<li>Assume that the reserve requirement is 20 percent and banks hold no excess reserves.
(a) Assume that Kim deposits $100 of cash from her pocket into her checking account. Calculate each of the
following.
(i) The maximum dollar amount the commercial bank can initially lend
[/quote]
Reserve requirement is 20%, so bank keeps 20% of money ($20) as required reserves, and lends out the remaining $80.</li>
</ol>
<p><a href=“ii”>quote</a> The maximum total change in demand deposits in the banking system
[/quote]
Most likely the answer is $500, as they probably want you to count the initial $100 that Kim put in a deposit at the beginning. Personally I gave “2” answers (kind of): I said that if one was counting the total change in demand deposits AFTER Kim’s initial deposit then it would be $400, but if one counted her initial deposit in the total change in demand deposits, then it was $500. But who really knows if they will accept that answer?</p>
<p><a href=“iii”>quote</a> The maximum change in the money supply
[/quote]
$400. The trick here was that Kim’s initial deposit was currency before it was a deposit, so it was already part of the money supply.</p>
<p><a href=“b”>quote</a> Assume that the Federal Reserve buys $5 million in government bonds on the open market. As a result of
the open market purchase, calculate the maximum increase in the money supply in the banking system.
[/quote]
Increase in money supply = (money multiplier) * (initial increase).
Money multiplier = 1/RR. RR is 20%, or 0.2 so the money multiplier is 5. (5) * ($5 million) = $25 million increase in money supply.</p>
<p><a href=“c”>quote</a> Given the increase in the money supply in part (b), what happens to real wages in the short run? Explain.
[/quote]
Real wages = (nominal wages) / Prive Level.
In the short run, wages are somewhat sticky and do not rise immediately to rising prices (people don’t notice the inflation so the labor force doesn’t demand higher wages, etc). So nominal wages do not change in the short run.
The increase in the money supply, though, causes nominal interest rates to decrease, which causes investment to rise, which shifts AD to the right and increase the Price Level. So since the price level increased and nominal wages did not change, real wages dropped.</p>
<p>philip curve shifts…ru sure abt that</p>
<p>SRPC definitely shifts left, but I think for number 2 part B Demand is the one that shifts left. It doesn’t really makes sense for the quantity of currency of Tara to increase and yet the supply of loanable funds to decrease. Plus, investors make up the Demand curve, so if they go away then the Demand curve shifts left.</p>
<p>mgoogly I agree with you. The only thing I said differently was that for Tara depreciation it was due to an increase in the supply of Tara’s currency in the foreign exchange market. This is because as investors pull money out of the nation, the foreign exchange market has a higher amount of Tara’s currency, and people are demanding other countries currencies, which is why Tara’s currency will depreciate.</p>
<p>vasudevank - hmm, I’m not sure. I was always taught just to remember that the Demand for Currency line represents foreigners and that the Supply for Currency represents the domestic economy (Tara, in this case).
So things that shift Demand: foreigners traveling into Tara, foreigners buying Tara’s goods and services on the current account (aka exports), foreigners buying Tara’s financial assets** (like stocks, putting money in Tara banks) on the capital account.
Things that shift Supply: Tara citizens traveling abroad, Tarans buying foreign goods and services on the current account (aka imports), Tarans buying foreign financial assets on the capital account.
Not sure how your explanation fits in, but if it was a good explanation they’ll probably give you the point, who knows.</p>
<p>hipster23 - A decrease (leftward shift) of the Supply for Credit would decrease the Quantity of Loanable Funds. Also, the investors that make up the Demand Curve are not those foreigners doing investing. It’s a little complicated because economics is stupid and has confusing terminology. Investment, that is the component of GDP, is done by firms who are spending money on capital production and inventories. But when the AP says “foreign investors” doing “foreign investment,” they don’t mean that kind of investment. Instead they mean the kind of investment that everyday people do in the stock market, bonds and etc. - the kind that brokers and investment banks do. We call those people investors, but in strictly economic terminology they’re not ACTUALLY investors doing investment - they’re not firms spending money on capital production! They’re just people who are investing and speculating their money in financial assets. This is the type of investor that the AP means when they say “foreign investors” - not the investor that is a firm building a factory. It really is pretty stupid, economics should use two names to make the distinction between the two obvious.
Anyway, the investors that invest in the stock market and stuff are the ones supplying the loanable funds - they put their money into banks who lend out the money to firms who want to do investment, or they put their money in stocks or bonds, which the issuing corporation uses to raise money to make an investment (build a factory or something). So when foreign investors take their money out of Tara, that is decreasing the supply of loanable funds.</p>
<p><em>Umm i have no idea why my post is being butchered, but it starts here</em></p>
<p>For question 2:</p>
<p>a) It is an increase in supply because the supply curve in the market for foreign currency exchange is equivalent to net capital outflow. In this case, since net capital outflow is increasing (investors are going abroad to invest), supply shifts right and the value of the currency depreciates. The concept that the supply curve = NCO is found in Manqiw. </p>
<p>Wiki states:</p>
<p>“the quantity of a country’s currency available on the foreign exchange market–essentially, Net Capital Outflow (i.e. it is the x-axis in that market’s graph). NCO serves as a perfectly inelastic supply curve for this market”</p>
<p>[Net</a> Capital Outflow - Wikipedia, the free encyclopedia](<a href=“http://en.wikipedia.org/wiki/Net_Capital_Outflow]Net”>Net capital outflow - Wikipedia)</p>
<p>There’s also a picture of a graph shown. </p>
<p>b) In the loanable funds market, the demand curve is equivalent to Domestic Investment + NCO and the supply curve is national savings. Since domestic investors are increasing their foreign investments, NCO is increasing and the demand curve shifts to the right in the market, increasing the real interest rate. This concept is also shown in Manqiw and I’m not going to bother looking for the wiki.</p>
<p>c) Seeing as the real interest rate (for Tara) increases, the rate of economic growth will decrease in the short run because of a decrease in AD resulting from decreased investment by citizens of Tara.</p>
<p>For question 3:</p>
<p>a) i)$80
ii)$500
iii)$400
b) $25 million
c) real wages decrease because wages are sticky in the short run</p>
<p>
Can you quote the passage from your textbook? That someone as well-regarded as Mankiw thinks there is a relationship between Demand for Credit and NCO seems rather unbelievable.</p>
<p>Also, that Wikipedia page of Net Capital Outflow was one of the most catastrophic misinterpretations of economic theory I have ever seen (on wikipedia at least). I wonder who the hell could have written that.</p>
<p>I can do better: <a href=“http://4.bp.blogspot.com/_N50_hOc61hw/R_o0D9LUAWI/AAAAAAAAAH4/MQcjPFCUl0k/s400/NCO+inelastic+savings.jpg[/url]”>http://4.bp.blogspot.com/_N50_hOc61hw/R_o0D9LUAWI/AAAAAAAAAH4/MQcjPFCUl0k/s400/NCO+inelastic+savings.jpg</a></p>
![http://4.bp.blogspot.com/_N50_hOc61hw/R_o0D9LUAWI/AAAAAAAAAH4/MQcjPFCUl0k/s400/NCO+inelastic+savings.jpg[/url]](http://4.bp.blogspot.com/_N50_hOc61hw/R_o0D9LUAWI/AAAAAAAAAH4/MQcjPFCUl0k/s400/NCO+inelastic+savings.jpg%5B/url%5D){kind=link}
<p>Here are the relevant graphs with labeled supply and demand curves in each market. They are the same ones used in Mankiw’s Principles of Economics. Notice the labels on the graphs. </p>
<p>In the loanable funds market:
- Supply = National Saving
- Demand = NCO + Domestic Investment</p>
<p>In the currency exchange market:
- Supply = NCO
- Demand = NX</p>
<p>I think you need to go back and relearn open market theory if you believe that the wiki page was “one of the most catastrophic misinterpretations of economic theory [you] have ever seen.”</p>
<p>“In the loanable funds market, the demand curve is equivalent to Domestic Investment + NCO and the supply curve is national savings. Since domestic investors are increasing their foreign investments, NCO is increasing and the demand curve shifts to the right in the market, increasing the real interest rate. This concept is also shown in Manqiw and I’m not going to bother looking for the wiki.”</p>
<p>NCO increases, but domestic investment still decreases, so how does this equate to an increasing Demand curve? Seems to me according to this theory that the two will balance out and the net change will be zero.</p>
<p>Wikipedia cites “the NCO graph has a negative slope as an increased interest rate domestically is an incentive for savers to do so at home rather than abroad.” But this seems more relevant to the Foreign Exchange Market and not the MLF. In the MLF, I thought the demand curve is set only by the fact that as interest rates increase domestic investors do not want to invest more because they also have to pay more.</p>