1. According to classical macroeconomic theory, monetary policy shocks are "neutral." Explain what this means. Based on that theory, how would a 5% increase in a nation's money supply affect its real wage rate (W/P), all else equal (up, down, or no change, and by how much)? Explain. According to the quantity theory of money, how would a 5% increase in the money supply affect the price of goods and services (P), all else equal (up, down, or no change, and by how much)? To be consistent with both theories, what would have to happen to the nominal wage rate (W)? Explain.

2. Describe the difference between "the real interest rate" and "the nominal interest rate." How is the "ex-post" real interest rate calculated?

3. Consider the following model of a closed economy:

• ? = ???1/2?1/2
• ??? = ?? + ?? + ??
• ? = ???
• ?? = 250 + 0.7(? - ??)
• ?? = 2000 - 20,000??
• ?? = 25
• ? = 144
• ? = 100
• ?? = 600
• ?? = 500
• ??? = 1500
• ?? = 8

a. What values of aggregate income (Y) and national saving (S) result from full employment of labor and capital?

b. What must the interest rate (r) be in order to establish long run equilibrium in the market for loanable funds?

c. According to the quantity theory of money, what is the equilibrium price of goods (P) for this economy?

d. If population growth increases the labor supply from 100 to 144, what will be the new equilibrium values of Y, S, r, and P?

4. Use the classical model and the quantity theory of money to predict how each of the following shocks would affect the real wage rate (W/P), the real interest rate (r), real aggregate income (Y), and the price of goods and services (P) in a closed economy in the long run, all else equal. For each shock, be sure to clearly state a prediction for all four variables, illustrate your predictions with the relevant diagrams, and explain your predictions intuitively in words.

a. A increase in the size of the domestic capital supply

b. An increase in the income velocity of money

5. Consider the following model of a small, open economy:

• ? = 4000
• ??? = ?? + ?? + ?? + ??
• ? = ???
• ?? = 400 + 0.8(? - ??)
• ?? = 800 - 5000??
• ?? = 800 - 400??
• ?? = 300
• ?? = 1000

a. Assuming that the world's real interest rate is 8% (rw* = .08), what will national saving (S) and investment (I) be for this economy?

b. What are the equilibrium values of net exports (NX) and the real exchange rate (?)?

c. What are the equilibrium values of net exports and the real exchange rate if the world's real interest falls to 6%, all else equal?

d. What are the equilibrium values of net exports and the real exchange rate if the world's real interest rate is 8%, but domestic government purchases (G) are reduced to 100, all else equal?

6. Define the terms "trade balance" and "net capital outflow," and explain why the two will always be equal.

7. Use the model from chapter 5 of the textbook to predict how each of the following shocks would affect national saving (S), investment (I), the trade balance (NX), and the real exchange rate (?) in a small, open economy with perfect capital mobility, all else equal. For each shock, be sure to clearly state a prediction for all four variables, illustrate your predictions with the relevant diagrams, and explain your predictions intuitively in words.

a. Technological progress increases domestic total factor productivity.

b. The world's supply of loanable funds decreases.

c. Rising domestic real estate prices increase aggregate domestic household wealth

d. A reduction in the rate at which domestic businesses are taxed creates an exogenous increase in desired domestic investment.

8. Suppose that last year, the nominal exchange rate between the Japanese yen and the British pound was ¥225.0 per £1.0, one unit of Japanese output cost ¥2000, and one unit of British output cost £8.0.

a. What was the real exchange rate between the U.K. and Japan last year, expressed as the cost of British output (in units of Japanese output)?

b. Suppose that, between last year and this year, the pound appreciated by 12% against the yen (a 12% increase in the number of yen required to buy 1 pound). What is the nominal yen-pound exchange rate this year?

c. If the British price level and the Japanese price level are the same this year as last year, what is the new real exchange rate between the U.K and Japan this year, expressed as the cost of British output (in units of Japanese output)?

d. Suppose, instead, that between last year and this year, the pound appreciated by 12% against the yen and Japan experienced a 20% increase in its price level (a 20% increase in the number of yen required to purchase one unit of Japanese output). All else equal,

what is the new real exchange rate between the U.K. and Japan this year?

9. What is arbitrage? Why don't arbitrage opportunities last?

10. Suppose that a Toyota Camry costs $25,000 in the U.S. and €20,000 in Europe, while the nominal dollar-euro exchange rate is 0.9€/$.

a. Describe how an arbitrageur could profit from this situation (What would they buy? What would they sell?)

b. Based on the Law of One Price, what is the equilibrium nominal exchange rate between the

U.S. dollar and the euro? What is the equilibrium real exchange rate between the U.S. and Europe?

c. Suppose the price of everything in the U.S. (including a Toyota Camry) increased by 5%. All else equal, how would that affect the equilibrium euro price of the U.S. dollar (i.e. - e*(€/$)) in the long run (up or down, and by how much)? Explain.

11. Consider the following model of a closed economy:

• ??? = ?? + ?? + ??
• ? = ???
• ?? = 200 + 0.80(? - ??)
• ?? = 600
• ?? = 1000
• ?? = 1000

a. What is "autonomous expenditure" for this economy?

b. Based on the Keynesian Cross model, what is the short run equilibrium value of real aggregate income (Y) for this economy?

c. All else equal, what is the new short run equilibrium value of income if government purchases (G) are increased by 200 (from 1000 to 1200)?

d. What is the government spending multiplier (i.e - the simple spending multiplier) for this economy?

e. If government purchases are held constant at 1000 and income taxes are cut by 200 (from 1000 to 800), what is the new short run equilibrium value of income?

f. What is the tax multiplier for this economy?

g. According to the Keynesian Cross model, which is more effective at raising aggregate income in the short run, tax cuts or government spending? Why?

12. According to the Keynesian Cross model, how would each of the following shocks affect real aggregate income in the short run, all else equal? For each shock, be sure to clearly state a predicted direction of change for income, illustrate your prediction with a Keynesian Cross Diagram, and explain your predictions intuitively in words.

a. Government purchases decline

b. Congress cuts household income taxes

c. Autonomous consumption increases

d. Total factor productivity increases

13. According to the Keynesian model of income determination, what determines a nation's real aggregate income? According to the classical model of income determination, what determines a nation's real aggregate income? What accounts for the difference between the two models?