Economics 111 - Principles of Economics - Accelerated Treatment - Problem Set 8

1. Explain whether the following statements are true or false:

a) The introduction of automatic teller machines (ATMs) has most likely increased the demand for money (M1).

b) Even if investment spending were not sensitive to the interest rate, the aggregate demand curve (AD) would still have a negative slope.

c) In some countries - like Argentina and Brazil - where virtually all workers' wages are indexed to the rate of inflation the short run aggregate supply curve is very steep.

d) Expansionary fiscal policy increases government spending at the expense of private investment spending, while expansionary monetary policy increases consumption spending at the expense of investment spending.

2. Consider the following numerical version of the AS - AD model:

C = 50 + .8Yd - 10P

I = 200 - 30P

G = 200

T = 50

Note that a rise in the price level causes a fall in both investment and consumption expenditures.

The equation for the AS curve in this economy is:

P = 1 + .00125Y.

a) Obtain the equation for the AD curve. (Hint: Set Y = C + I + G and solve to see how Y depends on P.)

b) Solve for the equilibrium output and the equilibrium price level.

c) Suppose taxes are increased from 50 to 100. Repeat a, and b above. Compare the change in consumption spending to the size of the tax increase. Which is greater? Explain this result briefly.