Problem Set - Intermediate Macro

1. Assume you begin in long run equilibrium. Suppose the Fed raises the money supply.

a. What happens to the aggregate demand curve?

b. What happens to the level of output and the price level in the short run?

c. What should happen to the level of output and the price level according to both the Keynesian and classical policy ideas?

d. According to Okun's law, what happens to unemployment in the short and long run?

2. Assume you have two different Central Banks each with a different policy goal. The first Central Bank targets inflation, while the second targets employment. Using the IS-LM model how would each use monetary policy to respond to each of the following situations?

a. A sharp decrease in the stock market.

b. An increase in the price of oil.

3. Find some projections for the future path of U.S. government debt to GDP ratio. If this trend continues how will it affect the U.S. economy? Explain this with reference to output, employment, interest rates, net capital outflow and trade balances. You should use the large open economy as you basis for analysis. What kind of exchange rate regime does this assume? Why?

4. Use the Keynesian cross to predict the impact on equilibrium GDP of the following:

a. A decrease in government purchases.

b. An increase in exports.

c. An equal-sized decrease in both government purchases and taxes.

5. Suppose you are looking at the Keynesian cross. What happens when the population becomes more prone to save money? The following consumption function might help you picture this scenario:

C = ζ + c(Y-T)

Where ζ is called "autonomous consumption" and c is the marginal propensity to consume.

a. What happens to equilibrium income when society saves more as represented by a decline in ζ?

b. What happens to equilibrium saving?

c. Why do you suppose this result is referred to as the paradox of thrift? Find a source on the internet to help you understand this topic. Provide a link to your source.