Subject: Economics / General Economics
QuestionA6-9. Suppose the long run equilibrium for a closed economy is described by model below:Y = 500 C = 250 – 10r G = 200 T = 210 I = 200 – 20rwhere Y is real (potential) GDP, C is consumption, G is government spending, T is taxes net of transfers,I is investment, and r represents the real interest rate in percentage points (eg. 10% is represented by 10)(a) Derive an expression for private saving, a value for government saving, and an expression for national saving. (b) Calculate the equilibrium interest rate and level of investment in the economy. Illustrate in a diagram. (c) Suppose the government institutes a revenue-neutral tax reform that favours saving overconsumption such that the new expression for consumption becomes: C = 240 – 15r. Re-solve to determine the new equilibrium interest rate and level of investment. Illustrate in your diagram. (d) With reference to an aggregate production function, explain why the policy change described above might affect future economic growth. A6-10. Suppose the consolidated balance sheet of an economy’s banking system is shown in the following table:Assets LiabilitiesReserves: 50 Deposits: 1000Government Bonds: 250Loans Outstanding: 900 Capital: 200Total: 1200In answering the following questions, assume that the banking system is initially in equilibrium and that the public holds all of its money in the form of deposits in the banking system.(a) What is the desired (target) reserve ratio of the commercial banks? What is the money supply? (b) Suppose the central bank buys $10 worth of government bonds from the banking system. Show the effect of this transaction on the balance sheet before any new loans can be made, or any old loans are called. Is the banking system still in equilibrium? Has the money supply changed? (c) Briefly explain how the commercial banks respond to this new situation. Show the eventual effect on the balance sheet when the banking system has returned to equilibrium. What is the new level of the money supply? A6-11. The US central bank, the Federal Reserve (the Fed), is currently expected to engage in what it calls a“normalization” of its policy. This will involve the Fed raising its policy interest rate in an effort to raise interest rates throughout the US economy.(a) In the context of the money market, if the money demand function is stable, explain how the change in policy would be reflected in the money supply. (b) Suppose we could treat the US economy as a closed one. What effect will there be on investment,on aggregate expenditure? Include diagrams in your answer. (c) The US an open economy. What additional effect will there be on aggregate expenditure? (d) How will aggregate demand be affected, whether we treat the economy as closed or open? Illustrate in a diagram.