(ECON112)sp112ps1sol.pdf

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RAG

3ET 1 ANSWERS

1.

C

2.

C

3.

D

4.

B

5.

B

6.

A

7.

C

8.

B

9.

A

10.A

11. B

12.B

13.C

14.A

15.B

16.B

17.B

18.A

19.A

20.B

21. D

22.C

23.C

24. C

25.D

26.B

r ~--

1.

a)

$10000 + $1,000 = $11,000at end of year 1

End of year 2: $11,000 + $1,100 = $12,100 End of year 3: $12,100 + 1210 = $13,310 End of year 4: $13, 310 +1331 = $14641 End of year 5: $14,641 +1404.10=$16105.10

b) The hamburger increases in price from $1 to $1.6105 at the end of year 5. Since nominal income and the price of hamburgers grow at the same rate, Real purchasing power does not change.

c) Taxpaidatthebeginningofyear1 =10%of$10,000 =$1,000

After tax income = $10,000 -$1,000 = $9,000

# of hamburgers = $9,000/$1 = 9,000

Tax paid at the end of year 5= .2 x 16105 = $3221.02

After tax income = 16,105.10-4221.02 = $12,884.08

# of hamburgers = $12,884.08/$16.15 = 8000

The standard of living has Fallen.

d) Repay friend $16,105.10at the end of year 5

[Note that $16,105.10 at the end of year 5 has the same purchasing power as $10,000 at the beginning of year 1. Hence, the real rate of interest is zero.]

If the actual inflation rate turned out to be less than 10% per year, then the $16,105.10you repay represents an increase in purchasing power: you lose, your friend gains.

That is, unexpected inflation results in: Lender loses, Borrower gains

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J. a. An increase in the money supply shifts the LM curve out and to the right. Thus, the

real interest rate falls and output increases.

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b. An increase in government spending shifts the IS curve out and to the right. The real interest

rate is higher and GDP is higher. 'h.

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The decrease in G shifts the IS curve down. The Fed's policy decreases the money

3.

A. supply and shifts the LM curve up, so the real interest rate doesn't change. But output declines in the very short run.

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The Fed can only control the money stock or the interest rate. It cannot target

Lr. both the money stock and the interest rate at the same time. By targeting the interest rate, the Fed is essentially adjusting the money stock so as to keep the interest rate constant. On the other hand, when the Fed targets the money stock it is essentially making a

commitment to keep money stock constant. This, in turn, means that it cannot adjust money supply to accommodate any changes in liquidity (money demand) which means that the interest rate can be volatile.

5a) Y="c+i"+G Y= 4250-125r (ISequation)

M/P =L

Y=2000+250r (LMequation)

b)4250 -125r =2000 +250r

r" =6

Y"=3500

c)Y = 3666.7

G = 800 (or G increases by 100).

The increase in G shifts the IS curve out and to the right.

The new equilibrium in