1997 Macro Free Response

1.    (a) Explain the short-run effect of a 5 percent increase in the money supply on each of the following.

  1. The real interest rate
  2. Output
  3. The price level

In Country X investment is only slightly responsive to changes in the real interest rate, while money demand is quite responsive to changes in the real interest rate. In Country Y investment is very responsive to changes in the real interest rate, while money demand is only slightly responsive to changes in the real interest rate.

(b) Using a single graph, draw a curve showing the relationship between the real interest rate and the demand for money foe each of the following.

  1. Country X
  2. Country Y

Label the curve for Country X as MX and the curve for Country Y as MY.

(c) Using a single graph, draw a curve showing the relationship between the real interest rate and the demand for investment for each of the following.

  1. Country X
  2. Country Y

Label the curve for Country X as IX and the curve for Country Y as IY.

(d) Based on your answers to parts (a) through (c), in which country will the change in the real interest rate be greater? Explain why.

(e) Based on your answers to parts (a) through (c), in which country will the change in output be greater? Explain why.

(f) In which of these countries do conditions more closely reflect the monetarists’ view of the economy?

Answer to #1

2.    Assume a market economy with a business sector, a household sector, and a government sector, but no international sector.

(a) Draw and label a circular flow diagram for this economy.

(b) Referring to the diagram you have drawn in part (a), identify two ways of calculating this economy’s gross domestic product (GDP).

(c) Identify each of the following.

  1. The components of aggregate demand
  2. The determinants of aggregate supply

Answer to #2

3.    Assume an economy is in a recession.

(a) Identify one monetary policy action and one fiscal policy action that could be used to help the economy out of the recession. Explain the effect of each policy on the price level and the equilibrium level of output.

(b) Given your answer in part (a) on the price level effect, explain the effect the policy actions you identified in part (a) would have on the economy’s imports and its exports.

(c) Given your answer in part (a) on the output effect, explain the effect the policy actions you identified in part (a) would have on the economy’s imports and its exports.

(d) Given your answers above, explain what effect the policy actions would have on the international value of the dollar.

Answer to #3

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