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201 Winter08 Final Solutions
201 Winter08 Final Solutions
103.194
100
100
99.0274
= 0.9774%. So,
chain-weighted ination =
0.031445+0.009774
2
= 2.0609%.
(d) (1 pt.) Write the equation that relates the velocity of money (call it V ) to the money
supply and nominal GDP.
SOLUTION: M V = P Y V =
PY
M
=
nominal GDP
money supply
(3 pts.) Suppose that in 2000, the money supply was $224,000. Assume that the
velocity of money is the same in 2000 and 2001. Use the values of nominal GDP
you found in part (a) for 2000 and 2001 to calculate the money supply in 2001.
SOLUTION: V =
nominal GDP
money supply
=
1120000
224000
= 5. Since V is the same in 2001, we
have M 5 = nominal GDP M =
1114500
5
= 222900.
Pg. 11
3. (17 pts.) Consider an economy in equilibrium with the following initial structure:
Equilibrium GDP = Y = 10, 000
MPC =
3
4
Income tax rate = t =
1
9
Reserve ratio = rr = 0.10
The desired currency to deposit ratio is 15%, so c = 0.15
Interest rate = i = 0.04 (= 4%)
Money demand is characterized by M
D
= 550 1000i (in millions of dollars, where i is
written as a decimal. For example, if i = 0.07, then M
D
= 550 1000 0.07 = 480).
Assume consumption takes the standard form C = A +MPC (Y T), and taxes take the
form T = T
a
+t Y .
A, T
a
, t, G, X, Im, and MPC do not change when the interest rate changes. However,
investment does change based on the interest rate. Specically, I = 1000 5000i.
(Again, i is written as a decimal. For example, if i = 0.07, then I = 10005000 0.07 = 650.)
(a) Given that the economy is in equilibrium:
(2 pts.) What is the money supply? (Hint: consider the market for money and the
equilibrium condition that relates M
D
to M
S
)
SOLUTION: M
S
= M
D
= 550 1000 0.04 = 510
(2 pts.) What is the monetary base?
SOLUTION: B =
M
S
1+c
c+rr
=
550
1.15
0.25
= 110.87
(b) (2 pts.) Now suppose that the central bank sells 5 million dollars worth of bonds on the
open market. What is the change in money supply?
SOLUTION: M
S
=
1+c
c+rr
B =
1.15
0.25
(5) = 23
(c) (2 pts.) What is the new interest rate?
SOLUTION: M
S
= M
D
510 487 = 550 1000 i i = 0.063
(d) (4 pts.) What is the new equilibrium Y that results from the open market operation
described in parts (b) and (c)? (Hint: rst, nd how I changes.)
SOLUTION: I = (1000 5000 0.04) (1000 5000 0.063) = 115
Y =
I
1MPC(1t)
=
115
10.75
8
9
= 345 Y = 9655
(e) (5 pts.) Going back to the initial equilibrium (i.e., before the open market operations in
(b) happened), suppose that net exports decreases by 100 and G increases by 20. The
central bank wants to keep output unchanged (i.e., wants to keep Y = 10, 000). How
many million dollars of bonds should they buy or sell?
SOLUTION: We want the change in I to oset the change in NX and G. If the Fed
does nothing, we will have AAE = 20100 = 80. So, we want I = 80 to oset the
changes. This means we want a new level of investment of I = (10005000 0.04)+80 =
880. If I = 880, we need an interest rate of 880 = 1000 5000 i i = 0.024. In
order to have i = 0.024, we need M
S
= 550 1000 0.024 = 526. Thus, we need a
change in M
S
of M
S
= 526 510 = 16. This means we needs a change in B of
B =
M
S
1+c
c+rr
=
16
1.15
0.25
= 3.47826. Thus, the Fed needs to buy 3.47826 million dollars worth
of bonds.
Pg. 12
4. (25 pts.) Suppose an economy has the following data:
Year Y Y
D
C I G X Im T NS
2004 700 200 150 200 150 100
2005 800 220 200 300 170 150
2006 250 200 300
The consumption function and the tax function are the same in every year.
Additionally, imports are a function of disposable income. In particular, the import function
is Im = a + b Y
D
where a and b are some numbers. This function also stays the same
every year.
(a) (2 pts.) What is Y (GDP or output) and Y
D
(disposable income) in 2004 and 2005?
SOLUTION: Y = C +I +G+X Im. In 2004, Y = 700 + 200 + 150 + 200 150 =
1100. In 2005, Y = 800 + 220 + 200 + 300 170 = 1350. Y
D
= Y T. In 2004,
Y
D
= 1100 100 = 1000. In 2005, Y
D
= 1350 150 = 1200.
(b) (2 pts.) What are national savings in 2004 and 2005?
SOLUTION: NS = PS + GS = Y T C + T G = Y C G. In 2004,
NS = 1100 700 150 = 250. In 2005, NS = 1350 800 200 = 350.
(c) (Hint: for the three sections in part (c), use the data for 2004 and 2005.)
(3 pts.) What is the consumption function? (Hint: your answer should be of the
form C = A+MPC Y
D
.)
SOLUTION: The two equations to solve are: 700 = A + MPC 1000 and 800 =
A + MPC 1200. These give MPC = 0.5 and A = 200. Thus, the consumption
function is C = 200 + 0.5 Y
D
.
(3 pts.) What is the tax function? (Hint: your answer should be of the form
T = T
a
+t Y .)
SOLUTION: The two equations to solve are: 100 = T
a
+ t 1100 and 150 =
T
a
+ t 1350. These give t = 0.20 and T
a
= 120. Thus, the tax function is
T = 120 + 0.20 Y .
(3 pts.) What is the import function? (Hint: as above, your answer should be of
the form Im = a +b Y
D
.)
SOLUTION: The two equations to solve are: 150 = a+b1000 and 170 = a+b1200.
These give b = 0.10 and a = 50. Thus, the import function is Im = 50 + 0.10 Y
D
.
(d) (Hint: you should be using the three functions you found in part (c), along with the
data from the table for 2006, to help solve for Y .)
SOLUTION: Y = C + I + G + X Im Y = A + MPC (Y (T
a
+t Y )) + I +
G+X (a +b (Y (T
a
+t Y ))) Y =
AMPCTa+I+G+Xa+bTa
1MPC(1t)+b(1t)
(2 pts.) What is the multiplier for 2006?
SOLUTION: From above, the multiplier is
1
1MPC(1t)+b(1t)
=
1
10.5(10.2)+0.10(10.2)
=
1.4706
(2 pts.) What is AAE for 2006?
SOLUTION: From above, AAE= A MPC T
a
+ I + G + X a + b T
a
=
200 0.5(120) + 250 + 200 + 300 50 + 0.10(120) = 948
Pg. 13
(1 pt.) What is equilibrium GDP for 2006?
SOLUTION: Y = 948 1.4706 = 1394.12
(e) (2 pts.) What is the trade balance in equilibrium in 2006?
SOLUTION: Trade balance= XIm = 300(50+0.10(1394.12 (120 + 0.2 1394.12))) =
126.47
(f) (3 pts.) Now suppose that the government changes the tax policy by decreasing T
a
by
80. By how much does equilibrium GDP change? (Hint: use the formula you found for
Y in part (d).)
SOLUTION: Y =
AAE
1MPC(1t)+b(1t)
=
MPCTa+bTa
1MPC(1t)+b(1t)
=
0.5(80)+0.1(80)
10.5(10.2)+0.10(10.2)
=
47.0588
(g) Return to part (d) (i.e., ignore the change in part (f)). Suppose between 2006 and 2007,
MPC changes to 0.70, and t changes to 0 (no income tax).
(1 pt.) What is the new multiplier in 2007?
SOLUTION: Multiplier =
1
1MPC(1t)+b(1t)
=
1
10.7(10)+0.10(10)
= 2.5
(1 pt.) Assume AAE is the same in 2007 as it was in 2006 (from part (d)). What is
equilibrium GDP in 2007?
SOLUTION: Y = 948 2.5 = 2370
NOTE: AAE does change. Its new value is AAE = AMPCT
a
+I +G+Xa+b
T
a
= 2000.7(120)+250+200+30050+0.1(120) = 972 Y = 9722.5 = 2430