Solution- Macro Eco

Semester Final (Spring-2020)

Prepared By- Super Eight

 Question-01
a) A gold standard is a monetary system in which the standard economic unit
of account is based on a fixed quantity of gold. The gold standard was
widely used in the 19th and early part of the 20th century. Most nations
abandoned the gold standard as the basis of their monetary systems at some
point in the 20th century, although many still hold substantial gold reserves.[
The gold standard involved buying and selling of paper currency in
exchange for gold on the request of any individual of firm. In this system
gold is freely transferable between countries. Participants in this system
included UK, France, Germany & USA.
This is the first modern international monetary system, in this System each
currency was linked to a weight of Gold.

b) The Bretton Woods system of monetary management established the rules

for commercial and financial relations among the United
States, Canada, Western European countries, Australia, and Japan after the
1944 Bretton Woods Agreement. The Bretton Woods system was the first
example of a fully negotiated monetary order intended to govern monetary
relations among independent states. The chief features of the Bretton Woods
system were an obligation for each country to adopt a monetary policy that
maintained its external exchange rates within 1 percent by tying its currency
to gold and the ability of the IMF to bridge temporary imbalances of
payments. Also, there was a need to address the lack of cooperation among
other countries and to prevent competitive devaluation of the currencies as
well.
c) Do Yourself (Sorry)
d) A fixed exchange rate is a regime applied by a government or central bank
ties the country's currency official exchange rate to another country's
currency or the price of gold. The purpose of a fixed exchange rate system is
to keep a currency's value within a narrow band.

Fixed rates provide greater certainty for exporters and importers. Fixed rates also
help the government maintain low inflation, which, in the long run, keep the
interest rates down and stimulates trade and investment.
Most major industrialized nations have had floating exchange rate systems, where
the going price on the foreign exchange market (forex) sets its currency price. This
practice began for these nations in the early 1970s while developing economies
continue with fixed rate systems.

e) A flexible exchange-rate system is a monetary system that allows the

exchange rate to be determined by supply and demand.
Every currency area must decide what type of exchange rate arrangement to
maintain. Between permanently fixed and completely flexible however, are
heterogeneous approaches. They have different implications for the extent to
which national authorities participate in foreign exchange markets.
According to their degree of flexibility, post-Bretton Woods-exchange rate
regimes are arranged into three categories: currency unions, dollarized
regimes, currency boards and conventional currency pegs are described as
―fixed-rate regimes‖; horizontal bands, crawling pegs and crawling bands
are grouped into ―intermediate regimes‖; and managed and independent
floats are described as flexible regimes. All monetary regimes except for the
permanently fixed regime experience the time inconsistency problem and
exchange rate volatility, albeit to different degrees.

 Question-02

a. The production function in the Solow growth model is Y = F(K, L), or expressed
terms of output per worker, y = f(k). If a war reduces the labor force through
casualties, then L falls but k = K/L rises. The production function tells us that total
output falls because there are fewer workers. Output per worker increases,
however, since each worker has more capital.

b. The reduction in the labor force means that the capital stock per worker is
higher after the war. Therefore, if the economy were in a steady state prior to the
war, then after the war the economy has a capital stock that is higher than the
steady state level. This is shown in Figure 7–2 as an increase in capital per worker
from k* to k1. As the economy returns to the steady state, the capital stock per
worker falls from k1 back to k*, so output per worker also falls.
Hence, in the transition to the new steady state, output growth is slower. In the
steady state, we know that technological progress determines the growth rate of
output per worker. Once the economy returns to the steady state, output per worker
equals the rate of technological progress—as it was before the war.

 Question-04:
a) Total planned expenditure is

E = C(Y – T) +I + G.
Plugging in the consumption function and the values for investment I, government
purchases G, and taxes T given in the question, total planned expenditure E is

E = 200 + 0.75(Y – 100) + 100 + 100

= 0.75Y + 325.

This equation is graphed in Figure 10–8.

 b) To find the equilibrium level of income, combine the planned-expenditure
equation derived in part (a) with the equilibrium condition Y = E:

= 0.75Y + 325
Y = 1,300.

The equilibrium level of income is 1,300, as indicated in Figure 10–8.

c) If government purchases increase to 125, then planned expenditure changes

to E = 0.75Y + 350. Equilibrium income increases to Y = 1,400. Therefore,
an increase in government purchases of 25 (i.e., 125 – 100 = 25) increases
income by 100. This is what we expect to find, because the government-
purchases multiplier is 1/ (1 – MPC): because the MPC is 0.75, the
government-purchases multiplier is 4.

d) A level of income of 1,600 represents an increase of 300 over the original

level of income. The government-purchases multiplier is 1/ (1 – MPC): the
MPC in this example equals 0.75, so the government-purchases multiplier is
4. This means that government purchases must increase by 75 (to a level of
175) for income to increase by 300.
  Question-05
a. The Keynesian cross graphs an economy’s planned expenditure function, E =
C(Y – T) + I + G, and the equilibrium condition that actual expenditure equals
planned expenditure, Y = E, as shown in Figure 10–6.

An increase in government purchases from G1 to G2 shifts the planned

expenditure function upward. The new equilibrium is at point B. The change in Y
equals the product of the government-purchases multiplier and the change in
government spending: ∆ = [1/(1 – MPC)]∆G. Because we know that the marginal
propensity to consume MPC is less than one, this expression tells us that a one
dollar increase in G leads to an increase in Y that is greater than one dollar.

b. An increase in taxes ∆T reduces disposable income – T by ∆T and, therefore,

reduces consumption by MPC × ∆T. For any given level of income , planned
expenditure falls. In the Keynesian cross, the tax increase shifts the planned
expenditure function down by MPC ×∆T, as in Figure 10–7.
 The amount by which Y falls is given by the product of the tax multiplier
and the increase in taxes:

∆Y = [ – MPC/(1 – MPC)]∆T.

c. We can calculate the effect of an equal increase in government expenditure and

taxes by adding the two multiplier effects that we used in parts (a) and (b):

∆Y = [(1/ (1 – MPC)) ∆G] – [(MPC/(1 – MPC))∆T].

Government Tax
Spending Multiplier
Multiplier

Because government purchases and taxes increase by the same amount, we

know that ∆G = ∆T. Therefore, we can rewrite the above equation as:
∆Y = [(1/(1 – MPC)) – (MPC/(1 – MPC))]∆G
= ∆G.
This expression tells us that an equal increase in government purchases and
taxes increases Y by the amount that G increases. That is, the balanced-budget
multiplier is exactly 1.