m3_a3

ECO

2

0

1

Module

3

Assignment 3

1. Assume the government follows a Keynesian approach and alters spending to return the economy to full employment. Complete the table based on the graph below, assuming the MPE in this economy is 0.8. (18)

Equilibrium real GDP (short run)

Equilibrium price level (short run)

Nominal GDP

Type of output gap (inflationary or recessionary)

Size of output gap

Spending Multiplier

Amount of Spending Necessary

Final equilibrium real GDP (short run)

Final equilibrium price level (short run)

2. Which model of expectations seems most accurate to you? Explain. How do these models affect the effectiveness of monetary policy? (7)

3. Assume the Phillips curve below applies to the economy in the short run. (14)

a) If the economy is currently at point B, the inflation rate is ____________ and the unemployment rate is __________.

b) If the central bank wants to move the economy from point B to point A, it will reduce inflation by _________ but increase unemployment by __________.

c) If the economy experiences deflation, the unemployment rate will fall below:

d) Assume the target rate of unemployment in this economy is

4%

. What should the target inflation rate be?

e) If people expect the Fed to pursue higher inflation, then we need _________ inflation to reach the target rate of unemployment.

4. Is Ricardian equivalence more associated with Classical theory or Keynesian theory? What effect will Ricardian equivalence have on mpe and the spending multiplier? Is Ricardian equivalence more associated with rational expectations or adaptive expectations? Do you think Ricardian equivalence explains how people actually behave? Explain all of your answers. (15)

5. If the government decides to conduct expansionary fiscal policy, which would be more effective, a temporary tax cut or a one-time spending increase, according to most Keynesian economists? Explain. (6)

6. The crowding out effect is more likely to occur as a result of
expansionary/contractionary
fiscal policy when the government budget deficit
increases/decreases
. What will happen to interest rates? What will happen to investment spending? (8)

7. For each of the following,
explain
whether it is an example of an automatic stabilizer: (8)

a. Unemployment benefits increase during a recession.

b. The government attempts to slow inflation by reducing military spending.

c. The government cuts income taxes to boost the economy.

d. Many taxpayers fall out of the top tax bracket and keep a larger share of their income as the economy worsens.

8. Tax revenue = $32,000,000

Government spending = $30,225,000

The government is running a
budget deficit/budget surplus/balanced budget
of (4):

9. Calculate the

Debt

/GDP ratios. Which country has a better fiscal position? Explain. (8)

Debt

Real GDP

Debt/GDP Ratio

Country A	Country B
	Debt	$500,000	$100,000,000
	Real GDP	$250,000	$1,000,000,000
	Debt/GDP Ratio

10. If the target rate of unemployment is

5%

, what is the structural deficit? (4)

Year	Unemployment rate	Government budget imbalance
1	4%	-$10,000,000
2	5%	-$11,500,000
3	8%	-$14,000,000

What is the cyclical deficit in year 3?

11. Based on the numbers below, complete the table: (6)

Government tax revenue: $150,000,000

Government spending: $225,000,000

Current price level: 120

Previous price level: 115

Current debt: $5,000,000,000

Nominal Deficit

Inflation Rate

Real Deficit

12. In the previous question, how would a higher inflation rate affect the country’s real deficit? Explain why this is the case. (2)