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Fiscal policy, the money market, and aggregate demand

Suppose there is some hypothetical economy in which households spend $0.75 of each additional dollar they earn and save the $0.25 they have left over. The following graph plots the economy's initial aggregate demand curve (AD1).
Suppose now that the government increases its purchases by $3.75 billion.
Use the green line (triangle symbol) on the following graph to show the aggregate demand curve (AD2) after the multiplier effect takes place.
Hint: Be sure the new aggregate demand curve (AD2) is parallel to AD1. You can see the slope of AD1 by selecting it on the following graph.
The following graph plots equilibrium in the money market at an interest rate of 7.5% and a quantity of money equal to $60 billion.
Show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves on the following graph.
Suppose that for every increase in the interest rate of one percentage point, the level of investment spending declines by $0.5 billion. Based on the changes made to the money market in the previous scenario, the new interest rate causes the level of investment spending to    by    .
Taking the multiplier effect into account, the change in investment spending will cause the quantity of output demanded to    by    at every price level. The impact of an increase in government purchases on the interest rate and the level of investment spending is known as the    effect.
Use the purple line (diamond symbol) on the graph at the beginning of this problem to show the aggregate demand curve (AD3) after accounting for the impact of the increase in government purchases on the interest rate and the level of investment spending.
Hint: Be sure your final aggregate demand curve (AD3) is parallel to AD1 and AD2. You can see the slopes of AD1 and AD2 by selecting them on

If households spend $0.75 of each additional dollar they earn, the marginal propensity to consume is 3/4, or 0.75. Recall that the formula for the spending multiplier is 11−MPC11−MPC. In this case, the economy's multiplier is 10.25=410.25=4. That is, each $1.00 increase in spending leads t...

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Posted by Cleveland on September 17, 2024
Suppose there is some hypothetical closed economy in which households spend $0.65 of each additional dollar they earn and save the remaining $0.35.
The marginal propensity to consume (MPC) for this economy is    , and the spending multiplier for this economy is    .
Suppose the government in this economy decides to increase government purchases by $350 billion. The increase in government spending will lead to an increase in income, creating an initial change in consumption equal to    . This increases income yet again, leading to a second change in consumption equal to    . The total change in demand resulting from the initial change in government spending is    .
The following graph shows the aggregate demand curve (AD1) for this economy before the change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD1). You can see the slope of AD1 by selecting it on the graph.

Suppose there is some hypothetical closed economy in which households spend $0.65 of each additional dollar they earn and save the remaining $0.35.The marginal propensity to consume (MPC) for this economy is0.65   , and the spending multiplier for this economy is2.8571   .Points:...

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Posted by Cleveland on September 17, 2024

The multiplier effect of a change in government purchases

Suppose there is some hypothetical closed economy in which households spend $0.85 of each additional dollar they earn and save the remaining $0.15.
The marginal propensity to consume (MPC) for this economy is    , and the spending multiplier for this economy is    .
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to    . This decreases income yet again, leading to a second change in consumption equal to    . The total change in demand resulting from the initial change in government spending is    .
The following graph shows the aggregate demand curve (AD1) for this economy before the change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD1). You can see the slope of AD1 by selecting it on the graph.

Suppose there is some hypothetical closed economy in which households spend $0.85 of each additional dollar they earn and save the remaining $0.15.The marginal propensity to consume (MPC) for this economy is0.85   , and the spending multiplier for this economy is6.6667   .Points:...

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Posted by Cleveland on September 17, 2024
The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3.5% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.
 Suppose the Fed announces that it is raising its target interest rate by 50 basis points, or 0.5 percentage points. To do this, the Fed will use open-market operations to    the    money by      the public.
Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate and quantity of money.
Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a higher interest rate will    the cost of borrowing, causing residential and business investment spending to    and the quantity of output demanded to     at each price level.
Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand.

Your AnswerNew MS CurveNew Equilibrium00.10.20.30.40.50.60.70.85.55.04.54.03.53.02.52.01.5INTEREST RATE (Percent)MONEY (Trillions of dollars)Money SupplyMoney Demand0.4, 3Y-Intercept: 3.25Slope: 0Correct AnswerSuppose the Fed announces that it is raising its target interest rate by 50 basis points, ...

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Posted by Cleveland on September 17, 2024

The theory of liquidity preference and the downward-sloping aggregate demand curve

Suppose the money market for some hypothetical economy is given by the following graph, which plots the money demand and money supply curves. Assume the central bank in this economy (the Fed) fixes the quantity of money supplied.
Suppose the price level increases from 90 to 105.
Shift the appropriate curve on the graph to show the impact of an increase in the overall price level on the market for money.
Following the price level increase, the quantity of money demanded at the initial interest rate of 6% will be    than the quantity of money supplied by the Fed at this interest rate. As a result, individuals will attempt to    their money holdings. In order to do so, they will    bonds and other interest-bearing assets, and bond issuers will realize that they    interest rates until equilibrium is restored in the money market at an interest rate of
.
The following graph plots the aggregate demand curve for this economy.
Show the impact of the increase in the price level by moving the point along the curve or shifting the curve.
The change in the interest rate found in the previous task will lead to a      in residential and business spending, which will cause      in the quantity of output demanded in the economy.

Suppose the money market for some hypothetical economy is given by the following graph, which plots the money demand and money supply curves. Assume the central bank in this economy (the Fed) fixes the quantity of money supplied.Suppose the price level increases from 90 to 105.Shift the appropriate ...

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Posted by Cleveland on September 17, 2024
Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the $5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond.
The opportunity cost of holding the inheritance as money depends on the interest rate on the bond.
For each of the interest rates in the following table, compute the opportunity cost of holding the $5,000 as money.
Interest Rate on Government BondOpportunity Cost
(Percent)(Dollars per year)
9    
6    
What does the previous analysis suggest about the market for money?

Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the $5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond.The opportunity cost of holding the inheritance as m...

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Posted by Cleveland on September 17, 2024
Which of the following best describes how an expansionary monetary policy shifts aggregate demand?

d. The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right....

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Posted by Cleveland on September 17, 2024
Which of the following statements about stabilization policy is true?

d. Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policy....

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Posted by Cleveland on September 17, 2024
Which of the following is an automatic stabilizer?

c. Income taxes...

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Posted by Cleveland on September 17, 2024
When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of _______.

e. the investment accelerator...

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Posted by Cleveland on September 17, 2024