Econ 2102 Intermediate Macroeconomics Fall 2015 Problem Set 2- Tax and Government Multipliers

Raul Razo-Garcia Econ 2102

Department of Economics Intermediate Macroeconomics

Carleton University Fall 2015

Problem Set 2

Due on October 22nd at the beginning of Lecture.

1 Tax and Government Multipliers [3 points]

Two identical countries, Country A and Country B, can each be described by a Keynesian-cross model.The MPC is 0.8 in each country. Country A decides to increase spending by $1 billion, while Country B decides to cut taxes by $1 billion. In which country will the new equilibrium level of income be greater?

Do not forget to include the formulas you need to use to answer the question and your calculations.

3 Shocks to the Aggregate Supply [4 points]

Suppose that an oil cartel effectively increases the price of oil by 50 percent, leading to a supply shock in both Country A and Country B. Assume that both countries were in long-run equilibrium (full employment) at the same level of output and prices at the time of the shock.

(a) Describe the short-run impact of this supply shock on prices and output in each country. Do not

forget to support your answer with a graph. [1 point]

(b) Now assume that the central bank of Country A takes no stabilizing-policy actions (i.e. central bank of Country A does not try to stabilize output). After the short-run impacts of the adverse supply

shock become apparent, the central bank of Country B increases the money supply to stabilize

output. Compare the long-run impact of the adverse supply shock on prices and output in each

country. Support your answer with a graph. [3 points]

4 Quantity Theory of Money. [2 points]

Consider a money demand function that takes the form Md

P =

Y

i

, where M is the quantity of money, P is the price level, Y is real output, and i is the nominal interest rate (measured in percentage points).

(a) What is the velocity of money if the nominal interest rate is constant? [1 point]

(b) How will the level of the velocity of money change if there is a permanent (one time) decrease in the nominal interest rate, holding other factors constant? [1 point]

5 Stabilization Policy [4 points]

Let’s examine how the goals of the Central Bank (BoC) influences its response to shocks. Suppose central bank A cares only about keeping the price level stable, and central bank B cares only about keeping output at its natural rates. Explain how each central bank would respond to (support your answer with a graph):

(a) An exogenous decrease in the velocity of Money.

6 Aggregate Demand [9 points]

Suppose the Central Bank of Brazil decides to increase supply of money by 10 percent.

(a) What happens to the aggregate demand curve [2 points]?

(b) What happens to the level of output and the price level in the short run and in the long run? [4 points]

(c) What happens to the real interest rate in the short run and in the long run? [3 points]

7 Keynesian Cross [2 points]

Assume that the government reduces taxes (T). Show graphically, how this Tax cut affects the Keynesian Cross and the equilibrium income. Label your graph properly and provide additional explanations. [2 points]

refer attachment for complete questions

Q2 given in attachment is not to be done