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1. The data provided represent Eastland's economy in 2018, when it was in short...
May 8, 2024
A
Key Concept
Actual Rate of Unemployment
Explanation
The actual rate of unemployment is the sum of the natural rate of unemployment and the cyclical rate of unemployment. Using the formula U=Unatural+Ucyclical, where Unatural=4% and Ucyclical=1%, the actual rate of unemployment is U=4%+1%=5%.
B
Key Concept
Expected Real Interest Rate
Explanation
The expected real interest rate is calculated by adjusting the nominal interest rate for expected inflation using the formula r=i−πe, where r is the real interest rate, i is the nominal interest rate, and πe is the expected inflation rate. With i=5% and πe=3%, the expected real interest rate is r=5%−3%=2%.
C
Key Concept
Phillips Curve
Explanation
The Phillips curve illustrates the inverse relationship between inflation and unemployment. The short-run Phillips curve (SRPC) shows this relationship for the short term, while the long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment, indicating no trade-off between inflation and unemployment in the long run. The equilibrium point E is plotted at the actual unemployment rate of 5% and the expected inflation rate of 3%.
D
Key Concept
Fiscal Multiplier and Aggregate Demand
Explanation
The fiscal multiplier effect describes how a change in government spending can lead to a larger change in aggregate demand. The change in aggregate demand (ΔAD) is calculated using the government spending multiplier formula ΔAD=1−MPC1×ΔG, where MPC is the marginal propensity to consume and ΔG is the change in government spending. With an MPC of 0.75 and ΔG=$20 million, the maximum possible change in aggregate demand is ΔAD=1−0.751×$20 million = \$80 million.
E
Key Concept
Loanable Funds Market and Real Interest Rate
Explanation
In the loanable funds market, an increase in government borrowing can lead to an increase in the equilibrium real interest rate due to higher demand for loanable funds. This is depicted by a rightward shift of the demand curve for loanable funds.
F
Key Concept
Long-Run Economic Growth and Financial Capital Inflows
Explanation
An increase in the real interest rate can negatively affect long-run economic growth by reducing investment spending due to higher borrowing costs. It can also attract more financial capital inflows as foreign investors seek higher returns on their investments in Eastland.$
Solution
a
In the long run, the self-adjustment mechanism in the economy of Antilly would involve changes in the wage and price levels. As the economy is experiencing an inflationary output gap, it implies that actual output is above potential output, leading to upward pressure on wages and prices. Over time, as wages and prices adjust upwards, the short-run aggregate supply (SRAS) curve will shift to the left, moving the economy back to its long-run equilibrium at the potential level of output
b
To decrease the inflation rate in the short run, the central bank of Antilly would likely increase the policy interest rate. This can be achieved by conducting open market operations where the central bank sells government securities to reduce the reserves in the banking system, thereby increasing the federal funds rate
c
The graph of the reserve market would show an increase in the federal funds rate as a result of the central bank's sale of government securities. The supply of reserves would decrease, shifting the supply curve to the left, and raising the policy rate
d
As a result of the increase in the policy rate, real output in Antilly is expected to decrease in the short run. Higher interest rates would lead to a decrease in investment and consumption, shifting the aggregate demand (AD) curve to the left, and reducing the inflationary pressure but also the output
Answer
a. The economy self-adjusts through wage and price level changes, shifting the SRAS leftward to potential output.
b. The central bank would increase the policy interest rate by selling government securities.
c. The reserve market graph would show a leftward shift in the supply of reserves and an increase in the policy rate.
d. Real output would decrease due to lower investment and consumption from higher interest rates.
Key Concept
Self-adjustment in the long run and central bank intervention in the short run
Explanation
The economy self-adjusts to its potential output in the long run through wage and price changes, while the central bank can use monetary policy to influence real output and inflation in the short run.
3(a) Solution
a
Decrease in Consumer Confidence: A decrease in consumer confidence typically leads to a reduction in consumption spending as consumers choose to save more and spend less due to uncertainty about the future
b
Impact on Price Level: With lower consumption, aggregate demand decreases. According to the aggregate demand and supply model, a decrease in aggregate demand leads to a lower price level in the short run
c
Impact on Unemployment: The decrease in aggregate demand results in lower production, leading firms to reduce their workforce, which increases unemployment in the short run
3(a) Answer
(i) The price level will decrease. (ii) Unemployment will increase.
Key Concept
Aggregate Demand and Aggregate Supply
Explanation
A decrease in consumer confidence reduces aggregate demand, leading to a lower price level and higher unemployment in the short run.
3(b) Solution
a
Impact on Net Exports: A lower price level in Singapore makes Singaporean goods and services cheaper relative to foreign goods and services, potentially increasing demand for exports
b
Supply of SGD in Foreign Exchange Market: As exports increase, foreign buyers need more SGD to purchase Singaporean goods, increasing the demand for SGD and reducing the supply of SGD in the foreign exchange market
3(b) Answer
(i) Singapore's net exports will likely increase. (ii) The supply of the Singapore dollar in the foreign exchange market will decrease.
Key Concept
Exchange Rate Dynamics
Explanation
A decrease in the price level can lead to increased net exports and a decreased supply of the domestic currency in the foreign exchange market due to higher demand from foreign buyers.
3(c) Solution
a
International Value of SGD: A decrease in the supply of SGD in the foreign exchange market, with demand holding constant or increasing, will lead to an appreciation of the SGD
3(c) Answer
The international value of the Singapore dollar will likely appreciate.
Key Concept
Currency Appreciation
Explanation
When the supply of a currency decreases in the foreign exchange market, its value tends to appreciate if demand remains constant or increases.
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