Assignment 3 final exam -Define the following concepts

Assignment 3Due Date & Place: To be handed in on the day of the final exam,just before the exam, in the exam room.Consider this assignment as a partial step towards your preparation for the final exam. 1. Define the following concepts (maximum two sentences each) Potential OutputRecessionary GapInflationary GapRecessionEmploymentLabour forceUnemployment rateFrictional UnemploymentStructural UnemploymentCyclical UnemploymentLabour productivityCPIThe price levelInflationInterest rateReal interest rateExchange rateDepreciationAppreciationValue addedGDPCapital stockInvestment ExpendituresGNPDisposable Personal IncomeGDP deflatorAutonomous aggregateexpendituresInduced aggregate expendituresConsumption functionAggregate expenditure function Average propensity to consumeMarginal propensity to consumeAverage propensity to saveMarginal propensity to saveMarginal propensity to spendSimple multiplierFiscal policyBudget surplusStabilization policyAggregate demand curveAggregate supply curveUnit cost of productionAggregate supply shockAggregate demand shockPhillips curveEconomic growthOpportunity cost of economicgrowthMedium of exchangeGresham’s LawFiat moneyDeposit moneyReserve ratioTarget reserve ratioExcess reservesMoney supplyM2IOUsPresent valueBond priceBond yields Page 1 of 5 2. How does the difference between the trends in actual GDP and potential GDP helpdefine business cycles? In this respect, define trough, recovery, and peak. 3. The value of CPI in April 2009 was 113.9 and in April 2008 it was 113.5.a.Calculate the rate of inflation during that one year expressed in percentageterms.b.How much is the CPI in the base year?c.Calculate the rate of inflation during the year ending in April 2008. 4. Imagine that your friend lends you $100 and that the loan is repayable in one year.a.If you are to pay her $108 in one year’s time, determine the principal, interestpayment, and the nominal interest rate.b.If you are to pay 10% nominal interest on this loan, how much do you have topay her at maturity?c.In the case of part (b), if the inflation rate is 6% per year, how much is the realinterest rate?d.If the inflation rate is higher than that of in part (c), who is benefiting and whois losing in terms of purchasing power? 5. What is the difference between CPI and GDP deflator? 6. Consider three economies, A, B, and C. Aggregate desired expenditure (AE) ineconomy A is composed of only consumption expenditures and Investment, in economyB is composed of consumption expenditures, investment expenditures, and governmentpurchases, and in economy C is composed of all those expenditures in Economy B plusnet exports expenditures.a.Assume appropriate parametric functions for each component of the AE andright down a parametric system for each economy that defines the economy.b.Derive the formula for aggregate expenditure function for each economy as afunction of autonomous expenditures and induced expenditures.c.What are the differences in the formula and size of the marginal propensity tospend between the three economies?d.What are the differences in the formula and size of the simple multiplierbetween the three economies?e.If a similar change in autonomous expenditures is introduced in the threeeconomies, in which one you expect a bigger change in equilibrium GDP?Page 2 of 5 f.g. h. i. 7. Under the same scenario as in part (d), in which economy you expect a biggerhorizontal change in the aggregate demand curve?Adding a linear supply curve that is exactly the same for all three economies(in terms of slope and intercepts) to the picture, under the same scenario as inpart (d), in which economy you expect a bigger increase in the price level?How does the change in price level in any of these economies depend on theslope of the aggregate supply curve? (i.e., assume a steeper/less steep AScurve.)Explain and graphically show all the changes (including all the steps) in theAE, AD, and AS curves in a 45-degree diagram (for AE) linked with a demandand supply diagram, for an exogenous increase in the autonomous expendituresin economy C. (See Figure 23-8 on page 581 of the text-book only after you tryto answer this part yourself for a comparison and if you find it difficult.) Consider a typical aggregate demand and supply curve of an economy operating at itslong-run equilibrium.a.Express the condition for long-run equilibrium and graphically show the longrun equilibrium of this economy in an AD-AS diagram.b.Explain and graphically show how a positive AD shock affects the short-runequilibrium of this economy. How do the price level and rGDP change in theshort term as a result?c.Does the positive AD shock result in a recessionary gap or an inflationary gap?Explain and clearly indicate the size of the gap.d.What does this short-term output gap imply in terms of the rate of usage offactors of production compared to the normal rate indicated by potential output:higher rate of usage or lower than the normal rate?e.How does rate of usage of factors of production you indicate in part (d) impactthe price of factors of production?f.What does the impact you identify in part (e) imply in terms of the unit cost ofproduction for firms?g.What does the impact you identify in part (f) imply in terms of the profits offirms if the price of their product, quantity of production, and amount of factorsof production they use for production remain constant?h.To remain as profitable as before, firms should increase their price at all levelsof production level in response to the impact on their unit-cost of productionthat you identified in part (f). What does it mean in terms of the position of theaggregate supply curve? Page 3 of 5 i. 8. Now that you know all the steps, explain the whole process of transition to anew long-run equilibrium after the same positive demand shock in (b). Clearlyindicate the reason why the AS curve shifts, if it does at all.(You should be able to analyse all these steps for a negative AD shock, positiveAS shock, and negative AS shock as well. The positive or negative AD shockscould be due to implementation of government fiscal policies. If you findanswering this question difficult, see chapter 24 (figures and the associatedexplanations) in the textbook. You should also be able to compare thecomposition of long-run equilibrium output between the initial long-runequilibrium and the new long-run equilibrium. See, e.g., the same chapterunder Fiscal Policy and Growth. ) Consider a new deposit to the Canadian banking system of $1000. Suppose that allcommercial banks have a target reserve ratio of 10 percent and there is no cash drain.The following table shows how deposits, reserves, and loans change as the new depositpermits the banks to create money.Round Change in Deposits Change in Reserves Change in Loans First $ 1,000 $ 100 $ 900 Second ________ ________ ________ Third ________ ________ ________ Fourth ________ ________ ________ Fifth ________ ________ ________ a. b.c.d. The first round has been completed in the table. Now, recalling that the newloans in the first round become the new deposits in the second round, completethe second round in the table….plete the entire table.After the fifth round, what is the total change in deposits so far as a result ofthe single new deposit of $1,000?This deposit-creation process will go forever. On the limit (the end of forever!),the total change in reserves becomes equal to the value of the single newdeposit of $1,000. I.e., until the new single deposit is completely held in thebanking system as reserves. We saw in class and this infinite process moneycreation has a finite sum. Essentially, we showed that the eventual total changePage 4 of 5 e. 9. in deposits is equal to 1? times the new deposit (or total change in reserves,as they are the same at the limit), where is the target reserve ratio. What is theeventual total change in deposits in this case?What is the eventual total change in reserves? What is the eventual change inloans? Graphically show and link the long-run equilibrium in goods market and money market,using MD-MS diagram, Investment Expenditure diagram, AE-Y diagram, and AD-ASdiagram.a.Clearly explain (using chain reactions) and show the short-run effect of anincrease in money supply on the equilibrium of this economy. Make sure youclearly show the impact in all diagrams.b.In the same way, explain and show the long-run effect of the increase in moneysupply noting that your answer to this question picks up where you finished inpart (a) and describes the adjustment process according to the output gap.c.Clearly describe based on your graphs, the long-term neutrality of money.d.Is the composition of Y* any different after the new long-run equilibriumestablishes. 10. Clearly describe the importance of long-run economic growth. List and briefly explainthe costs and benefits associated with long-run economic growth? Specifically, clearlyexplain why current material standard of living should be sacrificed to gain higherfuture material standard of living. Page 5 of 5

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