Fall 2000	ECONOMICS 1312	J.G. Gonzalez
	Problem Set # 3

 

            This problem set is due Tuesday, December 5, at the beginning of the class period.  Problem sets done on notebook paper or unstapled will not be accepted.  Late problem sets are unacceptable also.

 

1.  The Bank of Japan (the Japanese Central Bank) decides to increase the money supply in Japan.  In order to do that, it buys ¥ 150 billion (¥ = Japanese Yen) worth of Japanese government bonds.  You are also told that as a result of this action, consumers decide to increase their cash holdings by ¥ 50 billion.

 

a)  If the required reserve ratio equals 5%, how much would the Japanese money supply increase as a result of the Bank of Japan’s action?

 

b)  Calculate the change in the Japanese GDP resulting from the variation in the money supply described above.  In order to do this, take into consideration the following facts:

·  Each ¥ 410 billion increase in the money supply reduces the rate of interest by 1 percentage point.

·  Each 1 percentage point decline in interest rates stimulates ¥ 30 billion of new consumption spending.

·  Each 1 percentage point decline in interest rates stimulates ¥ 100 billion of new investment spending.

·  Each 1 percentage point decline in interest rates produces a depreciation of 2 percentage points in the value of the Japanese Yen.

·  Each 1 percentage point depreciation in the value of the Japanese Yen increases net exports by ¥ 50 billion. 

·  The MPC = 0.90 and the MPM = 0.30

·  The economy is producing under potential output.

 

 

2.  Assume that the economy is in the middle of a recession and that the government wants to revive it.  With that purpose in mind, the Federal Government increases expenditures on welfare programs.

 

a)  What predictions would you make about the effects of this policy if you were a true monetarist and a firm believer of the Quantity Theory of Money.  Explain fully and include a diagram in your answer.

 

b)  What predictions would you make if you were a mainstream economist.  Explain fully and include a diagram in your answer.

 

c)  What predictions would you make if you were a classical economist.  Explain fully and include a diagram in your answer.

 

 

3.  Assume that there are only two countries in the world:  Nirvana and Baha; and that they produce only two commodities:  Pearls and Jam.  To produce 1 pearl, Nirvana uses 3 labor hours and Baha uses 8 labor hours.  To produce 1 ton of jam, Nirvana needs 11 labor hours, while Baha needs 36 labor hours.

 

a)  Which country has (1) absolute advantage in the production of pearls, (2) absolute advantage in the production of jam, (3) comparative advantage in the production of pearls, (4) comparative advantage in the production of jam?

 

b)  Before trade takes place, (1) What is the price of one ton of jam in Nirvana?  (2) What is the price of one ton of jam in Baha?  (3) Where is jam cheaper?

 

c)  Assume that after trade opens up, one ton of jam is traded for 4 pearls.  Prove that if workers in both countries want to consume 10 pearls and 2 tons of jam, both of them would benefit from free trade.

 

 

4.  Visit the Federal Reserve Board of Governors web site (http://www.bog.frb.fed.us/).  Review the minutes from the October 3, 2000 meeting of the Federal Open Market Committee.

 

a)  Based on the information available in those minutes, write a short summary describing the state of the U.S. economy during the third quarter of 2000.

 

b)  What action did the FOMC decided to take during the October 3, 2000 meeting?  Why did the FOMC take that action?

 

c)  What do the minutes indicate about possible future action by the FOMC?  Why is the FOMC leaning in that direction?

 

 

5.  Visit the Federal Reserve Bank of St. Louis’ FRED web site (http://www.stls.frb.org/fred/).  Click on “Gross Domestic Product and Components.”

 

a)  Click on “Real Gross Domestic Product in Chained 1996 Dollars” and on “Real Potential Gross Domestic Product.”  Write down the figures for these indicators for every quarter from the first quarter of 1991 until the third quarter of 2000.  Use these data to calculate the difference between Potential GDP and Actual GDP for every quarter form 1991 until 2000.

 

b)  Use the information found for part a) to answer the following questions:  What direction should U.S. Fiscal and Monetary policies have today?  Should they be expansionary?  Should they be contractionary?  Explain.