Fall 2001	ECONOMICS 1312	J.G. Gonzalez
	Problem Set # 3

 

            This problem set is due Tuesday, December 11, 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 Schweizerische Nationalbank (Switzerland’s Central Bank) decides to decrease the money supply in Switzerland.  In order to do that, it sells Sfr 300 million (Sfr  = Swiss Francs) worth of Swiss government bonds.  You are also told that as a result of this action, consumers decide to decrease their cash holdings by Sfr 70 million.

 

a)  If the required reserve ratio equals 4%, how much would Switzerland’s money supply decrease as a result of the Schweizerische Nationalbank action?

 

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

·  Each Sfr 2,328 million decrease in the money supply increases the rate of interest by 1 percentage point.

·  Each 1 percentage point increase in interest rates produces a Sfr 200 million decline in consumption spending

·  Each 1 percentage point increase in interest rates produces a Sfr 300 million decline in investment spending.

·  Each 1 percentage point increase in interest rates produces an appreciation of 4 percentage points in the value of the Swiss Franc.

·  Each 1 percentage point appreciation in the value of the Swiss Franc reduces net exports by Sfr 25 million.

·  The MPC = 0.85 and the MPM = 0.05.

·  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 decreases income taxes.

 

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:  South Korea and Japan; and that they produce only two commodities:  Guns and Roses.  To produce 1 ton of roses, South Korea uses 6 labor hours and Japan uses 4 labor hours.  To produce 1 gun, South Korea needs 20 labor hours, while Japan needs 10 labor hours.

 

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

 

b)  Before trade takes place, (1) What is the price of one gun in South Korea?  (2) What is the price of one gun in Japan?  (3) Where are guns cheaper?

 

c)  Assume that after trade opens up, one gun is traded for 3 tons of roses.  Prove that if workers in both countries want to consume 2 guns and 5 tons of roses, both of them would benefit from free trade.

 

 

4.  Visit the Federal Reserve Board of Governors web site (http://www.federalreserve.gov/).  Review the minutes from the October 2, 2001 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 2001.

 

b)  What action did the FOMC decided to take during the October 2, 2001 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 2001.  Use these data to calculate the difference between Potential GDP and Actual GDP for every quarter form 1991 until 2001.

 

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.