| Fall 1997 | ECONOMICS 1312 | J.G. Gonzalez |
Problem Set # 3
This problem set is due Tuesday, December 9, 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. De Nederlandsche Bank (the Netherlands' Central Bank) decides to decrease the money supply. In order to do that, it sells 200 G million (G = Guilders -the Netherlands' currency-) worth of Netherlands' government bonds. You are also told that as a result of this action, consumers decide to decrease their cash holdings by 40 G million.
a) If the required reserve ratio equals 20%, how much would the Netherlands' money supply fall as a result of De Nederlandsche Bank action?
b) Calculate the change in the Netherlands' GDP resulting from the variation in the money supply described above. In order to do this, take into consideration the following facts:
·
Each 336 G 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 20 G million decline in consumption spending.·
Each 1 percentage point increase in interest rates produces a 50 G 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 Guilder.·
Each 1 percentage point appreciation in the value of the Guilder reduces net exports by 5 G million.·
The MPC = 0.8 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 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: Timbaland and Magoo; and that they produce only two commodities: Cranberries and Pumpkins. To produce 1 ton of cranberries, Timbaland uses 15 labor hours and Magoo uses 4 labor hours. To produce 1 ton of pumpkins, Timbaland needs 7 labor hours, while Magoo needs 3 labor hours.
a) Which country has (1) absolute advantage in the production of cranberries, (2) absolute advantage in the production of pumpkins, (3) comparative advantage in the production of cranberries, (4) comparative advantage in the production of pumpkins?
b) Before trade takes place, (1) What is the price of one ton of cranberries in Timbaland? (2) What is the price of one ton of cranberries in Magoo? (3) Where are cranberries cheaper?
c) Assume that after trade opens up, one ton of cranberries is traded for 1.85 tons of pumpkins. Prove that if workers in both countries want to consume 3 ton of cranberries and 2 tons of pumpkins, 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 most recent 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 1997.
b) In your opinion, what do the minutes indicate about possible action by the FOMC? Why is the FOMC leaning in that direction?