MICRO AND MACROECONOMICS By 15th, March C 2. A 3. B 4. C 5. C 6. D 7. D 8. A 9. B 10. A 11. B 12. C 13. C14. B 15. C 16. C 17. B 18. C 19. B 20. B 21. D 22. A 23. A 24. A 25. A 26. D 27. A 28. A 29. C 30. A 31. A 32. B 33. C 34. D 35. B 36. B 37. D 38. B 39. C 40. B 41. A 42. C 43. C 44. D 45. C 46. A 47. B 48. A 49. D 50. D 51. B 52. A 53. A 54. A 55. C 56. B 57. B 58. B 59. A 60. D Open-market operation involves the buying and selling of government bonds. Therefore, in a situation of high inflation, Fed sells government bonds and commercial bank reserves decreases by the amount of the bonds sold.
Money supply decreases in a multiple of the reduction in bank reserves. The demand for the bonds drops as fed sells and, therefore, interest rate on bonds increases. Open market operation is the most effective of the three monetary tools because of flexibility in selling and buying of government securities. Reserve ratio is the ratio of reserve required in the bank relative to customer’s deposits. The Fed has the power to increase the reserve ratio to check on high inflation.
Raising reserve ratio expands the commercial banks reserves and shrinks lending ability and also the money supply by a factor of the amount of the adjustment of the ratio. Discount rate is an interest rate that Fed changes from time to time to check on the level of inflation in the country. In a situation of high inflation, Fed raises the discount rate and thus makes borrowing by banks and customers more difficult due to high interest rate. Therefore, high discount rate shrinks the excess reserves and checks the money supply in circulation. Monetary contraction (Decrease in money supply) Monetary contraction results in decreased income, interest rates increases, consumption decreases, investment decreases and increased unemployment in the short run.
The effect of a decreased money supply on the IS/LM curve is a shift of LM1 to LM2. Interest rate rises from i1, to i2, and income decreases from Yn to Y1. In the diagram above, AD/AS curve AD1 shifts to the left to AD2 resulting to reduction in income from Yn to Y1 (panel A).
However, in the long run or medium run the effect of a reduction in money supply has no effect on both AD/AS and IS/LM as short run effects goes back to normal as shown in the diagram. 3. a) M1 include Checkable deposits 896 Currency 340 Total 1236 Billion b) M2= M1, small time deposits + money market mutual fund + saving deposits M2 = 1236 + 1260 +1290 +1750 + 850 = 6386 Billion. 4. a) Y = C + I + G At equilibrium, Y = 3.6, therefore while solving the economy’s problem using government spending only, then for the economy to realise full employment it has to spend extra government spending amounting to 4-3.6 = 0.4 trillion. b) The government need cut taxes amounting to 0.4 trillion for the economy to experience full employment.
4 = 3.6 + G, therefore, G = 0.4 c) In a case where the government operates under a balanced budget, the government taxes and spends only what it collect as taxes. Therefore, 3.6 = 0.8 + G G = 2.8 trillion