Economics – short answers

Questions are short-answers questions. Please provide a complete explanation (wherever necessary) and show full working of the solution in numerical questions.

1. Economists occasionally speak of “helicopter money” as a shorthand approach to explaining increases in the money supply. Suppose the chair of the Federal Reserve flies over the country in a helicopter, dropping 10,000,000 newly printed $100 bills (a total of $1 billion). By how much will the money supply increase in the following scenarios, holding everything else constant:

a. all of the new bills are held by the public as currency?

b. allofthenewbillsaredepositedinbanksthatchoosetohold10percentoftheirdepositsasreserves (and no one in the economy holds any currency)?

c. all of the new bills are deposited in banks that practice 100-percent-reserve banking?

d. people int he economy hold half oft heir money as currency and half as deposits ,while banks choose to hold 10 percent of their deposits as reserves?

2. Construct a bank balance sheet with the following items: reserves, deposits, and loans. Choose values so that the reserve–deposit ratio is 10 percent.

3.a.Suppose a government decides to reduce its spending and (lump-sum) income taxes by the same
amount. Using the long-run model of the economy developed in Chapter 3, graphically illustrate the impact of the equal reductions in spending and taxes. Be sure to label the axes, the curves, the initial equilibrium values, the direction curves shift, and the terminal equilibrium values.

b.State in words what happens to (i) the real interest rate; (ii) national saving; (iii) investment; (iv) consumption; and (v) output.

4. Suppose a government has a tax revenue shortfall. Will hyperinflation inevitably follow unless the government cuts its fiscal expenditures?
5. Assume that the production function is given by Y = AK L , where Y is GDP, K is capital stock, and L is labor. The

parameter A is equal to 10. Assume also that capital is 100, labor is 400, and both capital and labor are paid for their marginal products.

a.What is Y?
b.What is the real wage of labor?
c.What is the real rental price of capital (the amount of output paid per unit of capital)?

6. As the U.S. economy approached the millennium, January 1, 2000, many people cautiously began to hold larger than normal quantities of currency as protection against a possible disruption of banking services that could result from computer glitches.

a.How did this greater preference for currency affect the money supply?
b.How could the Federal Reserve offset such an increase in currency preferences?

7. The production of an economy is explained by a function Y = 20 (L.5K.5), where L is labor and K is capital with L = 400 and K = 400. Does this economy support constant returns to scale?
8. “Some economists believe that the large decline in the money supply was the primary cause of the Great Depression of the 1930s.” Explain how this can be the case.