BADM 685_Assignment 5

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University of the Cumberlands *

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Economics

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Apr 3, 2024

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Question One: If the reserve requirement for banks in an economy is 10 percent, how much money could be created with the deposit of an additional $5,000 into a deposit account? To calculate the potential money creation through the deposit, you can use the formula for the money multiplier: Money Created = Deposit Amount / Reserve Requirement Money Created = $5,000 / 0.10 (10 percent as a decimal) = $50,000 So, with a $5,000 deposit and a 10 percent reserve requirement, banks can create up to $50,000 in new money through loans and the deposit expansion process. Question Two: a. Determine the velocity of money circulation. Velocity of money (V) is given by the formula: V = (P x Y) / M Where:  P is the price per unit of output ($5)  Y is the real output (10,000 units)  M is the money supply ($5,000) V = ($5 x 10,000) / $5,000 = 10 b. Using the value for the velocity of money circulation from part (a), determine the change in price if money supply increases to $6,000. You can use the quantity equation of exchange to find the change in price (P): M x V = P x Y $6,000 (new money supply) x 10 (velocity) = P x 10,000 $60,000 = P x 10,000 P = $60,000 / 10,000 = $6 So, if the money supply increases to $6,000, the price per unit of output will increase to $6. Question Three: a. Determine the value of the fiscal multiplier. The fiscal multiplier (k) is given by the formula: k = 1 / (1 - MPC) Where MPC is the marginal propensity to consume. MPC = 85% = 0.85

k = 1 / (1 - 0.85) = 1 / 0.15 = 6.67 b. If the government increases its spending by $20 billion, by how much will the total income and spending increase? Total increase in income (ΔY) = Fiscal Multiplier (k) x Change in Government Spending (ΔG) ΔY = 6.67 x $20 billion = $133.4 billion So, if the government increases its spending by $20 billion, total income and spending will increase by $133.4 billion. Question Four: a. Which country has an absolute advantage in each of the commodities? Explain.  In wheat production, the U.S. has an absolute advantage because it can produce more bushels of wheat per hour (6) compared to the U.K. (1).  In cloth production, the U.S. also has an absolute advantage because it can produce more yards of cloth per hour (4) compared to the U.K. (2). b. Which country has a comparative advantage in each of the commodities? Explain. To determine comparative advantage, we need to calculate the opportunity cost of producing each commodity. Opportunity Cost of 1 Bushel of Wheat (U.S.): 4 yards of cloth Opportunity Cost of 1 Bushel of Wheat (U.K.): 2 yards of cloth Opportunity Cost of 1 Yard of Cloth (U.S.): 1.5 bushels of wheat (1/4 * 6) Opportunity Cost of 1 Yard of Cloth (U.K.): 0.5 bushels of wheat (1/2 * 1)  The U.S. has a comparative advantage in cloth production because its opportunity cost of producing 1 yard of cloth is lower (1.5 bushels of wheat) compared to the U.K. (2 bushels of wheat).  The U.K. has a comparative advantage in wheat production because its opportunity cost of producing 1 bushel of wheat is lower (0.5 yards of cloth) compared to the U.S. (4 yards of cloth). Question Five: a. Calculate the loss in consumer surplus arising from the imposition of the tariff. Before the tariff, the world price is $600. After the tariff, the domestic price is $660. Loss in consumer surplus = 0.5 * Tariff Rate * (Quantity Demanded Before Tariff - Quantity Demanded After Tariff) * (World Price - Domestic Price) Loss in consumer surplus = 0.5 * 0.10 * (3,500,000 - 3,000,000) * ($600 - $660) Loss in consumer surplus = $7,500,000 b. Calculate the gain in producer surplus arising from the imposition of the tariff.

Producer surplus increases due to the higher domestic price. Calculate the area of the producer surplus triangle. Gain in producer surplus = 0.5 * Tariff Rate * Quantity Produced After Tariff * (World Price - Domestic Price) Gain in producer surplus = 0.5 * 0.10 * 2,500,000 * ($600 - $660) Gain in producer surplus = $7,500,000 c. Calculate the change in government revenue arising from the imposition of the tariff. Government revenue is the tariff rate times the quantity imported after the tariff. Government revenue = Tariff Rate * Quantity Imported After Tariff * Tariff Price Government revenue = 0.10 * 1,500,000 * ($660 - $600) Government revenue = $900,000 d. Calculate the deadweight loss arising from the imposition of the tariff. Deadweight loss is the loss in total surplus due to the tariff. It includes both the loss in consumer surplus and the loss in producer surplus. Deadweight loss = Loss in Consumer Surplus + Loss in Producer Surplus Deadweight loss = $7,500,000 + $7,500,000 = $15,000,000

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