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Consider two economies - Avalon and Eternia. In Avalon, the central bank uses interest rates to conduct monetary policy. In Eternia, the central bank conducts monetary policy by changing the money supply. a Which economy would have a more effective monetary policy? Explain. Which country would have higher inflation? Explain. b Why can't Avalon and Eternia set both interest rates and money supply? c

Consider two economies - Avalon and Eternia. In Avalon, the central bank uses interest rates to conduct monetary policy. In Eternia, the central bank conducts monetary policy by changing the money supply. a Which economy would have a more effective monetary policy? Explain. Which country would have higher inflation? Explain. b Why can't Avalon and Eternia set both interest rates and money supply? c

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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← 2:12 Principles of Macroe... Vo LTE 4G+ R vecmeccssary: what would have happened to aggregate demand and aggregate output: 6 Consider two economies - Avalon and Eternia. In Avalon, the central bank uses interest rates to conduct monetary policy. In Eternia, the central bank conducts monetary policy by changing the money supply. a Which economy would have a more effective monetary policy? Explain. b Which country would have higher inflation? Explain. 33% c Why can't Avalon and Eternia set both interest rates and money supply? 7 This chapter explains that expansionary monetary policy reduces the interest rate and thus stimulates demand for consumption and investment goods. Explain how such a policy also stimulates imports, exports and overall net exports. (You may need to refer to chapter 13 to answer this question.) 8 Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion. a Is crowding out occurring in this case? Explain. b If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be? c Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one? a a decrease in government spending b an increase in the Australian corporate tax rate C an increase in interest rates 9 Suppose the government reduces taxes by $30 billion, that there is no crowding out and that the marginal propensity to consume is 3. a What is the initial effect of the tax reduction on aggregate demand? b What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand? c How does the total effect of this $30 million tax cut compare with the total effect of a $30 million increase in government purchases? Why? 10 Suppose consumers suddenly become more optimistic about their future incomes and decide to purchase $40 million more of additional goods and services. Will this change have a 'multiplier' effect on total output? Explain. 11 The Australian government is concerned about the growing budget deficit, so they decide to cut government expenditures by $15 billion. They also decide the economy needs a boost so they decide to cut income taxes by $40 billion. Would this simply mean a net increase in aggregate demand of $25 billion? Why or why not? 12 Suppose government spending declines and the RBA simultaneously decreases interest rates. What is the net effect on aggregate demand? What factors in the economy does your answer depend upon? 13 Assume the economy is in an expansionary phase. Explain how each of the following policies would affect consumption and investment. In each case, indicate any direct effects, any effects resulting from changes in total output, any effects resulting from changes in the interest rate and the overall effect. If there are conflicting effects making the answer ambiguous, say so. fierfluctuation Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-202 401/492 For various reasons, fiscal policy changes automatically when output and employment luctuate. a Explain why tax revenue changes when the economy booms. o Explain why government spending changes when the economy has high levels of inflation. If the government were to operate under a strict balanced-budget rule, what would it have to do in a booming economy? Would that make the boom more or less extre in response to a decrease in terest rates, would the following things be smaller, lar no different in the long run than in the short run? % a consumer expenditures o the inflation rate : the interest rate d aggregate output Suppose that the RBA decides to increase the interest rate. What will happen to the ney supply? Illustratur answer with an opriate diagram. What is the effect of this policy on the interest rate in the long run? How do you know?
Transcribed Image Text:← 2:12 Principles of Macroe... Vo LTE 4G+ R vecmeccssary: what would have happened to aggregate demand and aggregate output: 6 Consider two economies - Avalon and Eternia. In Avalon, the central bank uses interest rates to conduct monetary policy. In Eternia, the central bank conducts monetary policy by changing the money supply. a Which economy would have a more effective monetary policy? Explain. b Which country would have higher inflation? Explain. 33% c Why can't Avalon and Eternia set both interest rates and money supply? 7 This chapter explains that expansionary monetary policy reduces the interest rate and thus stimulates demand for consumption and investment goods. Explain how such a policy also stimulates imports, exports and overall net exports. (You may need to refer to chapter 13 to answer this question.) 8 Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion. a Is crowding out occurring in this case? Explain. b If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be? c Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one? a a decrease in government spending b an increase in the Australian corporate tax rate C an increase in interest rates 9 Suppose the government reduces taxes by $30 billion, that there is no crowding out and that the marginal propensity to consume is 3. a What is the initial effect of the tax reduction on aggregate demand? b What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand? c How does the total effect of this $30 million tax cut compare with the total effect of a $30 million increase in government purchases? Why? 10 Suppose consumers suddenly become more optimistic about their future incomes and decide to purchase $40 million more of additional goods and services. Will this change have a 'multiplier' effect on total output? Explain. 11 The Australian government is concerned about the growing budget deficit, so they decide to cut government expenditures by $15 billion. They also decide the economy needs a boost so they decide to cut income taxes by $40 billion. Would this simply mean a net increase in aggregate demand of $25 billion? Why or why not? 12 Suppose government spending declines and the RBA simultaneously decreases interest rates. What is the net effect on aggregate demand? What factors in the economy does your answer depend upon? 13 Assume the economy is in an expansionary phase. Explain how each of the following policies would affect consumption and investment. In each case, indicate any direct effects, any effects resulting from changes in total output, any effects resulting from changes in the interest rate and the overall effect. If there are conflicting effects making the answer ambiguous, say so. fierfluctuation Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-202 401/492 For various reasons, fiscal policy changes automatically when output and employment luctuate. a Explain why tax revenue changes when the economy booms. o Explain why government spending changes when the economy has high levels of inflation. If the government were to operate under a strict balanced-budget rule, what would it have to do in a booming economy? Would that make the boom more or less extre in response to a decrease in terest rates, would the following things be smaller, lar no different in the long run than in the short run? % a consumer expenditures o the inflation rate : the interest rate d aggregate output Suppose that the RBA decides to increase the interest rate. What will happen to the ney supply? Illustratur answer with an opriate diagram. What is the effect of this policy on the interest rate in the long run? How do you know?
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Step 1: Describe the role of central banks

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Central banks regularly monitor business expectations when making monetary policy decisions in order to analyze economic projections while successfully communicating with the public. Weak monetary policy can result in enormous production gaps, macroeconomic instability, perilous global financial circumstances, and incorrect inflation expectations.

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