Principles of Economics, 7th Edition (MindTap Course List)
7th Edition
ISBN: 9781285165875
Author: N. Gregory Mankiw
Publisher: Cengage Learning
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Chapter 34, Problem 5QCMC
To determine
Crowding out effect.
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In one or two sentences, explain why Keynesian economists believe that increasing the money supply will be effective at increasing aggregate demand in the short run.
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- The United States is at full employment when the Fed cuts the quantity of money, other things remaining the same. Which explains correctly the sequence of effects and the effect of the cut in money supply on aggregate demand? 1. We start with the money market equilibrium. The money supply curve shifts to the right and the rate of interest rises. This will decrease real investment that we can see from the Investment demand function. The AE curve will move down as investment (Ibar) declines. This will shift the AD to the left. 2. We start with the money market equilibrium. The money supply curve shifts to the left and the rate of interest rises. This will increase real investment that we can see from the Investment demand function. The AE curve will move down as investment (Ibar) declines. This will shift the AD to the left. 3. We start with the money market equilibrium. The money supply curve shifts to the left and the rate of interest rises. This will decrease real…arrow_forwardIf the Bank of Canada believes the economy is about to fall into recession, what actions should it take? If the Bank of Canada believes the inflation rate is about to increase, what actions should it take? If the Bank of Canada believes the economy is about to fall into recession, it should A. use an expansionary fiscal policy to increase the interest rate and shift AD to the right. B. use a contractionary monetary policy to lower the interest rate and shift AD to the left. OC. use its judgment to do nothing and let the economy make the self adjustment back to potential GDP. O D. use an expansionary monetary policy to lower the interest rate and shift AD to the right. If the Bank of Canada believes the inflation rate is about to increase, it should O A. use a contractionary fiscal policy to increase the interest rate and shift AD to the left. O B. use an expansionary monetary policy to lower the interest rate and shift AD to the right. OC. use a combination of tax increases and…arrow_forwardSuppose government spending increases. Would the effect on aggregate demand be larger if the Federal Reserve held the money supply constant in response or if the Fed were committed to maintaining a fixed interest rate? Explain.arrow_forward
- The money supply has risen, but total spending has declined. Is this state of affairs possible? Explain your answer.arrow_forwardSuppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, the central bank must a. decrease the money supply, which will move output back towards its long-run level. b. decrease the money supply, which will move output farther from its long-run level. c. increase the money supply, which will move output back towards its long-run level. d. increase the money supply, which will move output farther from its long-run level.arrow_forwardGiven the following information about the economy, determine the appropriate economic policy as well as the expected impact of the policy: Percent change in GDP: 7.9% Unemployment rate: 2.7% Inflation: 5.3% a The Fed should reduce the money supply by selling bonds, which will decrease the monetary base and increase the Fed Funds Rate. General interest rates will rise, and the AD curve will shift to the left. b The Fed should reduce the money supply by buying bonds, which will decrease the monetary base and increase the Fed Funds Rate. General interest rates will rise, and the AS curve will shift to the right. c The Fed should increase the money supply by buying bonds, which will increase the monetary base and decrease the Fed Funds Rate. General interest rates will remain unchanged. d The Fed should do nothing as the economy is in an expansion.arrow_forward
- can you answer this for mearrow_forwardA country's central bank is engaging in monetary contraction, with M going from M0=40 to M1=20. Its economy is as follows. Goods: slc = 3 MPC = 0.7 G = 10 T = 9 Before the policy, the goods market equilibrium is at Y0 = 54. Financial: I = 18-200r Before the policy, the loans market equilibrium is at r = 4.25% and I = 9.5 Money: M0 = 40 P0 = 2 M/P = 0.02 / (r - Y/5000)^2 and finally, Labor: w = MPL = 0.5 * 4.5 * 16^0.5 / L^0.5 w = EP / P0 * L^0.5 Where workers currently expect the price level of EP=2. How does the monetary contraction directly and immediately affect the goods market? There are four endogenous variables that adjust in response to shock/policy: Y, I, r, P. The policy variable of interest is M. Therefore, let's approach our solution by first recognizing that all other letters are just constants and plug them in. For example: Y = 2 + 0.5(Y-6)+7+I becomes Y = 12 + 2*I First, express the goods market as expenditure being a linear function of investment I of the form: Y = a…arrow_forwardA country's central bank is engaging in monetary contraction, with M going from M0=40 to M1=20. Its economy is as follows. Goods: slc = 3 MPC = 0.7 G = 10 T = 9 Before the policy, the goods market equilibrium is at Y0 = 54. Financial: I = 18-200r Before the policy, the loans market equilibrium is at r = 4.25% and I = 9.5 Money: M0 = 40 P0 = 2 M/P = 0.02 / (r - Y/5000)^2 and finally, Labor: w = MPL = 0.5 * 4.5 * 16^0.6 / L^0.5 w = EP / P0 * L^0.5 Where workers currently expect the price level of EP=2. - There are four endogenous variables that adjust in response to shock/policy: Y, I, r, P. The policy variable of interest is M. Therefore, let's approach our solution by first recognizing that all other letters are just constants and plug them in. For example: Y = 2 + 0.5(Y-6)+7+I becomes Y = 12 + 2*I First, express the goods market as expenditure being a linear function of investment I of the form: Y = a + b*I 1. How does the monetary contraction directly and immediately affect the…arrow_forward
- Classify each description according to whether or not it can cause aggregate demand to increase. Answer the bank in the images below. Can cause aggregate demand to increase Will not cause aggregate demand to increasearrow_forwardThe answer choices for the blanks are Blank 1: fall, remain the same, rise Blank 2: remain the same, rise, decline Blank 3: international trade, real balance, interest-ratearrow_forwardGraphically show and link the long-run equilibrium in goods market and money market, using MD-MS diagram, Investment Expenditure diagram, AE-Y diagram, and AD-AS diagram. a. Clearly explain (using chain reactions) and show the short-run effect of an increase in money supply on the equilibrium of this economy. Make sure you clearly show the impact in all diagrams. b. In the same way, explain and show the long-run effect of the increase in money supply noting that your answer to this question picks up where you finished in part (a) and describes the adjustment process according to the output gap. c. Clearly describe based on your graphs, the long-term neutrality of money. d. Is the composition of Y* any different after the new long-run equilibrium establishes?arrow_forward
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