Housing in the US between 2006 and 2008 - Assignment Example

Q. 4 (Page 175) When price of commodities fall, consumers ability and willingness to buy at constant income increases and hence, the aggregate demand (AD) increases. The decline in cost of housing in the United States between 2006 and 2008 is among the factors that led to the 2008 recession. Several mortgage and subprime companies were declared bankrupt, with some opting out of business. Q. 6 (Page 175) The classical theorists argue that market forces can balance the smooth running of the economy without the risk of running into a crisis. However, the classic theory failed in 1929-1933 when the economy experienced both low prices of commodities and high unemployment. This is because as the country experienced inflation, the central bank raised interest rates to reduce inflation. High-interest rates reduce consumer spending, thus lowering the AD. Low AD will consequently reduce inflation; however, there is fewer consumers spending which means the real GDP is low. Firms are, therefore, not willing to hire more employees and thus, high rates of unemployment despite the low inflation. Q. 10 (Page 175) President Obamas response to the 2008 recession was the right decision. His government offered stimulus to the falling economy and resuscitate the crumbling housing industry. His policy led to a slow but sure recovery of the economy. P. 4 (Page 176) Price Level Output Demand($) Output Supplied($) 100 0 1000 100 900 100 a) Equilibrium occurs at price level 500 b) The demand curve would shift if equilibrium were to shift to price level 800 c) Supply curve P.5 (Page 176) a) GDP fell by 3.8% in the fourth quarter of 2008. b) At that rate, a total of $0.532 trillion would have been lost in the $14 trillion economy. c) The loss represented an approximate of $1,773 for each of the 300 million U.S. citizens. d) The largest percentage GDP decline in the post-World War II U.S. recession was 14.7% during the 1973-1975 recessions. P. 5 (Page 205) $1000=0.60 $2trillion= ? (2000000000000*0.6)/1000=$1.2 billion P.7 (Page 206) a) Consumer spending was 16 b) Investment spending was 22 P. 8 (Page 206) a) Equilibrium GDP=185 b) Equilibrium price Level=80 c) At real GDP=$200, the GDP gap is 25 d) The macro problem is inflation Q. 1 (Page 224) Declining cost of houses saw the companies unwilling to borrow and invest as a result of increased unintended investment Q. 3 (Page 224) When unwanted investments pile up in retail stores, production may not be hampered in the short run. However, products pile up may affect pricing, investment and at the long run, level of production. Q. 5 (224) Job losses in one industry affect incomes in other industries. For instance, job loss in construction industries means that the population’s income reduces. Therefore, the ability and willingness to buy things like clothes and leisure travels declines, thus affecting the clothing and travel industry. Q. 7 (Page 224) “Belt-tightening” by consumers is unwelcome in a recession because it lowers the amount of money available for investment, worsening the economic crises. P. 2 (Page 225) If C=$300 billion+ 0.9Y a) When Y=$4 trillion, C=$3.9 trillion b) Savings=$0.1 trillion P. 3 (Page 225) If the marginal propensity to consume (MCP) is 0.8 a) The multiplier is 1.25 b) Marginal propensity to save is 0.2 Q. 3 (Page 247) Aggregate demand remains constant when both transfer payments and taxes to pay them rises at the same rate Q. 7 (Page 247) China launched a fiscal stimulus in 2008 so as to boost domestic demand and avoid the booming global recession. Without the stimulus, China would have recorded a growth of between 5 and 6% as opposed to 8-9% growth recorded. P.1 (Page 248) Consider tax cut Example 236-37 Initial increase in consumption = MPC X Tax cut, Where Tax cut=$200billion, MPC=0.75 a) Consumer savings increased by MPC=0.75, therefore, MPS=0.25. Savings increase by (0.25x$200billion)=$50 billion b) Initial spending injection was Initial consumption injection = MPC X Tax cut Initial Spending Injection=0.75x$200billion = $150billion Q. 7 (Page 248) a) Households spent $91 more on appliances, electronics, and furniture when they received a 2008 tax rebate. b) Aggregate consumption increase= 110x$(91+87+60+32.7) =$29,777 c) If the MPC was 0.75, how much would cumulative spending increase as a result? Cumulative change in spending = 1 / (1 - MPC ) X Initial increase in consumption =1/ (1-0.75) x$29,777 =$119108 P. 8 (Page 249) a) Chinas 2008 fiscal stimulus was$586 billion b) Chinas GDP expected to grow by 8-9% as opposed to 5-6% without a stimulus c) President Obamas proposed fiscal stimulus was$787 billion P. 12 (Page 249) a) Rate of equilibrium GDP is 800 b) If full employment occurs at $880, Real GDP gap is $200 c) At full employment, price= 30 Q. 1 (Page 272) Revolutionary war was financed through the deficit debt. Whether the cost of deficit spending is passed on to the future generation is debatable. Economists argue that it is usually borne at the time of debt-financed activity; however, the benefits may persist even to the future generation. Others argue that if deficit spending is spent on consumption goods, the cost is transferable to the future generation Q. 2 (Page 272) Debts are desirable when the government wishes to expand the public sector without affecting the private sector output. Q. 4 (Page 272) Future generation may benefit from deficit spending in different ways. For example, deficit spending could raise economic growth in the future, finance projects such as infrastructure or be used to educate the future generation. Q. 5 (Page 272) There is no debt that can be considered as “too much” because it all depends on the economic situation, the purpose of the debt and the repayment mode. Q. 9 (Page 272) The time taken to repay the national debt is not static, could be immediate or long term. Q. 10 (Page 272) Cutting non-social security benefit could be more effective in resolving Social Security deficit. P. 2 (Page 273) Since 1980, the federal government had a budget surplus for four years P. 7 (Page 273) Suppose the government has no debt and a balanced budget. Suddenly it decides to spend $4 trillion while raising only $3 trillion worth of taxes. b) Governments deficit would be $1 trillion c) $1trillion worth bonds d) Annual interest $50 billion P. 10 (Page 273) a) Foreigners hold 31% of U.S. debt b) If the interest rate on U.S. Treasury debt is 4 percent (Assume a total debt of $16 trillion.), foreigners collect; 0.04x (0.31x$16trillion) = $198.4 billion each year from the U.S. Treasury Q. 1 (Page 292) People do not use credit cards to make payments but checking accounts through credit cards. Q. 5 (Page 292) To encourage longer term deposits because they use such deposits to issues loans at much more interest. Q. 6 (Page 293) Keeping a fraction of money in reserve should not make bankers uncomfortable. People do not rush to retrieve their bank deposits because they have confidence with the financial system. If everyone withdrew their deposits at the same time, banks could run into a crisis. Q. 9 (Page 293) Federal government insurance encourages greater risk-taking since they cover the risk of losing money to bad debtors. Banking would not be efficient without government deposits. Q. 2 (Page 294) a) Excess reserve= $40 b) Bank can lend $40 more Q.1 (Page 311) Banks want to hold as little excess reserves as possible because depositing excess reserves is an unprofitable procedure. Banks might want to hold excess reserves when the federal funds rate is higher. Q.4 (Page 311) China raised reserve requirement so as to reduce the amount of money in the economy. This would increase the cost of loans to the businesses and consumers. Q.5 (Page 311) FED may want to reduce the amount of the money supply so as to control inflation. Q.8 (Page 311) Bank loan volumes did not increase in 2008 Fed’s reduction of both discount and funds rates. The following might have been the constrained: Effects of the global economic recession such as poor export demand Commercial banks may have been reluctant to reduce their interest despite the reduced discount and fund rates Effects of deflation Perhaps commercial banks were not willing to lend Lack of market confidence from the investors as a result of the recession P.3 (Page 312) a) Money supply = (Transaction deposit+ Cash held by public)= $1200 billion b) Required reserves= (0.2x$800)= $160 c) Excess reserve= $200-$160= $ 40 P.9 (Page 313) Feds target for the funds rate in December 2008 hit its all-time low, set at 0% to 0.25% Q. 2 (Page 336) High-interest rates affect the demand for housing but have minimal effect on the price of a pizza because most people buy houses on borrowed money that is directly affected by change in interest rates. Q. 2 (Page 336) Equation of exchange, M.V=P.Q, Where, M= money supply in the economy, V= velocity of circulation P=price level in the economy Q= output produced by the economy If Fed mailed everyone with $100 bill, the money supply would reduce. This in turn reduces the quantity demanded and hence the value of output, Q. Consequently, decrease in demand causes a fall in prices. Q. 9 (Page 336) Banks were reluctant to lend to their capacity in 2008 so as to increase their Fed reserve. They did cross-bank lending with their excess reserves. Q. 9 (Page 336) Even at 0% mortgage rate, people would still be reluctant to buy home for fear that homes could eventually lose value. Also, most people are not ready to burden themselves with the responsibility of repaying the principle amount. In addition, people will be afraid that the rates may rise before a borrower has fully serviced the mortgage, thus increasing the amount. P. 2 (Page 337) Suppose homeowners owe $5 trillion in mortgage loans. a) If the mortgage interest rate is 7 percent, homeowners are paying approximately $350 billion annual mortgage interest. b) If the interest rate drops to 6 percent, annual interest payments decline by $50 billion. P. 7 (Page 337) Nominal interest rate – Inflation = Real interest rate 5 - Inflation = 3 Inflation is anticipated to be 2% P. 9 (Page 337) According to Bernankes rule of thumb (p. 320), $400 billion fiscal stimulus would be equivalent to a 2-point reduction in long-term interest rates. Read More