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Economics tuesday project - Assignment Example

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When government spending rises, it leads to a rise in real GDP as a first step and then leading to a rise in income. The extra amount of tax is deducted from this increased income only at the second stage and that is why the effect of the rise in real GDP for a rise in…
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Economics tuesday project
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Answer to Chapter 12 6. When government spending rises, it leads to a rise in real GDP as a first step and then leading to a rise in income. The extra amount of tax is deducted from this increased income only at the second stage and that is why the effect of the rise in real GDP for a rise in government expenses persists.
7. When government deficit rises, the government takes loans from banks leading to a shortage in the credit availability in the nation and thus a rise in interest rates. This rise in the rate of interest leads to a rise in the value of the national currency and thus a rise in the national price level in terms of foreign currency. Hence, exports drop leading to an international trade deficit.
8. During recessions, the government strives to increase the amount of real GDP and hence income in the economy. One way by which it can accomplish this is through increasing its expenditures and keeping its tax revenues low at the same time, which however leads to government budget deficit.
Answer to Chapter 13
7. A) A bank can always advance loans out of its excess reserves. Hence, out of $5,000, if the reserve requirements is 2%, then the maximum loan that Bank A can advance is, $4,900.
B) Due to the loan advanced by Bank A, money supply in the economy can increase by the amount of the initial deposit times the money multiplier. Now, the money multiplier formula is given by,
m = 1/R, where, R = Reserve requirement.
Hence, the maximum amount by which money supply can be increased = $ (5,000 x 1/0.02) = $ 250,000.
9. The factors which can cause the actual expansion of the money supply to differ from that given by the deposit expansion multiplier are -
i) A rise in the reserve requirement and
ii) A change of mind of a customer to keep the money with himself rather than deposit it in a bank.
Answer to Chapter 14
8. If the total deposits with the bank = $ 2,000,000 and the legal reserves of the bank = $ 220,000, then the banks excess reserves = $ (2,000,000 – 220,000) = $ 1,780,000.
A. Thus, if the reserve requirement is 10%, then, the maximum amount of loan that the bank can make = $ (1,780,000 – 178,000) = $ 1,602,000.
Again, the maximum increase in money supply possible in the economy if this amount of loan is advanced = $ (1,602,000 x 1/0.1) = $ 16,020,000
B. If the reserve requirement is lowered to 5%, then, the maximum loan that First Bank can advance = $ (1,780,000 – 89,000) = $ 1,691,000.
Again, the maximum increase in money supply in the economy in this case
= $ ( 1,691,000 x 1/0.05) = $ 8,455,000.
13. If the Fed increases money supply (M) (other things remaining equal), then,
a. Interest rates (r) fall. r


M
b. Money demand falls, since rise in money supply implies a rise in liquidity and thus a fall in the value of money.
c. Investment spending (I) rises since investors take this opportunity of a low value of money.
r r

M I
d. Aggregate demand rises.
e. The equilibrium level of national income rises due to rise in investment spending.
Bibliography
Mankiw, N. G. Principles of Macroeconomics (3rd Edition). Georgia: South-Western College Publication, 2003. Read More
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