ECON 1BB3 Lecture Notes - Money Supply, Interest Rate

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Published on 20 Sep 2012
School
McMaster University
Department
Economics
Course
ECON 1BB3
CHAPTER 15 HOMEWORK ANSWERS
Suggested problems: 1,2,4,5,6,8,9,10,11.
1. a. Increase in money supply. Interest rate falls.
b. Decrease in money demand. Interest rate falls.
4. a.
()
3/2 3/11 11*3 11
3
11
=
=
=
=
=
MPC
MPC
MPC MPC
MPC
multiplier
b. If there is crowding out, then the multiplier would be larger than 3, so the
MPC would be larger than the answer in part (a).
5. a. Consumption would increase by 3/4 of $20 billion, or $15 billion (AD
shifts out by $15 billion).
b. There is a multiplier effect here - the AD curve will shift out by $15
billion * multiplier (which is 4) - AD shifts out by $60.
c. If the government had increased spending by $20 billion, the outward AD
shift would be $80 billion - this is because only part of a tax cut is spent,
the rest is saved.
6. If G increases, the AD curve shifts out to the right. As money demand increases
due to higher income levels, the interest rate rises and there is crowding out (the
AD curve shifts back to the left a bit). If the Bank of Canada wants to maintain
interest rates at a constant level, they will increase the money supply. The interest
rate does not change and there is no crowding out. So the AD curve shifts out by
more if the Bank of Canada maintains a constant interest rate.
9. Flexible ER – if the world interest rate rises, there is now excess money demand
at the initial Canadian interest rate. People try to buy foreign assets, so they need
to buy foreign currency and sell Canadian dollars. The nominal exchange rate
goes down in Canada, which causes NX to rise, the AD curve to shift out, and Y
to rise – thus the Md curve shifts out in the money market diagram until Ms and
Md intersect at the new, higher, world interest rate.
Fixed ER – when people try to buy foreign currency and sell C$, the BofC buys
the C$ in order to keep e fixed. The removal of the C$ from the market causes
the Ms curve to shift in to the left until it intersects the original Md curve at the
new, higher, world interest rate. The exchange rate does not change and the AD
curve does not shift.
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Document Summary

If there is crowding out, then the multiplier would be larger than 3, so the. Mpc would be larger than the answer in part (a). Consumption would increase by 3/4 of billion, or billion (ad shifts out by billion). There is a multiplier effect here - the ad curve will shift out by billion * multiplier (which is 4) - ad shifts out by . If the government had increased spending by billion, the outward ad shift would be billion - this is because only part of a tax cut is spent, the rest is saved. If g increases, the ad curve shifts out to the right. As money demand increases due to higher income levels, the interest rate rises and there is crowding out (the. Ad curve shifts back to the left a bit).

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