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Chapter 1

ECO349H5 Chapter 1: HW1 - Goods, Money markets

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Michael H O

ECO202: Homework Assignment 1 1. Read the statements below carefully. Decide whether the underlined statement is true, false or uncertain and explain the arguments for your answer. If any sentences appear before the underlined statement, it provides information to you about the scenario – it is true. Answers without an explanation will not receive credit. If the answer you give is based on any assumptions, be sure to state them clearly; otherwise, you will not receive full marks. a. An increase of one unit in government spending leads to an increase of one unit in equilibrium output. b. If both government spending and taxes increase by the same amount, the IS curve does not shift. c. The IS curve is downward sloping because goods market equilibrium implies that an increase in taxes leads to a lower level of output. d. All markets are in equilibrium. True, False, or Uncertain: To encourage economic growth, the Central Bank should engage in a course of monetary policy that will lead to a decrease in money demand and an increase in bond demand. e. All markets begin in equilibrium. True, False, or Uncertain: When the Federal Government works towards reducing the budget deficit, they will also inadvertently cause investment levels in the economy to decrease. 2. Consider the following closed economy, where Y is tne level of GDP that the government would like GDP to equal. C = 100 + 0.75Y d T = 100 Yn= 525 I = 125 – 5i (M/P) = 0.1Y – 2i G = 100 (M/P) = 60 a. Derive equations for the IS and LM curves. The final equation should have interest rate as a function of Y (i on the left hand side, Y on the right hand side of the equation). b. What is the equilibrium level of output and interest rate? Note: the interest rate will already be expressed as a percent. For example, if i = 1, the interest rate is 1%. c. Using your answer from above, what type of fiscal policy would move the economy to Y = 525? d. Using your answer from above, what type of monetary policy would move the economy to Y = 525? 3. Suppose the government and Central Bank together want to keep GDP constant, but raise the level of investment. Using a policy mix, what policies can they follow to achieve this? Using an IS-LM graph, show the effect before and after the policies. Explain the effect on Y, I, and i. 4. Suppose you’ve been hired by the Government of Canada as an economic consultant to help make some policy recommendations. You’ve been given the following information about the domestic closed-economy: the consumption function can be described as 5,0000.5Y D ; the 1 investment function has been estimated to be 200  Y350i ; government spending is currently equal to $2,200; lump-sum taxes are currently equal to $2,200; and the estimated 100 money demand function is 30 Y  2000i . You are also told that the Bank of Canada has currently set the nominal money stock to be equal to $100,000. The Government of Canada’s goal is to increase GDP to $35,000, but they cannot decide between the two fiscal policy tools (taxes or government spending). They’ve asked you to accomplish three tasks. Note: interest rates in this question are quoted as integers, not in decimals (for example: i = 1 means interest rates are 1%). a. If they decided to change taxes (while keeping government spending the same), determine what the new lump-sum tax amount should be set equal to in order to achieve their previously stated goal. b. If they decided to alter levels of government spending to raise GDP (while keeping taxes the same), determine what the new level of government spending should be. c. If the change to taxes (ΔT) and change in government spending (ΔG) for the first two tasks are different, please explain why. 5. Assume that the closed-econ
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