EC-312 Macroeconomic Theory

Fall 2013

Assignment 1

DUE Oct 14 in class

1. [20 points] State whether the statement is true or false. Provide brief explanation. If statement is

false, provide correct statement.

a. [10 points] Goods market is in equilibrium when consumption is equal income.

b. [10 points] Interest rate falls when the Central Bank sells bonds

2. [35 points] Suppose the United States economy is represented by the following equations:

Z = C + I + G C = 500 + .5YD T = 600 I = 300

YD = Y – T G = 2000

a. [10 points] Given the above variables, calculate the equilibrium level of output. Hint: First

specify (using the above numbers) the demand equation (Z) for this economy. Second, using

the equilibrium condition, equate this expression with Y. Once you have done this, solve for

the equilibrium level of output. Using the ZZ-Y graph (i.e., a graph that includes the ZZ line

and 45-degree line with Z on the vertical axis, and Y on the horizontal axis), illustrate the

equilibrium level of output for this economy.

b. [10 points] Now, assume that consumer confidence decreases causing a reduction in

autonomous consumption (c0) from 500 to 400. What is the new equilibrium level of

output? How much does income change as a result of this event? What is the multiplier for

this economy?

c. [5 points] Graphically illustrate the effects of this change in autonomous consumption on

the demand line (ZZ) and Y. Clearly indicate in your graph the initial and final equilibrium

levels of output.

d. [10 points] Briefly explain why this reduction in output is greater than (in absolute terms)

the initial reduction in autonomous consumption.

3. [10 points] Graphically illustrate and explain what effect a purchase of bonds by the Federal

Reserve will have on the money market.

4. [10 points] Explain in detail what effect a Fed sale of bonds will have on: (1) the LM curve; and (2)

the IS

5. [10 points] Explain in detail what effect a reduction in government spending will have on: (1) the

LM curve; and (2) the IS curve.

6. [5 points] Which of the following about IS relation is NOT correct? A) It is the the relation between interest rate and savings.

B) It is the equilibrium condition for the goods market.

C) It stands for “Investment equals saving.”

D) It shows what firms want to invest must be equal to what people and the government wants to

save.

7. [5 points] An open market sale of securities will tend to cause

A) a reduction in the supply of central bank money.

B) a reduction in the demand for currency.

C) a reduction in the demand for reserves.

D) none of the above

8. [5 points] Suppose there is an increase in consumer confidence. Which of the following represents

the complete list of variables that must increase in response to this increase in consumer

confidence?

A) consumption

B) consumption and investment

C) consumption, investment and output

D) consumption and output

E) consumption, output and the interest rate