Submit your work at the beginning of class on Monday (July 23rd, 2017). You may work with other students but the write-ups must be unique. For calculation questions you must show your work in order to get partial credits. The write-ups MUST be handwritten.
PART I: SHORT ANSWER QUESTIONS
1. What is the budget deficit? How are budget deficits financed? Why do Keynesians believe that budget deficits will help the economy during a recession? (12 Points)
2. Imagine that the country is in a recession and the government decides to increase spending. It commissions a very large statue for $50 million. To pay for the statue, the government borrows all of the $50 million. As a result, the interest rate increases from 3% to 4%.
What is crowding out? (4 Points) Assuming total crowding out, what will happen to C, I , G and total AD as a result of the government action? (7 Points)
3. Assume very bad weather conditions that led to a notable decline in agriculture production in a predominantly agricultural economy. Use the AD-AS model to trace the effect of this shock. More specifically, answer the following questions (and draw a graph):
a) Which curve(s) will shift and in which direction? (7 Points)
b) Describe the SR effects of such a shock (7 Points)
c) How will the economy adjust in the LR? (7 Points)
d) Suppose that the terrible weather conditions extended for multiple years and the economy fell in a deep recession. From a Keynesian perspective, how can the economy get out of this recession? Show in a graph (7 Points)
ECON 121 Homework 2 Ayesha Jamal
e) Discuss possible factors that would weaken the government efforts to get out of the recession (discuss in detail here… do not just list)? (7 Points)
f) If the government decided to use monetary policy instead of fiscal policy, what type of monetary policy should the Fed follow? Discuss the possible tools that the Fed can use (14 Points)
5. What is the difference between commodity money and fiat money? Under which category does the Euro fall and why? (14 points)
PART II: PROBLEM SOLVING
1. In early 2009, the U.S. economy was in deep recession. The newly elected President, Obama, vowed to use fiscal stimulus spending on “shovel-ready” project. The projects are deemed shovel-ready because they had already been approved and were just waiting for funding. Obama hoped this stimulus plan would create new jobs. For the entire question, assume that in the short-run equilibrium, output is less than full- employment.
a. If the MPC = 0.5, what is the value of the government spending multiplier? (7 points)
b. Given the size of the multiplier, what would be the implied change in income (GDP) from the stimulus package of $800 billion? (7 points)