Answer these questions

Economics 104 (M. Bahmani)

Fall 2014

Take home Problem Set # 3

Direction: Please return your answers to the following problems to your own TA during the week of December 8th. Your TA is instructed to provide the answers during the same week. This problem set worth 10 points.

Note 1: If you have your discussion section on Friday December 12th, please attend another DIS with your own TA since classes are done on December 11th.

Note 2: Any dispute about midterm exams, take homes, attendance, etc. must be resolved with your TA before the final exam since some of the TAs graduate and leave UWM. However, I will keep your final with me.

I. Answer questions 4 and 8 on page 278. (also practice 5 on the same page and check your answers with those at the end of the book.)

II. Now consider the following model and answer related questions.

Y = C + I + G + X - IM

C = 49 + 0.9DI

I = 300 - 2000r

G = 800

T = 10 + 1/3(Y)

X - IM = 60

a. If fed decides to set the interest rate at r = 0.05, how much will be the equilibrium GDP?

b. At that rate how much is budget deficit or surplus?

c. By how much GDP will change if government cuts tax rate from 1/3 to

0.20 and at the same time the Fed raises the interest rate from 0.05 to 0.06?

d. Now suppose net exports drops by 20. In order to offset its contractionary impact

on GDP, Fed decides to lower the rate of interest from 0.05 to 0.04 (just like

during Asian crisis). How much is your prediction for a change in GDP?

III. Consider the following model and again answer related questions.

Y = C + I + G + X - IM

C = 300 + 0.75DI where DI = Y - T

I = 600 - 1000r

G = 300

X-IM = 100

T = 0

a. How much is equilibrium level of income or output if Fed decides to set the rate

of interest at 10 percent (r=0.10).

b. In an effort to cool down the economy, the Fed raises the rate of interest to r

=0.15. By how much will Y change?

c. To coordinate the fiscal and monetary policies, assume government decides to

balance the budget by raising taxes by 300. At the same time Fed decides to

counter the contractionary effect of the tax hike and lowers the rate of interest to

r = 0.05. Can you predict the change in Y?