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College of Business Administration

ECON 1311- Macroeconomics

Homework 2 (10% of total grade)

Student’s Name:
Student’s ID:
Course Section:

	Mark out of	%	Letter grade
Maximum grade	10	100	A+
Student’s Grade

Questions to CLO Mapping	Max Grade	Weight	Student Grade
CLO4		10	100%

INSTRUCTIONS:

Answer all the questions below. Your answers can be either handwritten or typed on a computer. Please, don’t forget to include your name, ID and course section on your homework.

Hand in your homework as a hard copy either to me in person or leave your homework in the box in front of my office F098. The deadline for submission is Sunday, April 9, 2017. Submission after the deadline is under no circumstances possible.

1.) The loanable funds market

Demand and Supply

Real interest rate	Loanable funds demanded	Loanable funds supplied
(percent per year)	(million Saudi Riyal)
5	900	500
5.5	850	550
6	800	600
6.5	750	650
7	700	700
7.5	650	750
8	600	800

a.) Draw the supply and demand balance of the above loanable funds market. What is the equilibrium interest rate and equilibrium loanable funds level? (1 Points)

b.) What is going to happen to the equilibrium interest rate and equilibrium loanable funds level, when there is an increase in expected future income? (1.5 Points)

2.) Money creation process

Banks in New Transylvania have a desired reserve ratio of 15% of deposits and no excess reserves. Households want to keep 8% of their money as currency. Now suppose that the Central Bank increases the monetary base by $12,000 billion.

a.) How much do the banks lend in the first round of the money creation process? (0.5 Points)

b.) How much of the initial amount lent flows back to the banking system as new deposits? (0.5 Points)

c.) How much do the banks lend in the second round of the money creation process? (0.5 Points)

d.) Show with the help of a graph of the money market what happens to the interest rate as a result of the increase in the monetary base by the Central Bank. (No actual numbers needed) (2 Points)

e.) In the long run, what is going to happen to the price level when the monetary base increases and the economy is at full capacity? (1 Point)