ECO 200 810 Principles of Macroeconomics Homework #5, due 4/20
Answer Key

  1. Consider the equation of exchange. Suppose the economy is characterized by

    2.  
      M = $4 trillion
      V = 2
      P = 100
    1. What is the value of real output (Q)?

      2. MV = PQ
      $4 trillion x 2 = 100 x Q
      Q = $ .08 trillion  or $80 billion, an increase 10%

      Suppose the Fed increases the money supply by 10%, and velocity is stable.

    2. If the price level remains constant, what will happen to real output?

      3. $4.4 trillion x 2 = 100 x Q
      Q = $.088 trillion or $88 billion, an increase of 10%
       
    3. If instead real output is fixed at it's full employment level, what will happen when M increases by 10%?

      4. $4.4 trillion x 2 = P x $.08 trillion
      P = 110, an increase of 10%
       
    4. By how much would V have to fall to offset the increase in M?

      5. $4.4 trillion x V = $8 trillion
      V = 1.8, or a decrease of about 10%
  2. Explain why traditional fiscal or monetary policies are not good options in dealing with stagflation. Be sure to consider the impact on aggregate demand and/or aggregate supply in your answer.
      3. Traditional monetary and fiscal policies only shift the aggregate demand curve.  Shifting AD left will help inflation but make unemployment worse.  Shifting AD right will help unemployment in some cases but it will make inflation worse.  Thus, shifiting AD cannot solve both inflation and unemployment problems simultaneously.  This tradeoff is demonstrated with the Phillips curve.
  3. Contrast the views of Keynesians vs. Supply-siders on tax cuts.
      4. Keynesians see any tax cut expanding output by increasing disposable income and thus spending, shifting AD to the right.  Supply-siders want specific types of tax cuts in order to boost incentives to work and produce, shifting AS to the right and expanding output.
  4. Economists and environmentalists alike predicted a halt to economic growth long before the year 2000 due to a combination of overpopulation and resource exhaustion. How do markets provide incentives that postpone resource exhaustion?
      5. When resources become scarce, their prices rise.  This price is the signal that gives consumers the incentive to conserve, and firms the incentive to discover cheaper (and thus more plentiful) substitutes and increase efficiency in the use of resources.