Macro and Micro Economics
Macro and Micro Economics – 2 By Due Q1 A. In expansionary monetary policy, the Federal Reserve Bank would look to increase the total money supply in the economy through following tactics:i. The primary tool is open market operation under which it would buy government bonds on the open market. It would change the monetary base and increase the circulating money supply in the economy.ii. It can exercise its regulatory control over the commercial banks and can decrease the reserve requirements for them which would increase their loan base and would result in increased money supply.iii. It can use discount window lending under which it can lend commercial banks reserves at a lower rate. This would have an impact on the interest rates and more loans would be given out by the commercial banks hence resulting in increased money supply.B. A banking system that prefers to keep excess reserves would not have much impact on the Federal Reserves’s ability to increase the money supply because when the FRB lowers the reserve requirements, the excess reserves increase automatically. The commercial banks would have more freedom in lending out money and money supply would increase.Q2The MPC of the economy is 1/3. The total government spending is $20 billion. This means that out of $20 billion, $6.66 billion would be spent and the rest would be saved. This $6.66 billion would become the income of subsequent consumers, who would spend $2.22 billion and save the rest. This is a geometric progression and its sum can be found out by the formula 1/1-r. Since MPC is 1/3, MPS becomes 2/3 or 0.66. The multiplier becomes 1.5 (1/0.66). Therefore, the total impact of initial increase of $20 billion is $30 billion ($20 billion* 1.5).Q3A. Irving Fisher’s equation of exchange is derived from the equation of velocity (V) which is number of times in a year that a dollar is used to purchased goods and services. Firstly, GDP is required to be calculated. Then, the quantity of money in the economy (M) is to be calculated. GDP is divided by M to calculate V. It is given as follows:V=GDP/MGDP is equal to the product of price level (P) and the aggregate output (Y) of the economy. Multiplying both sides by M makes the equation: MV = PYThis is known as the equation of exchange.B. In the stock market, the timing of investment decisions is of paramount importance. When a major market correction is expected, people look to sell their stocks and increase their holding of money because of the possibility that the market might soon turn into a bear market. During a market correction, the values of the stocks fall and losses are suffered. Therefore, it is better to sell the stock before the correction arrives.Q4A. Imposition of tariffs saves the local producers from the competition of foreign producers. It also brings tax revenue and helps in decreasing the imports of undesirable items. Importantly, it serves for the betterment of balance of trade.However, it also results in retaliation from other countries which makes exports costly. It may also result in a decrease in product quality.Quotas tend to be more protective than tariffs. They require a lot of paperwork and are hard to administer. Tariffs are easier to manage and unlike quotas, they bring in tax revenue which is an income. Therefore, the arguments for tariffs are stronger than those for import quotas.B. Export subsidies encourage the local producers to export their goods. They protect the local producers as they can export at lower costs than the foreign producers. Export subsidies can contribute in increasing inflation in a country because they are usually spent on wage hikes demanded by employees. Their incomes increase and employees of other employers also demand higher wages due to which prices increase and hence result in inflation.Q5A. The government of an economy in recession would try to revive it by application of expansionary fiscal policy. It would increase government expenditure so that the level of employment increases. It would reduce taxes so that the consumers are left with more to spend so that the aggregate demand of the economy can increase. Improvement in level of employment would increase the aggregate income which would result in an increase in aggregate demand. This would also result in an increase in the price level. Therefore, the economy would start to revive.B. It is simple to understand that fiscal policy works in a way that seems to start a chain reaction. However, there is a limitation to it as there is a time lag in each impact. For instance, an increase in government expenditure would result in the level of employment which would then result in an increase in aggregate demand of the economy but each of the processes would take time in its completion. During that time, the economy might deteriorate further and the government would be facing more problems by the time the fiscal policy takes effect.