A) You Putmoneyinto an Accountthatearnsa5percentnominal Interestrate.The

Question2

a) You putmoneyinto an accountthatearnsa5percentnominal interestrate.The

inflationrateis3percent,and yourmarginal taxrateis20percent.Whatisyourafter-tax real rateof interest?(2points)

b) Supposethatchangesinbankregulationsexpandtheavailabilityofcreditcardssothat peopleneedtoholdlesscash.Howdoesthiseventaffectthedemandformoney?What istheimpactonthepricelevel?IftheFedwantstokeepthepricelevelstable,whatshould itdo?Drawmoneydemand andmoneysupply diagramtoexplain.Labelthediagram clearly.(2points)

c) Ifthemoneysupplyisgrowingatarateof6percent peryear,realGDPisgrowingata rateof3percentperyear,andvelocityisconstant,whatwilltheinflationratebe?Ifvelocity isincreasing1percentperyearinsteadofremainingconstant,whatwilltheinflationrate be?(2points)

a) Theeconomyisinarecession withhighunemployment andlowoutput. Useagraphofaggregatedemandandaggregatesupply (AD-ASdiagram)toillustrate thecurrent situation. Besuretoincludetheaggregatedemandcurve,theshort-runaggregatesupply curve,andthelong-runaggregatesupplycurve.Now,supposetheFedexpandsthemoneysupplytohelpthe economy torecover fromtherecession.UsingAD-ASdiagram,show how itwillhelptheeconomytogetbacktothelong-runequilibrium.(5points)

b) AstudentwasaskedtodrawanAD-ASgraphtoillustratetheeffectofanincreasein aggregatesupply.Thestudentdrewthefollowinggraph.

Thestudentexplainsthegraph asfollows:

“AnincreaseinaggregatesupplycauseashiftfromSRAS1toSRAS2.Becausethisshiftin theaggregatesupplycurveresultsinalowerpricelevel,consumption,investment,andnet exports willincrease.Thechangecausestheaggregatedemandcurveto shiftto the right, fromAD1toAD2.WeknowthatrealGDPwillincrease,butwecan’tbesurewhetherthe pricelevelwillriseorfall becausethat dependson whetherthe aggregatesupplycurveor theaggregatedemandcurvehasshiftedfurthertotheright.Iassumethataggregatesupply shiftsoutfartherthanaggregatedemand,soIshowthefinalpricelevel,P3,asbeinglower than theinitial pricelevel,P1”

Explainwhether youagreewiththestudent’s analysis.Becarefultoexplainexactlywhat- ifanything-youfind wrongwiththisanalysis.(4points)