PROBLEM SET 6
1) Why is it possible to change real economic factors in the short run simply by printing and
distributing more money?
Increased money supply will lower the interest rate. lower interest rate increases the
more investment in plant and machinery. It increases employment in the short run.
Therefoer, by printing more money and distributing it lowers the interest rate and
lower interest rate increases investment and employment. As a result,it leads to more
output.
2) Explain why a stable 5% inflation rate can be preferable to one that averages 4% but varies
between 1–7% regularly.
It is basically argument between stable vs fluctuating inflation. In case of fluctuating
inflation prices changes more frequently than stable inflation. Investors do not get
proper price signals so they can invest because fluctuating inflation increases the
uncertainty in the economy. This means that investors/businesses do not know what
price their product will command in the market.Therefore, there will be less investment
in the economy.
3) Explain the difference between active and passive monetary policy.
Active Monetary Policy is trying to reach specific goals. Some examples might be a
specific inflation rate, unemployment, or money supply. Active means that the central
bank may have to fight (or "steer") market forces to get there. Passive tends to be more
flexible responding to market forces. I want to explain difference between both of two
by adapting basketball. Active policy is like a coach that says "we want to score 3pointers, so we’re going to do what it takes to get 3s". Howver, Passive policy is "we
want to score points, so take whatever’s open"
4) Suppose the economy is in long-run equilibrium, with real GDP at $16 trillion and the
unemployment rate at 5%. Now assume that the central bank unexpectedly decreases the
money supply by 6%.
a. Illustrate the short run effects on the macro-economy by using the aggregate supplyaggregate demand model. Be sure to indicate the direction of change in Real GDP, the
Price Level and the Unemployment Rate. Label all curves and axis for full credit.
People will invest less because the central bank unexpectedly decreases the money
supply by 6. Therefore, AD will fall if investment decreases.
5) Suppose the economy is in long-run equilibrium, with real GDP at $16 trillion and the
unemployment rate at 5%. Now assume that the central bank increases the money supply by
6%.
a. Illustrate the short-run effects on the macro-economy by using the aggregate supplyaggregate demand model. Be sure to indicate the direction of change in Real GDP, the
Price Level, and the Unemployment Rate. Label all curves and axis for full credit.
It is exactly opposite of the previous question. Higher money supply will lower the
interest rate. Lower interest rate will increase investment and AD. This means that
the price level and GDP will increase but unemployment rate will decrease.
