Keynesian ad-as model

Question

Question 1. Using AD-AS model, compute the equilibrium price level of the following economy. C=10+0.1(Y-T)-0.9P, I=50-0.5r, G=T=0, NX=10, Md=10-0.5r, Ms=9, and Yas=P, where C is consumption, Y is output (before-tax income), T is tax, P is price level, I is investment, r is the interest rate, NX is net exports, Md is money demand, Ms is money supply, and Yas is the aggregate supply.

Question 2. Consider the economy in the previous question. Suppose the required reserve ratio is 0.1, the ratio of excess reserve to checkable deposit is 0.2, and the ratio of currency outstanding to checkable deposit is 0.3. If the Fed increases monetary base by 10, what will be the resulting equilibrium price level?

Question 3. Suppose the money supply is $400, checkable deposits are $150, excess reserve is $20 and total reserve is $40. Compute the money multiplier.

Question 4. Explain why AD curve is downward sloping.

Question 5.Among the theories of money demand, compare Quantity Theory, Cambridge approach, Keynes' liquidity preference theory, and Friedman's modern quantity theory of money in terms of velocity (i.e., is velocity constant? If not, which factor does affect velocity?)

Question 6. Suppose the nonbank public (a person or corporation) sells the $100 bonds to the Fed and deposits the Fed's check in the local bank. Describe what will happen to balance sheets of the nonbank public, the local bank, and the Fed by using t-accounts.

Question 7. Consider a discount bond whose days to maturity is 60 days. Suppose the face value of the discount bond is $100 and the price of the discount bond is $98. Compute the yield on a discount basis (discount yield).

Question 8. Suppose a bank's balance sheet is summarized as follows.

Assets	Liabilities
Fixed-Rate Asset           $50 million Rate-Sensitive Asset        $60 million	Fixed-Rate Liabilities       $20 million Rate-Sensitive Liabilities   $30 million

a. Compute net worth ratio and debt-to-equity ratio.

b. Assume the interest rate increases from 4% to 6%. According to Gap analysis, what will be the change in the bank's profit due to the increase in the interest rate?

Question 9. Suppose a bank's balance sheet is summarized as follows. Assume that an average duration of fixed rate assets is 2 years and an average duration of fixed rate liabilities is 4 years. Suppose the interest rate decreases from 10% to 5%.

Assets	Liabilities
Fixed-Rate Asset          $100 million	Fixed-Rate Liabilities       $50 million

a. According to Gap analysis, what will be the change in the bank's profit due to the decrease in the interest rate?

b. According to Duration analysis, what will be the resulting net worth of the bank due to the decrease in the interest rate?

Question 10. Suppose there are two assets, asset 1 and asset 2, and two possible states of world, state A and state B. State A occurs with probability 0.4 and state B occurs with probability 0.6. You will construct a portfolio by combining these three assets to attain zero risk (i.e., standard deviation of your portfolio will be zero). Compute a proportion of each assts in your portfolio.

	State A	State B
Asset 1's return	$50	$100
Asset 2's return	$80	$40
Probability	0.4	0.6

Question 11.  List items on the asset side of the Fed's balance sheet.

Question 12.  List items on the liability side of the Fed's balance sheet.

Question 13.  List the three major monetary policy tools available for use by the Federal Reserve and the advantages and disadvantages of each tool.  Which of these tools does the Fed use most often?

Question 14.  Draw diagrams representing the bond market and the loanable funds market in equilibrium. On your diagram, explain what would happen to the price of bonds, the interest rate, the quantity of bonds and the quantity of loanable funds if the expected inflation rate increases.

Question 15.  Consider a two-year coupon bond with face value of $2,000 and coupon rate is 20%. Suppose the after-tax real interest rate for the first year is 10%, the tax rate on the interest income for the first year is 10%, the expected inflation rate for the first year is 5%, the after-tax real interest rate for the second year is 15%, the tax rate on the interest income for the second year is 20%, and the expected inflation rate for the second year is 10%. Compute the present value of this bond.

Question 16.  Suppose excess reserves are $600 and free reserves are $200. Compute the volume of discount loans.

Question 17.  Suppose net profits after tax is $200 and the return on equity (ROE) is 2. Compute equity capital.

Question 18.  Suppose total assets are $300 and the equity multiplier (EM) is 1.5. Compute equity capital.

Question 19.  Suppose net profits after tax is $400 and the return on assets (ROA) is 4%. Compute total assets.

Question 20.  Suppose ROA is 10% and the equity multiplier is 5. Compute ROE.

Question 21. Consider the Keynesian AD-AS model. Suppose that an economy in initial long run equilibrium is disturbed simultaneously by a decrease in government spending and the development of a new technology that lowers production costs. In the short run, what will happen to the price level and the output level?