Questions:
Question 1: Using AD/AS analysis, verbally and graphically explain how and why each of the following affects the equilibrium price level and output in the short run. Assume the economy starts at Potential GDP. (This question is worth 20 points if correctly answered.)
a. Bad weather in the United States causes the production of agricultural products to decrease.
b. The foreign exchange rate increases making the U.S. dollar more valuable.
c. Productivity increases in the United States.
d. As the stock market reaches record highs and home prices continue to rise, consumer wealth increases.
Question 2: Use AD/AS analysis to answer each of the following. (This question is worth 20 points if correctly answered.)
a. RGDP is currently $195 million in the small economy of Frescia. Potential GDP in Frescia is $200 million. Identify the type of gap Frescia is experiencing. You are an economic advisor to the central bank in Frescia. The central bank in Frescia has monetary policy tools like those in the United States. Which monetary policy tool do you recommend using? Why? Using your recommended tool, design a monetary policy to get the economy out of the gap. Explain how your tool works and how the use of tool affects the macro economy of Frescia. Draw a graph to illustrate the effect of using the tool in Frescia. Describe any risks Frescia may face because of your recommended monetary policy.
b. RGDP is currently $500 billion in the larger economy of Romia. Potential GDP in Romia is $450 billion. Identify the type of gap Romia is experiencing. You are an economic advisor to the President of Romia. The President asks you to design a fiscal policy to eliminate the gap. Explain which fiscal policy tool you recommend, why you recommend that tool and how the tool could be used to move the economy of Romia out of the gap. Draw a graph to illustrate the effect of using the tool in Romia. Describe any risks Romia may face because of your recommended fiscal policy.
c. The central bank chair in Frescia believes the risks to the economy are too great to use the monetary policy you recommended. Verbally and graphically describe how the economy will return to Potential GDP if left on its own.
d. The President of Romia believes the risks to the economy are too great to use the fiscal policy you recommended. Verbally and graphically describe how the economy will return to Potential GDP if left on its own.
Question 3: International (This question is worth 10 points if correctly answered.)
a. It is a presidential election year, and you expect the Federal Reserve to raise interest rates after the November election. You are an exporter of goods. Do you keep production steady or try to concentrate production now? If you concentrate production, do you want to get more products out the door during summer or after the election? Please explain.
b. An American student studying in South America takes out a bank loan in the United States and receives the loan money in dollars in August. She has to pay tuition in September, December, and March in the foreign currency of her host country. What happens if the dollar depreciates in January? Please explain.
c. You read online that the United States is running record trade deficits. Using your knowledge of the balance of payments, why might you be worried about large trade deficits?