U.S. consumer spending rose solidly in December as demand for goods and services increased, but the gain came at the expense of savings, which dropped to a 10-year low in a troubling sign for future consumption and economic growth

  1. (10 points) Read the following article: S. consumer spending rises; savings drop to 10-year low. Using the production possibilities model, diagram and explain what the reporter means by, “U.S. consumer spending rose solidly in December as demand for goods and services increased, but the gain came at the expense of savings, which dropped to a 10-year low in a troubling sign for future consumption and economic growth.” Assume that the economy is at full employment.
  2. (10 points) Private versus public goods. Define and explain the difference between a private good and a public good. Why does the private sector willingly produce and sell private goods, but we need collective action for provision of public goods? Diagram and explain how equilibrium price and quantity are determined in each market.
  3. (10 points) Discretion or rules for making policy? Which is preferred? Using Keynesian and Hayekian (monetarist) economic methodologies, outline the arguments for and against each strategy. What are the underlying assumptions that give rise to your conclusions?
  4. (20 points) Identify and explain the tools of monetary policy. Using the federal funds market as a starting point, compare and contrast the tools. Rank their effectiveness for (a) stimulating the economy and (b) contracting or slowing down the economy.
  5. (20 points) Alphabetania is a small island country in the middle of the South Pacific. Quiet, peaceful, tranquil. It has one supermarket, one pharmacy, one saloon, one church, and one bank. The current money supply is 1.8 million clam shells. However, clam shells are fragile, so everyone holds their clam shells in the bank in clam shell accounts. No one ever withdraws clam shells for fear of breaking them. Instead, depositors write drafts against the clam shells in their accounts.
    1. If the island has no laws and the bank has no internal restrictions on how many loans it can make, what is the potential for the money supply? Why?
      1. Show with a T-account how money supply is created.
      2. Show with a T-account how money supply is destroyed.
    2. What happens to the amount of loans, demand deposits, and the money supply, if the government imposes a 20% reserve requirement on demand deposits? Calculate them AND show loans, demand deposits, and the money supply with a T-account.
    3. What happens to the amount of loans, demand deposits, and the money supply that an individual bank can make, if there are four banks on the island and the government imposes a 20% reserve requirement on demand deposits? Calculate them AND show loans, demand deposits, and the money supply with a T-account.
    4. What happens to the amount of loans, demand deposits, and the money supply that the banking system can make, if the people on the island trade with another island and net imports are 600,000 clam shells? Assume a monopoly bank and a 20% reserve requirement on demand deposits? Calculate them AND show loans, demand deposits, and the money supply with a T-account.
  6. (130 points – 5 points each) NOTE: Answer this question in the order the questions are asked. Do not skip ahead! On Friday, December, 2017, President Donald Trump signed the “biggest tax cut” into law. The “cut” is expected to reduce federal tax revenue by $5.5 billion over 10 years. Read  Trump signs tax cut bill, first big legislative win. President Trump hailed the sweeping tax cut, saying, “It’s going to be a tremendous thing for the American people. It’s going to be fantastic for the economy. … I consider this very much a bill for the middle class, a bill for jobs. … We are making America great again.” Are we? Assume that the tax cut is a cut in the personal income tax and that the marginal propensity to consume is .9.
    1. Using the aggregate expenditures model, diagram and explain the expected impact of the tax cut on GDP.
    2. Using the aggregate demand-aggregate supply model, diagram and explain the expected impact of the tax cut on output, prices, and employment.
    3. What is the difference in the impact of the Trump tax cut on the economy, if the economy is in recession or if the economy is at full employment?
    4. Congress did not cut spending at the same time it cut taxes. As a result, the tax cuts are expected to generate budget deficits of $1.5 trillion over the next 10 years. Deficits must be financed. Using a money market model, diagram and explain the “crowding out” effect. What happens to interest rates?
    5. Using an investment demand function, diagram and explain the impact of the “crowding out” effect on investment spending.
    6. Using the aggregate expenditures model, diagram and explain the expected impact of the “crowding out” effect on GDP.
    7. Using the aggregate demand-aggregate supply model, diagram and explain the expected impact of the “crowding out” effect on on output, prices, and employment. Is the tax cut fantastic for the economy? Is it a bill for jobs?
    8. Read Why the Tax Law Might Make Your Car Payments Go Up. Using the above analyses, explain why your tax payments will go down, but your car payments will go up. Is the tax cut a tremendous thing for the American people? Is it a bill for the middle class?
    9. What is the difference in the impact of the Trump tax cut on the economy, if the Federal Reserve monetizes the debt? Using a money market model, an aggregate expenditures model, and an aggregate demand-aggregate supply model, diagram and explain.
    10. By all measures, the current economy is at full employment. Define full employment? Explain full employment by way of frictional, structural, and cyclical unemployment.
    11. The current unemployment rate is 4.1% and the current inflation rate is 2.0%. Draw a short-run through the point where p = 2.0% and u = 4.1%. What happens to that point withthe “crowding out” effect? What happens to that point in the long run? What happens to that point without a crowding out effect, say, monetary accommodation? What happens to that point in the long run? Draw the long-run Phillips curve.
    12. The current trade-weighted value of the US dollar is approximately 120/$1. This means that a dollar buys, on average, 120 units of foreign currencies. Draw a demand and supply model for the US dollar, where the amount of dollars is on the horizontal axis and the trade-weighted value is on the vertical axis. Draw equilibrium at 120/$1. What happens to the value of the dollar withthe “crowding out” effect? What happens to exports, imports, GDP, prices, and employment? What happens to the value of the dollar without a “crowding out” effect, say, monetary accommodation? What happens to exports, imports, GDP, prices, and employment?
    13. What can you conclude about President Trump’s boast that the sweeping tax cut will be “a tremendous thing for the American people,” “fantastic for the economy,” “a bill for the middle class,” “a bill for jobs,” and “make America great again”?

 

 

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