ECO205/ PRINCIPLES OF MACROECONOMICS/ Q3 (12-13)

Problem Set #3
Due: before 7:40am May 24th, 2013 (Group 2) Due: before 12:40pm May 24th, 2013 (Group 1)
Pham Tran Bao Ngoc Thien An 1132300159 Pham Thi Ngoc Bich 1132300161 Question 1: (30 points, 3 points each) A. Read the following description of each person, and determine if each person is unemployed, unemployed, or not in the labor force, according to the BLS definitions. Explain. 1. Johns company put 50 people on a temporary furlough (temporarily laid off) and has promised to recall them to work next month. In the mean time, he has been working at home making scarves that he sells at the flea market. John is unemployed because hes not working now and waiting to be recalled for work. 2. Tom worked for the ABC Manufacturing Company for six years until he was laid off when the firm closed his factory. He registered for unemployment compensation, and he has been sending out resumes and competing applications each week since that time. Is Tom employed or unemployed? Although he has been sending his resume but he is not still employed so that Tom is unemployed. 3. Susan has been out of work for over four months. She has had no luck finding a new job because the businesses in her town are all reducing their employment. She has become so frustrated that she has not even looked for a job since the past month. Susan is not in the labor force because she has not even looked for a new job in the previous week. 4. Lisa works as a volunteer twenty hours a week for a church food pantry without being paid. She previously worked at an insurance company until she was laid off. At this time, she is not looking for another job. Lisa is not in the labor force because she works as a volunteer which is not specific job. Moreover she has not tried to find new job. 5. Nick is fifteen and has dropped out of school. He is looking for a job so that he can move out of his parent house and live on his own. Someday, he wants to be an electrician, but his school did not have a vocational program. Nick is not in the labor force because hes less than 16 years old which does not belong to employed or unemployed category. B. Multiple Choice Questions

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ECO205/ PRINCIPLES OF MACROECONOMICS/ Q3 (12-13) 1. Assume a very small economy comprised of the following people, all of whom are civilians, 16 years and older. A is happily employed. B does not have work, but is actively sending out his resume to employers. After several months of an unsuccessful job search, C has stopped looking and entered a job retraining program to become a nurse. D has just graduated from college and is starting his job search. E has left her job to care for her newborn child. The labor force participation rate in this economy would be: a. 60% b. 50% c. 40% d. 30% 2. Suppose the population is 300 million. There are 146 million employed, and 7.2 million unemployed. Then the unemployment rate is: a. 2.4% b. 4.7% c. 4.9% d. 5.3% 3. Suppose the population is 300 million. There are 146 million employed, and 7.2 million unemployed. Suppose that 1 million of the 7.2 million unemployed become so discouraged that they drop out of the labor force. The unemployment rate is: a. 2.1% b. 2.4% c. 4.1% d. 4.7% 4. Jack lost his job during the last recession. What type of unemployment is he experiencing? a. frictional unemployment b. structural unemployment c. natural unemployment d. cyclical unemployment 5. Minimum-wage laws, labor unions and efficiency wages are the three explanations for: a. cyclical unemployment b. natural unemployment c. frictional unemployment d. structural unemployment Question 2: (20 points, 4 points each) 1. What is included in M1, the simplest definition of money? (4pts) Money is understood as the set of assets in an economy that people can use to buy goods and services from other people. Money has the horizontal value. It usually issued by the state to ensure value by other assets such as gold, precious metals, bonds, foreign EIU BEXAMEX BUSINESSS SCHOOL Page 5

ECO205/ PRINCIPLES OF MACROECONOMICS/ Q3 (12-13) currency. Furthermore, M1 is used as a dimension to quantify the amount of money in circulation. 2. Suppose that the T-account for XYZ Bank is as follows: XYZ BANK Assets Reserves Loans Total $100,000 $ 500,000 $600,000 Liabilities Deposits Total $600,000 $600,000

a. If the FED requires banks to hold 10% of deposits as reserves, how much in excess reserves does XYZ now hold? (4pts) Required reserves = $ 600,000 x 10% = $ 60,000. Excess reserves = total deposits required reserves = $100,000 - $60,000 = $40,000

b. If XYZ decides to hold only the required reserves amount, correct changes in the above T-account. (4pts) Reserves Loans Total $ 60,000 $ 540,000 $ 600,000 Deposits Total $600,000 $600,000

c. What is the numerical value of the money multiplier, based on this example? (4pts) Money multiplier = 1 / R = 1 / 10 % = 10 d. Assume all other banks hold only the required amount of reserves. When XYZ holds the amount of reserves mentioned in part c, by how much will the nations money supply change? (4pts) With a required reserve ratio of 10 percent, the money multiplier is 1/(10%) = 10. If First National Bank lends out its excess reserves of $40,000, the money supply will increase by ($40,000) x (10) = $400,000 Question 3: (20 points) How many options the Fed can choose to increase the money supply? What are they? Explain how each works. EIU BEXAMEX BUSINESSS SCHOOL Page 5

ECO205/ PRINCIPLES OF MACROECONOMICS/ Q3 (12-13) Firstly, the Fed should buy the government bonds. Buying the government bonds will directly increases the quantity of dollars in circulation, and will have an even bigger impact when people deposit some of this money that is newly in circulation. Banks can increase the impact of Open Market. Secondly, Banks keep some parts of their deposits in reserve and do not loan these out. Therefore, if the Fed reduces the reserve requirement, there will be more money that banks can loan. As a result, banks can create more money through loans. Thirdly, Discount Rate is the interest rate that banks pay to the Fed if they borrow from it. Therefore, if the Fed decreases the discount rate that they charge to the banks, banks will have more incentive to loan money to the public and thus reduce their reserves, because the cost of borrowing from the Fed has decreased. By loaning more, banks will be creating more money, and the money supply will increase. How can the effectiveness of these policies be limited by the actions of banks and the public? If these policies do not exist that can affect the minority of money that the public chooses to deposit in banks and that can not the policies affect the fraction of their deposits that the banks choose to hold as excess reserves. These are the two main limitations of these policy instruments: + If the banks prefer to keep high excess reserves, a decrease in the smallest reserve requirement may not be effective. + If consumers are not depositing much money in the banks, and instead keep their extra money as cash in their pockets, then open market operations will be less effective in increasing the money supply. Consumers will sell their bonds to the Fed, but they will not deposit much of the proceeds in banks Question 4: (20 points, 5 points each) Consider the money supply-demand diagram we learnt in class, with the quantity of money on the horizontal axis, the value of money on the left vertical axis and the price level on the right vertical axis. 1. Suppose first that real GDP rises and that, as a result, the consumers & firms who are buying more goods & services want to hold more money at any given level of prices. In the diagram, will the money demand curve be shifted to the left or to the right? The money demand curve will be shifted to the right. 2. As a result of this shift in the money demand curve, will the price level rise, fall or stay the same? Price level will rise. 3. Now, suppose instead that the money demand curve remains unchanged, but the Federal Reserve conducts an open-market operation to increase the money supply. In the diagram, will the money supply curve be shifted to the left or to the right? EIU BEXAMEX BUSINESSS SCHOOL Page 5

ECO205/ PRINCIPLES OF MACROECONOMICS/ Q3 (12-13) The money supply curve will be shifted to the right. 4. As a result of this shift in the money supply curve, will the value of money rise, fall or stay the same? The value of money will fall. Question 5: (10 points, 2 points each) 1. Fiat money, such as the dollar bills we use nowadays: a. is backed by gold. b. has no intrinsic value at all. c. is based on the amount of precious metals held by the government. d. is printed and introduced into the economy by the Treasury of the US 2. Which of the following occurs when the Fed reduces the reserve requirement? a. The money multiplier gets bigger. b. Banks become more reluctant to lend. c. The amount of money in the economy is reduced. d. Interest rates tend to rise in the economy. 3. Liquidity refers to a. The ease with which an asset is converted to the medium of exchange. b. How many time a dollar circulates in a given year. c. The suitability of an asset to serve as a store of value. d. A measurement of the intrinsic value of commodity money. 4. Rapid and persistent inflation occurs mainly due to: a. high wage increases demanded by labor unions. b. greedy firms that abuse consumers with higher-than-necessary prices. c. rapid increases in the quantity of money in the economy. d. trade with other countries. 5. If the interest rate is below equilibrium in the Money Market, people will choose to ________ their interest bearing accounts in banks, causing the interest rate in the economy to ________. a. deposit some money into, increase b. deposit some money into, decrease c. withdraw some money from, increase d. withdraw some money from, decrease

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