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    Aggregate Demand Aggregate Supply

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    Problem 1
    Suppose you earn $1,800 at the beginning of each month from your part-time job. Initially you cash your entire paycheck and spend your money evenly throughout the month.

    A. What are your average cash balances?
    B. What is your velocity of money (when calculating V, use monthly values rather than daily)?
    C. Now suppose the interest rate increases and you decide to cash half of your paycheck at the beginning of the month, putting the remainder in bonds. Half way through the month you convert the bonds into cash. What are your average cash balances in this case?
    D. Under the scenario above (in c) what is your velocity of money?

    Problem 2
    Suppose that cookies cost $0.50 in 2007 and $1 in 2011, while candies cost $1in 2007 and $1.50 in 2011. If 10 cookies were produced in 2007 and 12 in 2011, while 20 candies were produced in 2007 and 25 in 2011, using 2007 as the base year what was the value of the GDP price deflator in 2011?

    Problem 3
    A farmer grows wheat and sells it to a miller for $1.00; the miller turns the wheat into flour and sells it to a baker for $3.00; the baker uses the flour to make bread and sells the bread for $6.00.

    A. What is GDP assuming this is the only economic activity in the economy?
    B. What is the value added by the miller in this example?

    Problem 4
    Suppose that the long-run aggregate supply curve (potential output, Y*) is vertical at
    Y = $3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. Suppose as well that the aggregate demand curve is Y = 2(M/P) and M = $1,500.

    A. If the macroeconomy is initially in long-run equilibrium, what are the values for P and Y?
    B. If M increases to $2,000, what are the new short-run values of P and Y?
    C. Once the economy adjusts to long-run equilibrium at M = $2,000, what are P and Y? Also, what is the long-run percentage change in aggregate output (%ΔY)? What is the long-run percentage change in the aggregate price level (%ΔP)?

    Problem 5
    Which will increase output more: a $1 million increase in government spending, or a $1 million increase in government transfers in an economy where taxes and transfers exist? Specifically, explain your reasoning and incorporate the concepts of the MPC and MPS.

    Problem 6
    Consider an economy with no income taxes, and where the mpc (c) = 0.75.

    A. What is the value of the multiplier associated with autonomous spending?
    B. How much will output in this economy change if government expenditures are decreased by $500?
    C. How much will output in this economy change if government transfers are decreased by $500?
    D. What explains the difference in your answers (if any) between part (b) and part (c) of this problem?

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    Solution Summary

    This solution answers the question asked in detail.