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Monetary Policy as a Tool for Regulating the Economy

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Q1. Define money and list the functions it performs.

Q2. Assume the government cuts its purchases by $120 billion. As a result, the budget deficit is reduced by $40 billion, private domestic saving decreases by $10 billion, disposable personal income decreases by $80 billion and the trade deficit is reduced by $15 billion. By how much has national income (Y) changed?

Q3. Using the information in the following table:

Component Number of People (millions)

Total Population 300
Working-age population 258
Employed 145
Unemployed 10

to calculate the:

(a) Unemployment rate and

(b) the Labor Force Participation rate

Q4. If C = 0.05; rr = 0.1 and e = 0.05 What is the Money Multiplier?
Where C = currency ration; rr = reserve requirement and e = excess reserve ratio.

Q5. Discuss the tools used by the Federal Reserve System in its monetary policy to regulate the economy.

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Solution Summary

Money serves several purposes in regulating the economy. Fluctuations in the supply of money can directly influence interest rates and income. This problem set defines the purpose of money and directly outlines how IS/LM curves are affected by changes in the money supply by the Federal Reserve. The problem set also calculates (1) unemployment rates and labor participation rates given population data and (2) the money multiplier given currency ration, reserves, and excess reserves.

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Hello. I have attached my response below. I have some graphs that will not copy and paste directly so I am also attaching an MS Word file that includes everything below plus the graphs. I have some comments throughout that I highlighted in green (for the purpose of guiding you through extra examples or to explain something if I was unsure you had been exposed to it in your economics course).

Q1. Define money and list the functions it performs.

In general, money is that which is used as payment for goods and services (and repayments of debts). Its primary functions include being a medium of exchange (intermediary used in trade, rather than bartering), a unit of account (establishing a value/cost for goods and services), a store of value (monies saved for future), and a standard of deferred payment (a means for settling debt).

Q2. Assume the government cuts its purchases by $120 billion. As a result, the budget deficit is reduced by $40 billion, private domestic saving decreases by $10 billion, disposable personal income decreases by $80 billion and the trade deficit is reduced by $15 billion. By how much has national income (Y) changed?

Marginal Propensity to save = MPS = change in saving/change in income
= 10/80
= 0.125
Multiplier = 1/MPS
= 1/0.125
= 8

Change in National Income = DY = 8 X 120 = 960
Therefore, cutting government purchases by $120 billion will reduce national income by $960 million.

Q3. Using the information in the following table to calculate the:

(a) Unemployment rate and
UE rate = Unemployed/Employed X 100
= (10/145) X 100
= 6.9%

(b) the Labor Force Participation rate

LFP rate = (Civilian Labor Force/Total Non-Institutional Civilian Population) X 100

(Total Non-Institutional Civilian Population is the total ...

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