Question

ASSUME FEDERAL RESEVE BANK THROUGH AN EXPASSIONARY MONETARY POLICY  (OPEN MARKET OPERATION) HAS INCREASED  MONEY SUPPL BY 60  BILLION, EXPLAIN THE IMPACT OF THIS POLICY ON REAL GDP IF:

A.EACH $ 5  BILLION INCREASE IN MONEY SUPPLY REDUCES THE RATE OF INTEREST BY 0.3 PERCENTAGE POINT

B.EACH 1 PERCENTAGE DECLINE IN INTEREST RATES STIMULATE 24 BILLION WORTH OF NEW INVESTMMENT.

C.MPC = 0.75 .

D.THE AGGREGATE SUPPLY CURVE IS SO FLAT PRICES DO NOT RISE NOTICABLY (NO INFLATION) WHEN DEMAND INCREASES. MAKE SURE DO ALL CALCULATION AS WELL PROPPER GRAPHS

Answer 1

Money Supply has been increased by $60 billion

$5 billion Increase in money supply Decreases interest rate by 0.3%

$60 billion Increase in money supple would cause the internet rate to Decrease by=( 0.3/5)×60= 3.6%

Interest rate would Decrease by 3.6%

If interest rate declines by 1%, Increase in Investment= $24 billion

Here interest rate declined by 3.6%, thus Increase in Investment= 3.6×24=$ 86.4 billion

Investment would Increase by $86.4 billion

MPC= 0.75

Investment Multiplier= 1/(1-MPC)= 4

Increase in Aggregate Demand when Investment Increased by $86.4 billion= Investment Multiplier× Increase in Investment= 4× 86.4= $345.6 billion.

Since Aggregate Supply curve is flat, Increase in Aggregate Demand is equal to increase in Output.

Increase in output= $345.6 billion.

Diagram showing this change in AS-AD framework is given below.