Question

Assume that the following conditions​ exist:

a. All banks are fully loaned​ up- there are no excess​ reserves, and desired excess reserves are always zero.

b.

The money multiplier is

77.

   

c. The planned investment schedule is such that at a 4 percent rate of​ interest, Investment

​=$14501450

billion. At 5​ percent, investment is

​$14201420

billion.

d. The investment multiplier is

44.

e..

The initial equilibrium level of real GDP is

​$1313

trillion.

f. The equilibrium rate of interest is 4 percent

Now the Fed engages in contractionary monetary policy. It sells

​$22

billion worth of​ bonds, which reduces the money​ supply, which in turn raises the market rate of interest by 1 percentage point.

Calculate the decrease in money supply after​ FED's sale of​ bonds: ____billion

Equilibrium GPC decreases by: _____ billion

Calculate the new equilibrium level of real GPC ___ trillion

Answer 1

Solution:

All banks are fully loaned​ up- there are no excess​ reserves, and desired excess reserves are always zero.

The money multiplier is = 7.

The planned investment schedule is such that at a 4 percent rate of​ interest, Investment ​= $1450 billion.

At 5​ percent, investment is $1420 billion.

The investment multiplier is = 4.

The initial equilibrium level of real GDP is $13 trillion.

The equilibrium rate of interest is 4 percent

Now the Fed engages in contractionary monetary policy. It sells $2 billion worth of​ bonds, which reduces the money​ supply, which in turn raises the market rate of interest by 1 percentage point.

The decrease in money supply after​ FED's sale of​ bonds: $14 billion

Explanation: (Worth of bonds)*(money multiplier) = Decrease in supply of money

Decrease in money supply = ($2 billion)*7 = $14 billion

Equilibrium GDP decreases by: $120 billion

Explanation: (Investment at 5% - Investment at 4%)*(investment multiplier) = Decrease in Equilibrium GDP

Decrease in Equilibrium GDP = ($1420 billion - $1450 billion)*4 = -$120 billion

Negative sign indicates that there is decrease in equilibrium GDP

The new equilibrium level of real GDP: $12.88 trillion

Explanation: Equilibrium Real GDP = (Initial equilibrium level of GDP) - (Decrease in Equilibrium GDP)

Equilibrium Real GDP = $13 trillion - $120 billion = $12.88 trillion