Question

For example:

Question: If income changes by $40 billion for each $2.28 billion change in spending, h much will income change by?

Answer:   91   (rounded down from the calculated value of $91.2 billion)

[Not acceptable would be: 91.2, nor $91, nor $91.2, et al.]

For the following five questions, assume the following characteristics of the monetary transmission mechanism:

The money multiplier is 2.33

Interest rates will change by 2.25% for every $75 billion change in the money supply.

Investment will change by $60 billion for every 1.5% change in the interest rate.

Income will change by $15 billion for every $3.8 billion change in investment.

1)Identify the change in income when the Fed does the following:

a. Buys $35 billion in bonds.

b. Buys $18 billion in bonds.

c. Buys $5.5 billion in bonds.

d. Sells $12 billion in bonds.

e. Sells $22 billion in bonds.

Answer 1

Answer a

Buying bonds worth $35 billion will increase money supply

Increase in money supply=35*2.33=$81.55 billion

Change in interest rate=2.25%/75*81.55=2.4465%

Change in investment=60/1.5%*2.4465%=$97.86 billlion

Change in income =15/3.8*97.86= $386.29 billion

Answer b

Buying bonds worth $18 billion will increase money supply

Increase in money supply=18*2.33=$41.94 billion

Change in interest rate=2.25%/75*41.94=1.2582%

Change in investment=60/1.5%*1.2582%=$50.328 billion

Change in income =15/3.8*50.328= $198.66 billion

Answer c

Buying bonds worth $5.5 billion will increase money supply

Increase in money supply=5.5*2.33=$12.815 billion

Change in interest rate=2.25%/75*12.815=0.38445%

Change in investment=60/1.5%*0.38445%=$15.378 billlion

Change in income =15/3.8*15.378= $60.7 billion

Answer d

Sellin bonds worth $12 billion will decrease money supply

Increase in money supply=12*2.33=$27.96 billion

Change in interest rate=2.25%/75*27.96=0.932%

Change in investment=60/1.5%*0.932%=$37.28 billlion

Change in income =15/3.8*37.28= $147.16 billion

Answer e

Selling bonds worth $22 billion will decrease money supply

Increase in money supply=22*2.33=$51.26 billion

Change in interest rate=2.25%/75*51.26=1.5378%

Change in investment=60/1.5%*1.5378%=$61.512 billlion

Change in income =15/3.8*61 512= $242.81 billion