Question

1. a) When the Fed lowers interest rates, what is the impact on the value of the dollar, exports, imports, consumption, investment, and the AD curve?

b) When the Fed raises interest rates, what is the impact on the value of the dollar, exports, imports, consumption, investment, and the AD curve?

2.Explain the differences between classical economists and Keynesians in regards to monetary policy during a recession.

3. Explain efficiency-wage theory.

Answer 1

1. When Fed lowers interest rates, it means that bank provide loan at lower rate of interest. It causes more and more people take loan or credit from the bank for their consumption and investment purposes to run and set up business. The value of dollar weaken because the rate of return of US assets and securities reduces due to which less people want to invest in US. The export falls because US dollar become weaker as compare to other countries, the import rise because US goods are cheap for other countries, the consumption of the people rises because more and more people take loan at lower interest rate, rise in investment and AD curve shift rightward.

b, when Fed raises interest rate, it mean the bank provide loan or credit at high interest rate. Due to which people discourage to take credit from the bank because the cost of credit increases. The value of dollar strengthen because more and more people want to invest in US assets and securities, the export of the US also increases because US dollar strengthen in comparision with other countries currency, import falls, the consmption of people reduces because less money in the hands of people, investment also falls because loan or credit become costlier and finall AD curve shift Leftward.

2. Classical economists emphasis that during the time of recession the goverment should use monetary policy to overcome the recession. Through monetary policy by decreasing interest rate, and increasing money supply. When central bank reduce rate of interest it causes loan and credit avaliable at cheap rate through which people increase their consumption and investment.

On the other hand keynnesians emphasis that during the time of recession government should use fiscal policy to overcome the recession. Through fiscal policy by the decreasing tax rate and increasing government spending. When government lower the tax rate the disposal income of the people increases which causes more consumption and investment.

3 Effiicieny wage theory says that if we increase the wage rate of the labour it lead to increased labour productivity because labour get motivated to work with higher wages and when worker work with more motivation their productivity increases.So in other words we can say that there is positive relation between wage rate and marginal productivity of labour.