Question

Notes: Your answer will include a comma for thousand and no space. For example 1 thousand is 1,000 No $ sign, just the value.. Assume that all the following conditions exist. a. All banks are fully loaned up, meaning that there are no excess reserves, and desired excess reserves are always zero. b. The money multiplier is 4. c. The planned investment schedule. is such that at 8 % rate of interest, investment is $1200 billion; at 5 %, investment is $ $1400 billion. d. The investment multiplier is 5. e. The initial equilibrium level of real GDP is $11 trillion. f. The equilibrium rate of interest is 8%. Now the Federal Reserve (Fed) engages in expansionary monetary policy. It buys $2 billion worth of bonds, which increases the money supply, which in turn lowers the market rate of interest by 3 percentage point. Question 1: The increase in money supply is $: 4 billion. Question 2: The increase in real GDP is $: 100 billion. Question 3: The new equilibrium real GDP is $: trillion.

Answer 1

Question 1

Fed has purchased $2 billion worth of bonds.

Money multiplier = 4

Calculate the increase in money supply -

Increase in money supply = Amount of bonds purchased by Fed * Money multiplier

Increase in money supply = $2 billion * 4 = $8 billion

The increase in money supply is $8 billion.

Question 2

The equilibrium interest rate is 8%.

The increase in money supply due to expansionary monetary policy being administered by the Fed has resulted in a decrease in market interest rate by 3%.

So, the new market interest rate is 5%.

When interest rate was 8%, investment is $1,200 billion.

When interest rate is 5%, investment is $1,400 billion.

So, decrease in market interest rate by 3% has increased investment by $200 billion.

Calculate the increase in real GDP -

Increase in real GDP = Increase in investment * Investment multiplier

Increase in real GDP = $200 billion * 5 = $1,000 billion

Thus,

The increase in real GDP is $1,000 billion.

Question 3

Calculate the new equilibrium real GDP -

New equilibrium real GDP = Initial equilibrium real GDP + Increase in real GDP

New equilibrium real GDP = $11 trillion + $1,000 billion = $11 trillion + $1 trillion = $12 trillion

Thus,

The new equilibrium real GDP is $12 trillion.