Question

Explain why each of the following statements is True, False, or Uncertain according to economic principles. Use diagrams where appropriate. Unsupported answers will receive no marks. It is the explanation that is important.

A6-1. An economy with a recessionary gap will never return to long run equilibrium without policy intervention.

A6-2. In a closed economy, investment will equal the sum of private saving and government saving.

A6-3. An increase in private saving for a closed economy implies lower consumption in long-run equilibrium and also leads to lower GDP growth.

A6-4. You have two Canadian dimes. One is from 1962 and contains 25 cents worth of silver; the other is from 2013 and contains no silver. You would clearly use the later coin when paying for a coffee rather than the earlier one.

A6-5. Suppose a $1000 bond pays annual “coupon interest” equal to 10% and matures in two years. If the yield on bonds with similar risk characteristics is 3%, the price of this bond today is greater than $1000.

A6-6. Suppose the Bank of Canada (BOC) buys $10B worth of bonds from the Canadian banking system that operates with a desired reserve ratio of 5%. Immediately after the transaction, the balance sheet of the BOC expands by $10B, while balance sheet of the banking system is the same size, but in the long run, the balance sheet of both the BOC and the banking system expand by $200B.

A6-7. In the long-run, the money supply is neutral with respect to (does not affect) real GDP.

A6-8. A given increase in the money supply is more effective at shifting the aggregate demand curve the more interest rate responsive (elastic) is the money demand curve.

Answer 1

1) "False"

At the point of the recession, the demand is low and the unemployment is high. In the long run, this high unemployment will lead to a fall in wages and hence a positive supply shock in the market. This will increase the production and reduce the price bringing the economy back into the long run equilibrium without government intervention.

2) "True"

In a closed economy, we have output = Consumption and Saving we also have Output = Consumption + Investment.

We have, Y = C +S and Y = C + I

We get S = I. In a closed economy we have saving and investment equal.

3) "False"

In the short run, the aggregate demand will decrease because of the saving in the long-run things will be back at the equilibrium. All the effect will be in the short run only.

4) "False"

In the modern economy, we use Fiat Currency and those currency doesn't get any value form the asset backing but the value is decided by the central bank. The old money which we have is useless because the central bank doesn't ensure its value.