Question 2 Suppose that full employment GNP (FE Y) is = 4000 (2 points each) A.

Question

Question 2 Suppose that full employment GNP (FE Y) is = 4000 (2 points each)

A. Explicitly find the necessary change in G to get the economy to full employment GDP.

B. Explicitly find the necessary change in Taxes to get the economy to full employment GDP.

Question 3 Given the position of the economy in question one and that full employment GDP = 4000 explain how the following monetary policies would get the economy to full employment GDP (1.5 point each)

A. Open market operations

B. Discount rate

C. Federal funds rate

D. Required reserve ratio

Explanation / Answer

Answer 2 : a) To control the situation of excessive demand i.e., the case of inflation government expenditure should be reduced because infation cause due to increase in aggregate demand.Aggregate demand is increased because it is money with the people increase . So to control that situation it is necessary that to decrease money in the economy which can be done by reducing government expenditure so the money provided by the government to the people for their services will reduce hence the aggregate demand will reduce. vice versa will be the case in deflation i.e., the situation where excess supply. Government had to increase their government spending in order to increae money supply and to increase aggregate demand of the people.  

b) Government collects large funds through taxes so aggregate demand is influenced through taxes.In case of excess demand i.e., in inflation money supply with the people increase which lead to increase in aggregate demand of the people. To cure the situation it is necessary to increase tax rate and levy new taxes on the people so that government could decrease money supply and hence aggregate demand could decrease. Increasing the current tax rate and levying new taxes will give burden to the people which will decrease the money supply and helps to decrease the aggregate demand and sitauation of inflation can be controlled. Vice versa will be the case in deflation of in shortage of aggregate demand taxes should be decreased in order to increase money supply and which will increase aggregate demand.

Answer 3 A) Open Market Operation means buying and selling of securities in the open market. In order to control the situation of inflation i.e., excess demand federal bank started selling their securities in the open market. this will decrease decrease money supply of the people and aggregate demand will decrease and problem of inflation will be cured. vice versa will be the case of deflation .i.e., excessive supply in open market operations securities are purchased from the market.

B) Discount rate is the rate at which federal bank lend loan to the commercial bank . In order to control the situation of excess demand federal bank increases the discount rate and this will reduce money available with the bank to provide loan to the people hence money available with people decreases and hence aggregate demand will decrease and hence problem of excessive demand will cure.Vice verso in the case of excessive supply Discount rate is decreased in order to increase money supply.

C)  The rate of interest at which commercial banks lend reserve balances to other commercial bank overnight, on an un collateralized basis is called federal fund rate. In the case of excess demand these federal fund rate is increased in order to reduce money supply with the people and hence situation of excessive demand can be controlled. Vice versa will be the case of excessive supply. Federal fund rate will decreased .

D)   The minimum fraction of that deposits and notes of the customers that each commercial bank must hold as reserves is called required reserve ratio. In case of excess demand this required reserve ratio will increase so that money supply with the people could decrease and hence problem of excessive demand can be cured. Vice versa will be the case of excessive supply required reserve ratio will decrease.

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