Practice Problems 1. Explain the multiplier effect as it relates to Expansionary Fiscal Policy....

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Practice Problems    1. Explain the multiplier effect as it relates to Expansionary Fiscal Policy. If the goal of the expansionary policy is to increase GDP by $500 and the Multiplier = 1, how much will government spending have to increase? Is there a multiplier effect? Why or why not?      2. Does the Fed directly increase or decrease interest rates? If they do not, how does the Fed go about increasing or decreasing the interest rates?    3. When conducting Monetary Policy, why does the Fed influence bank reserves?      4. Give three economic changes that would shift out the Aggregate Demand Curve. What will happen to the equilibrium level of GDP, what will happen to the equilibrium price level? Illustrate with a graph    5. Contractionary Policy: Solve for the decrease in G and the increase in T using the MPC = 0.95 and 0.45           	 		 			 			AS 			 		 	    	 		 			 			 			 		 	    	 		 			 			RGDP 			 		 	    	 		 			 			Price Level 			 		 	    	 		 			 			563 			 		 	    	 		 			 			AD 			 		 	    	 		 			 			AD’ 			 		 	    	 		 			 			435 			 		 	           6. Discuss the sequence of the inflating the Housing Bubble?    7. What was the purpose of commercial banks creating mortgage-backed securities?  
	
Document Preview: ECO 120Exam 2 Topics and PracticeAggregate Demand-Aggregate Supply Model 	AD, SAS, LAS: Why they look the way they do and shifters	Self-Correction: What happens to the curves, why they shift the way they do	Fiscal Policy: Expansionary vs. Contractionary: tools, when to use, goals	Multiplier Effect	Fiscal Policy ProblemsCrowding out: Steps and impactsAutomatic Fiscal Policy: Built-in-Stabilizer definition, relation to taxes, how it happensMoney	Functions of Money	Money Supply: M1, M2	The Financial SectorThe Federal Reserve	Fed Functions	Independence from the Government	Money Multiplier and the reserve requirement	Banking:  Money creation, bank reservesMonetary Policy	Expansionary vs. Contractionary: Steps, Tools, how they work	Show all the steps of monetary policy graphically with explanations.2008 Crisis	Subprime vs. Fully-Documented Mortgages	Bubble inflating and bursting	Practice ProblemsExplain the multiplier effect as it relates to Expansionary Fiscal Policy.  If the goal of the expansionary policy is to increase GDP by $500 and the Multiplier = 1, how much will government spending have to increase?  Is there a multiplier effect?  Why or why not?Does the Fed directly increase or decrease interest rates?  If they do not, how does the Fed go about increasing or decreasing the interest rates?When conducting Monetary Policy, why does the Fed influence bank reserves?Give three economic changes that would shift out the Aggregate Demand Curve.  What will happen to the equilibrium level of GDP, what will happen to the equilibrium price level?  Illustrate with a graph  Contractionary Policy:  Solve for the decrease in G and the increase in T using the MPC = 0.95 and 0.45ASRGDPPrice Level563   ADAD’435Discuss the sequence of the inflating the Housing Bubble?What was the purpose of commercial banks creating mortgage backed securities?EquationsMultiplier=change GDPchange...

Robert · Accepted Answer

ECO 120 
Exam 2 Topics and Practice
Aggregate Demand-Aggregate Supply Model  
 AD, SAS, LAS: Why they look the way they do and shifters 
 Self-Correction: What happens to the curves, why they shift the way they do 
 Fiscal Policy: Expansionary vs. Contractionary: tools, when to use, goals 
 Multiplier Effect 
 Fiscal Policy Problems 
Crowding out: Steps and impacts 
Automatic Fiscal Policy: Built-in-Stabilizer definition, relation to taxes, how it happens
Money 
 Functions of Moneyy 
 Money Supply: M1, M2 
 The Financial Sector
The Federal Reserve 
 Fed Functions 
 Independence from the Government 
 Money Multiplier and the reserve requirement 
 Banking:  Money creation, bank reserves
Monetary Policy 
 Expansionary vs. Contractionary: Steps, Tools, how they work 
 Show all the steps of monetary policy graphically with explanations.
2008 Crisis 
 Subprime vs. Fully-Documented Mortgages 
 Bubble inflating and bursting
Practice Problems
1. Explain the multiplier effect as it relates to Expansionary Fiscal Policy.  If the goal of the 
expansionary policy is to increase GDP by $500 and the Multiplier = 1, how much will 
government spending have to increase?  Is there a multiplier effect?  Why or why not?
The multiplier effect refers to the overall increase in equilibrium GDP arising from any 
new injection of spending.   For example, if there is an increase in G, Equilibrium GDP 
will increase by more than the increase in G due to multiplier effect. In a closed economy 
the simple expenditure multiplier depends on MPC or MPS. Multiplier =1/1-MPC. But in 
an open economy model, the multiplier effect depends on Marginal propensity to 
consume, marginal tax rate and marginal propensity to import.
We only get the multiplier equal to 1, when there is an equal increase in Government 
expenditure and tax.
If there is an increase in $1 in G then GDP will increase by multiplier times 
 Expenditure multiplier= 1/1-MPC
If there is an increase in $1 in T , equilibrium GDP will decrease by tax multiplier times 
Tax multiplier= -MPC/1-MPC
Overall effect on equilibrium GDP can be find out through Balanced Budget multiplier  
BBM=1/(1-MPC) - MPC/(1-MPC)  
 =(1-MPC) / (1-MPC) 
=1
If the goal of the expansionary policy is to increase GDP by $500, then government 
spending must increase by $500 and tax must be also increased by $500. It would raise 
the equilibrium GDP by the same amount that is $500
This is a multiplier effect.

Practice Problems 1. Explain the multiplier effect as it relates to Expansionary Fiscal Policy. If the goal of the expansionary policy is to increase GDP by $500 and the Multiplier = 1, how much will...

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