Course & Section: BU204-04
Date: May 18, 2012
1. Define any key terms that you feel are important in answering the following question as they are defined in the textbook and explain, in your own words what those definitions mean, and then thoroughly analyze each of the following changes in the market for loanable funds to answer the these questions Use the diagrams below, resizing them as necessary, to illustrate your analysis in explaining what happens to private savings, private investment spending, and the rate of interest if the following events occur. Assume the economy is closed (no transactions are made with foreign countries).
a. The government reduces the size of its deficit to zero (10 points).
Loanable funds – funds received by the bank by depositors that do not have to be retained and are available to be loaned out. This is how banks create money.
Private savings – disposable income not spent on consumption
Private investment spending – buying of capital goods by private business (non-government spending)
Rate of interest – the amount charged/paid for the use of money, specifically money that is borrowed from a Lender (bank)
If the government reduces the size of its deficit to zero, the demand for loanable funds shifts to the left. The number of loans decrease and private investment increases because interest rates decrease. As more invest, private savings decrease.
b. At any given interest rate, consumers decide to save more. Assume the budget balance is zero (10 points).
When the budget balance is zero, private savings increase. This increases the amount of loanable funds and is illustrated by a supply curve shift to the right. This also causes a reduction in interest rates and an increase in private investment spending.
c. At any given interest rate, businesses become very optimistic about the future profitability of investment spending. Assume the budget balance is zero (10 points).
If businesses become very optimistic about the future profitability of investment spending, the demand for loanable funds increases. This also increases the equilibrium interest rate, because supply remains the same. Because interest rates rise, private savings increase.
2. Define any key terms that you feel are important in answering the following question as they are defined in the textbook and explain, in your own words what those definitions mean, and then thoroughly analyze each situation to answer the following questions.
Using aggregate demand, short-run aggregate supplies, and long-run aggregate supply curves, explain the process and causes by which each of the following economic events will move the economy from one long-run macroeconomic equilibrium to another. Use the diagrams below, resizing them as necessary, to illustrate your analysis. In each case, what are the short-run and long-run effects on the aggregate price level and aggregate output?
Aggregate demand – the total amount of goods and services demanded in an economy at a certain price during a certain period of time
Short-run aggregate supplies – the aggregate production of goods and services available in the economy at various prices during a period of time when prices are adjusting but wages appear to be constant
Long-run aggregate supplies – the aggregate production of goods and services available in the economy when both prices and wages are in a state of adjustment
a. There is a decrease in households’ wealth due to a decline in the stock market (9 points).
[pic] A decrease in household wealth leads to a decrease in consumption. The aggregate demand curve shifts to the left and reduces the prices that people are willing to pay for goods. A decrease in price level and given wages increases hiring costs and...