MACRO1 Group Work Assessment

Short Answer Questions:

• Suppose that you are an investment advisor and after checking the latest interest rates in the bond market, you collect the following information:

Explain briefly, which of these bonds you would recommend, and why, to a client who tells you (0.5 mark for each):

1. “I’m saving for retirement, so I won’t need the money for many years, but above all I don’t want to risk losing my money.”
2. “I’m saving to buy a new house. I may need the money next year, and I don’t want to take any risk either.”
3. “I’m in a high federal income tax bracket and would really benefit from a tax break on the income from my savings.”
4. “I want to aim for a high return and don’t care if that means taking on a lot of risk.”
5. “I want a decent return and am willing to tolerate some risk, but not too much risk.”

• Consider a closed economy in which GDP equals $15 billion, consumption equals $9 billion, government purchases equal $2 billion, and tax revenue equals $1 billion. Use this information to answer the following questions (0.5 mark for each):

1. What is investment equal to in this economy?
2. What is national saving equal to in this economy?
3. What is public saving equal to in this economy?
4. What is private saving equal to in this economy?
5. What are net exports equal to in this economy?

• Suppose the new government act to cut government spending and, by doing so, eliminate the current federal government budget deficit. (0.5 mark for each):

1. Does this change in policy shift the demand curve or the supply curve in the market for loanable funds?
2. Use a supply‐and‐demand diagram for loanable funds to show in which direction the relevant curve shifts.
3. Does the interest rate rise or fall as a result of this change in policy?
4. What happens to private investment as a result of this change in policy?
5. What effect would this policy have on the productivity of US workers?

• Consider an economy in which, initially, there are no banks. Suppose that one consumer initially holds the economy’s entire money supply, in the form of $100 in currency. Then a new bank – call it the First National Bank – opens, and the consumer deposits the entire $100. (0.5 mark)

1. Assuming that the First National Bank has a 100 percent reserve ratio, use a T‐account to show what effect this deposit has on the Bank’s balance sheet.
2. Still assuming a 100 percent reserve ratio, explain what effect this deposit will have on the economy’s total money supply.
3. Show how the First National Bank’s T‐account will look if, instead, it chooses a 10 percent reserve ratio.
4. Assuming that many other banks open up, all choosing the same 10 percent reserve ratio, and assuming that every consumer now chooses to hold all of his or her money as deposits instead of currency, explain what effect the initial deposit will eventually have on the total money supply.
5. Are consumers as a group wealthier when the banking system chooses a 10 percent reserve ratio?