# Calculating Aggregate Demand, Money Supply and Investment in an Economy

Question

Problem 1: An open economy has the following expenditures and money demand.
C= 2000+0.8(Y-T)            Md/P = Y/20i
I = 1900-30,000i            i* = 0.05
G = 1000                P* = 1
T = 1000
NX = 800-0.1Y - 400e

Nominal exchange rate is fixed at 1(E=1).
(1) Derive (1) the aggregate demand (AD) curve algebraically and  (2) depict it on (Y, P) plane. (3) Explain the determinants of the location of AD curve.
(2) Suppose from now on the domestic price level is fixed at 1. (1) What are the output,  interest  rate,  consumption,  investment  and  net  export in  the  short  run equilibrium?  (2) What is the money supply?  (3) Using figure(s), describe the short run equilibrium.
(3) Suppose government expenditure increases from 1,000 to 1,300. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium?  (2) What is the money supply? (3) What is the government expenditure multiplier?  Compare the multiplier with the one in Keynesian cross and explain why there is a difference. (4) Using figure(s), describe the policy effect.
(4) Explain why monetary policy does not have any effect in  a fixed exchange rate regime.
(5) The government expenditure stays at 1,000, but the government devalues the exchange rate from 1 to 0.25. (1) What are the output, interest rate, consumption, investment and net export in the short run equilibrium?  (2) What is the money supply? (3) Using figure(s), describe the policy effect.
(6) The government expenditure stays at 1,000 and nominal exchange rate at 1. However, foreign interest rate has decreased from 0.05 to 0.04. (1) What are the output,  interest  rate,  consumption,  investment  and  net  export in  the  short  run equilibrium?  (2) What is the money supply? (3) Using figure(s), describe the effect of the decrease in foreign interest rate.

Now suppose the aggregate supply is given as follows.

Y = 10000 + 1000 (P-Pe)
The expected price level is given as 2 initially.
(7) (1) What is the output in medium run equilibrium?  (2) What is the equilibrium output and price level in the short run?
(8) The short run equilibrium is allowed to be adjusted to the medium run equilibrium through automatic (market) mechanism without any government policy intervention. (1)  What are the output, price, consumption, investment and net export in the medium run equilibrium? (2) Using figure(s) of AD-AS/IS-LM, explain the adjustment process.
(9) Now the  government  uses its expenditure to  move the  economy  from  the short  run  to medium  run  equilibrium.  (1) How much has government expenditure to be increased to achieve the goal?  (2) Using figure(s) of AD-AS/IS-LM,  analyze the policy effect.
(10) Instead of fiscal policy, the  government  would like to  use  devaluation  to move the economy from the short run  to medium run  equilibrium.  (1) What should the new exchange rate be? (2) Using figure(s) of AD-AS/IS-LM,  analyze the policy effect.

Problem 2: An open economy has the following expenditures and money demand.
C= 2000+0.8(Y-T)            Md/P = Y/20i
I = 1900-30,000i            i* = 0.05
G = 1000                P* = 1
T = 1000
NX = 800-0.1Y - 400e

Money supply is 10,000. Nominal  exchange rate is flexible. To make  the problem simple, assume that  they always expect the future  exchange rate to be the same as the current exchange rate.
(1) Derive (1) the aggregate demand (AD) curve algebraically and (2) depict it on (Y, P) plane. (3) Explain the determinants of the location of AD curve.
(2) Suppose from now on the domestic price level is fixed at 1. (1) What are the output,  interest rate,  consumption,  investment,  net  export and  nominal  exchange rate  in  the  short  run  equilibrium?   (2)  Using  figure(s),  describe  the  short  run equilibrium.
(3) Analyze the effect of an increase in government expenditure.
(4) Suppose money supply increases from 10,000 to 11,000. What are the short run output, consumption, investment, net export and nominal exchange rate?
(5) Money supply  stays at  10,000, but  foreign  interest rate rises from  0.05 to
0.0505. (1) What are the output,  interest rate, consumption,  investment, net export and  nominal   exchange  rate  in  the  short  run   equilibrium?   (2)  Using  figure(s), describe the effect of the increase in foreign interest rate.
Now suppose the aggregate supply is given as follows.
Y = 10000+ 1000 (P – Pe)
The expected price level is given as 7 initially. Money supply is 10,000 and foreign interest rate is 0.05.
(6) (1) What is the output in medium run equilibrium? (2) What is the equilibrium output,   price level  and   nominal   exchange  rate  in  the  short  run?   Note the following.
P2+ 3P -10 = (P+5)(P-2)
(7) The short  run  equilibrium  is  allowed to  be  adjusted  to  the  medium  run equilibrium  through  automatic  (market) mechanism  without any government policy intervention.  (1) What  are  the  output,  price,  consumption,  investment,  net  export and  nominal  exchange rate in  the medium  run  equilibrium?  (2) Using figure(s) of AD-AS/IS-LM,  explain the adjustment process.
(8) Now the central bank  uses monetary policy to move the economy from the short  run  to  medium  run  equilibrium.  (1)  How much  has  money  supply  to  be increased  to  achieve  the  goal?  (2)  Using  figure(s) of  AD-AS/IS-LM,  analyze  the policy effect.

Summary

These questions belong to Macroeconomics and they deal with the expenditures of the whole economy. Various factors such as aggregate demand, money supply, governmental policy, output, price, consumption, investment, net export, etc are calculated in the solution.

Total Word Count 1993

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