Addis Ababa University College of Business and Economics Department of Economics Macroeconomics I (Econ 2031) Worksheet

Addis Ababa University
College of Business and Economics

Department of Economics
Macroeconomics I (Econ 2031) Worksheet
1. Distinguish between the effect of different policy actions on equilibrium level of income
in perfect flow of capital model in different exchange rate regimes (a) fixed exchange rate
regime and (b) in a floating exchange rate regime.
2. Consider an economy described by the following equations:
Y = C + I + G + NX,
C = 500 + 2/3 (Y - T)
I = 900 - 50r; where r=5%
NX = X-M, where X = 1000; M = 250+0.2Y
G = 2,500
T = 2,000
(a) Derive government multiplier and its value
(b) Find equilibrium value of income, consumption and saving
(c) If G increases decreases from 2500 to 2000, what will the change in income,
consumption and saving?
Y = C + I + G + NX,
C = 500 + 2/3 (Y - T)
T = 50+0.2Y
I = 900 - 50r; r =5%
NX = X-M, where X = 1000; M = 250+0.2Y
G = 2,500
T = 2,000
(d) Derive government multiplier and its value

(e) Find equilibrium value of income, consumption and saving
1
(f) If G increases decreases from 2500 to 2000, what will the change in income,
consumption and saving?
(g) Compare the results in 3 and 2 and give reasons as to why such differences arise.
Y = C + I + G + NX,
Y = 8,000
G = 2,500
T = 2,000
C = 500 + 2/3 (Y - T)
I = 900 - 50r
NX = 1,500 - 250e
r = r * = 8.
a) In this economy, solve for private saving, public saving, national saving,
investment, the trade balance, and the equilibrium exchange rate.
b) Suppose now that G is cut to 2,000. Solve for private saving, public saving,
national saving, investment, the trade balance, and the equilibrium exchange rate.
Explain what you find.
c) Now suppose that the world interest rate falls from 8 to 3 percent [Hint: in a
perfect flow of capital model the domestic interest rate adjusts to its equilibrium
level, which is r =r*]. (G is again 2,500.) Solve for private saving, public saving,
national saving, investment, the trade balance, and the equilibrium exchange rate.
Explain what you find.
5. The country of Leverett is a small open economy. Suddenly, a change in world fashions
makes the exports of Leverett unpopular.
a) What happens in Leverett to saving, investment, net exports, the interest rate, and
the exchange rate?
b) b. The citizens of Leverett like to travel abroad. How will this change in the
exchange rate affect them?
c) The fiscal policymakers of Leverett want to adjust taxes to maintain the exchange
rate at its previous level. What should they do? If they do this, what are the
overall effects on saving, investment, net exports, and the interest rate?
2
6. A small open economy with perfect mobility of capital is described by the following
equations:
C = 50 + .75(Y - T)
I = 200 - 20r
NX = 200 + 50e
M/P = Y - 40r
G = 200
T = 200
M = 3000
P=3
r* = 5
a) Derive and graph the IS and LM curves.
b) Calculate the equilibrium exchange rate, level of income, and net exports.
c) Assume a floating exchange rate. Calculate what happens to the exchange rate,
the level of income, net exports, and the money supply if the government
increases its spending by 50. Use a graph to explain what you find.
d) Now assume a fixed exchange rate. Calculate what happens to the exchange rate,
the level of income, net exports, and the money supply if the government
increases its spending by 50. Use a graph to explain what you find.
7. The Mundell–Fleming model takes the world interest rate r* as an exogenous variable.
Let’s consider what happens when this variable changes.
a) What might cause the world interest rate to rise? (Hint: The world is a closed
economy.)
b) If the economy has a floating exchange rate, what happens to aggregate income,
the exchange rate, and the trade balance when the world interest rate rises?
c) If the economy has a fixed exchange rate, what happens to aggregate income, the
exchange rate, and the trade balance when the world interest rate rises [Hint:
always keep truck of the effect of the rise in r as against r* or the rise in r* as
against r on the equilibrium level of income, exchange rate, trade balance, etc]?
8. Explain the different theories of aggregate supply. On what market imperfection does
each theory rely? What do the theories have in common?
3
9. In the sticky-price model, describe the aggregate supply curve in the following special
cases.
a) All firms have sticky prices (s = 1).
b) The desired price does not depend on aggregate output (Y-bar= 0).
10. Suppose that the economy is initially at long run equilibrium. Then the central bank
increases the money supply.
1. Assuming any resulting inflation to be unexpected, describe any changes in GDP,
unemployment, and inflation that are caused by the monetary expansion. Explain
your conclusions using three diagrams: one for the IS–LM model, one for the
AD–AS model, and one for the Phillips curve [Hint: You have a long-run Phillips
curve – vertical and short-run Phillips’s curve-short run and assess the immediate
and long-lasting effect].
2. Assuming instead that any resulting inflation is expected, describe any changes in
GDP, unemployment, and inflation that are caused by the monetary expansion.
Once again, explain your conclusions using three diagrams: one for the IS–LM
model, one for the AD–AS model, and one for the Phillips curve.

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(d) Derive government multiplier and its value

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