Type: Economics
Pages: 3 | Words: 814
Reading Time: 4 Minutes

In this paper, an analysis and discussion of various macroeconomic concepts are discussed as different variables are applied or varied. This assignment is done under three questions; question. It is assumed that the Federal Reserve strictly follows a rule of keeping the interest rate at 3% per annum. Initially, this interest rate equates to the demand and supply of real money balances. The economy is then said to experience a negative shock to the demand for money, meaning the demand for real money balances drops.

  1. If the Federal Reserve does not change the money supply, what happens to the interest rate? With the demand for real money balances low, people or investors would maintain their money in deposits with financial institutions. With many deposits, banks would lower interest rates to attract borrowers. The interest rates would then come down.
  2. How could the Fed respond to the money supply if it wants to keep the interest rate constant? The fed could lower the supply of money so that there is need to borrow. This could force investors to borrow hence increasing demand for real money balances and rising of the interest rate due to the increased demand for loans.
  3. If the economy experiences many positive and negative shocks, would the Fed’s constant interest rate rule increase the variance of the money supply? Yes, it will increase the variance of money supply (O’Sullivan & Steven, 2003). This is because the money supply is used to check and regulate the other variables. This is good under the circumstances because it does not interfere with the interest rate, which is critical to investor confidence in the economy.

Question No. 2. According to the Solow Growth Model, how would each of the following developments affect output per worker and consumption per worker in the long-run if, (a) there is a destruction of the nation’s capital stock in a war? With destruction of capital stock in a war, government expenditure would be curtailed, meaning fewer jobs are created and hence less income is earned. With less income, earned, workers are less motivated leading to low output per worker. The consumption per worker would also decrease given that the income is much less.

(b) In case there is a permanent increase in the rate of immigration from a country where religion forbids birth control, the population would increase. This means there is a high number of available labor force. Many people would be employed. Workers would not therefore be overworked. This would improve each worker’s productivity. With n increase in the workers’ productivity, income would also be enhanced (Snooks, 1999). This will lead to increased wages and salaries paid to the workers, which will in turn increase the consumption per worker given that they are paid well from their work places.

(c) If the consumers become more concerned about the future and decide to consume a smaller portion of their income, their productivity would rise. This is because, they would be motivated to put in more effort to increase the productivity of the firm so that they may get extra income to compensate for the more savings they are making. Their consumption would decrease because the disposable income has been reduced due to the extra savings being made.

Question No. 3. West Bubble makes ordinary soap that are sold for 5 guiders each. Each bubble makes deluxe soap bars that are sold for 100 florins each. The real exchange rate between West and East Bubble is two ordinary soap bars per deluxe soap bar. (a) What is the nominal exchange rate between the two countries? The calculation is as follows: Real exchange rate is 2 ordinary soaps for a single deluxe soap. A guider’s value would be; (2)/100 florins which gives 10 guiders for every 100 florins. Therefore, the nominal exchange rate is 1 guilder for 10 florins. The West Bubble Guilder goes for 10 East Bubble Florins.

(b) There is inflation at the end of the year for the two economies. For the West Bubble, it is recorded at 10% while it is given at 20% for the East Bubble economy. This has an effect of increasing the prices of the two commodities. The new prices would thereby be; West Bubble Economy; 1.1guiders for each bar soap.

East Bubble Economy: 1.2

The real exchange rate remains constant, that is two bar soaps for each Deluxe soap.

So, 2for Economy West Bubble

120 florins for each Deluxe soap.

11 guiders for 120 florins, 1 guilder would be, 120/11, which gives 10.9 florins.

Therefore, the exchange rate becomes 10.9 florins for each guilder. The West Bubble has had a nominal appreciation because it now buys more of the products of East Bubble with the same amount of Gilder, one unit of it. East Bubble has had a nominal depreciation because it now requires much more units of its currency to be able to attain the value of one foreign currency, the Florin.

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