Vanier College Faculty of Arts, Business and Social Sciences
Introduction to Macroeconomics
383-920-VA
Bonus Assignment #5
Instructions:
Get into groups your study groups in order to complete this assignment. Staple your answers to this cover page: Maximum 4 students.
Show all work/calculations as failure to do so will severely diminish your grade.
Where asked to “explain” something, “poor explanations” will receive “poor grades”. Also, the quality of your written work will also be taken into account (e.g. grammar, spelling, punctuation), and so proofread your answers. Consult Omnivox for grading rubric on written take-home assignments.
You are reminded about the College’s policies on copying and plagiarism.
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Due Date: The day of your midterm #3.
Grade:
Question #1(16 marks):
A little village isolated from any other human settling has one bank, the bank ABC. Bank ABC has deposits for 10000$ and a desired reserves coefficient of 2%, Assuming that there are no leakages and excess reserves from untaken loans of 2000$. Answer the following questions:
(3 marks) How much currency (cash) is in circulation?
The formula for the total currency in the country is:
Hence:
Therefore, the total currency in the market is:
Total currency = 10,000 + (10000*0.02) = $10,200
(3 marks) How much money (monetary mass) there is in this little village?
The equation will give the total monetary mass
Total Monetary Mass=money in circulation+deposit+untaken loans
Therefore,
Total monetary mass = 10,000 + 10,200 + 2000 = $ 22,200
(5 marks) Explain why your answers b and a differ.
The difference between the two figures is that the total currency in circulation does not reflect on the entire money in the economy. On this note, many countries in a bid to control inflation limit the money supply, which means that the money in circulation is less than that in the country’s reserves. Furthermore, the government has to ensure that there is some money set aside for loans, which will ensure that people can access it for investments. In this regard, the money in circulation is always less than the total money mass in the country.
(5 marks) All of a sudden, the village has an influx a great number of banks. Assuming that the reserves coefficient do not change, there are no leakages and 0$ in excess reserves, how much monetary mass could be created from the initial 10000$ deposit?
The amount of monetary mass in the country will not register any change because there is no extra money that will be injected into the economy. Precisely, the banks will share the $10,000 deposits since there are no leakages in the market.
Question #2 (16 marks) :
Answer true or false and give a brief explanation.
(4 marks) When inflation increases, the Central bank will apply a restrictive policy that consist on selling government bonds in the open market.
True: Selling government bonds means that the households will have reduced income, which will reduce the propensity to purchase other goods, thereby reducing inflation in the economy.
(4 marks) An increase in the policy rate will increase the interest rate for mortgages.
True: when the central bank increases the policy rate, the banks subsequently increase the interest on all credit, including mortgages.
(4 marks) The bank of Canada will buy government bonds whenever is demanded by the prime minister.
False: The Bank of Canada is independent and makes a decision based on the prevailing economic environment and not from political coercion.
(4 marks) Selling bonds in the open market will drive the overnight rate down.
False: The overnight rate will increase because the bonds will be attractive in an open market.
Question #3 (16 marks) :
(8 marks) In your own words, explain why a classic laissez-faire economist would let the economy self-adjust following a cyclical overemployment situation.
According to the Keynesian theory of involuntary employment, there is no evidence that the classical theory is applicable, and therefore an economist doesn’t need to interfere with other aspects of an economy. On this note, classical assumptions indicate that to reduce the impact of over employment on the economy, the government should interfere with the wage-price equilibrium (Appelbaum 36). However, in a laissez-faire economy, the government should have minimal involvement in economic activities. In this regard, the economist should not interfere in the labor market by influencing wages because this is one of the ways that inefficiencies in the economy occur because employees may be forced to receive below-average salaries, which does not have a positive effect on the economy.
(8 marks) Does the Keynesian criticism apply to the aforementioned argument? Explain.
The Keynesian criticism on unemployment is applicable in the above argument because it mentions that the government should have minimal involvement in the economic activities of the country. In this regard, it is essential to note that the government will have to use various mechanisms to ascertain that the economy is headed in the right direction. If the government does not interfere with different aspects of the economy, the outcomes may have adverse outcomes that will have repercussions on the citizens. In this regard, although government involvement is not desired, the government needs to instill some form of control to ensure that there is a balance in the economy.
Question #4 (26 marks) :
Consider the following data on a fictional economy:
MPC: 0.85
(2 marks) Calculate the keynisian multiplier.
Keynesian multiplier
The formula for the Keynesian multiplier is:
Thus, multiplier = 1 / (1-0.85) = 6.67
(4 marks) How much the government should increase its spending in order to increase GDP in 250 billion $?
According to the Keynesian theory, when the government increases a dollar, it will increase the GDP by the Keynesian multiplier. In this regard, for the government to increase the GDP with 250 billion, it will have to increase its spending by the following number.
Increment in government spending = 250/6.67 = 37.5 billion.
(8 marks) Illustrate the previous change in a graph with income in the x axis and spending in the y axis.
Graph
In this regard, while the government increases its spending, the level of income increases because the money is redirected to households with the economy. Precisely, it is essential to note that the government will be injecting money into the economy, enhancing the ability of citizens to increase their income levels.
(4 marks) How much the government should decrease its taxes in order to increase GDP in 250 billion $?
The Keynesian multiplier on taxes
The formula gives the multiplier of tax:
On the other hand, MPS = 1 – MPC
Therefore, the multiplier for tax is equal to:
M(tax) = 0.85 / 0.15 = -5.67
Therefore, for the government to increase the GDP by 250 billion, it will have to institute a new tax of 250/-5.67 = -44 billion
In this regard, the government will have to reduce taxation by 44 billion.
(8 marks) Explain why your answers b) and e) differ.
The difference between the two equations is that the two equations are derived from the fact that government spending increases the GDP because households will increase their income. On the other hand, when the government raises taxes, the income level of the household diminishes, reducing the levels of GDP (Hatton 84). In this regard, government spending enhances economic growth while taxation limits the ability of the people to invest in the economy.
Question #5 (Worth a total of 26 marks):
Here are some data to make an analysis of the finances of the Spanish government.
Spain’s GDP (billion of euros)
Spain’s budgetary balance
(8 marks) Calculate the debt of the government from 2000 to 2010. Take into account that Spain’s debt in 2001 was 441.10 Billion of Euros.
DEBT OF THE SPANISH GOVERNMENT
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Answer
In order to identify government debt, it is essential to identify the coefficient determining the government debt concerning budgetary balance and the GDP. In this regard, we will use the year 2001 as the indicator of the coefficient.
Government debt = 441.1 billion
GDP = 902.6 billion
Budgetary balance = 19.4
Tersely, budget balance indicates the amount of money that the government has used concerning when the government has left zero amount after spending the entire GDP. Therefore, for the year 2011, the government had a budget surplus of 19.4. In this regard, the amount of money used by the government in 2001 is:
Government budget = 902.6
Thus, considering that the country incurred a debt of 441.1 billion, the actual spending was:
National spending = 902.6 + 441.1= 1343.7
The coefficient is, therefore: 441.1 = 1343.7x
x = 441.1 / 1343.7
x = 0.33
Plugging in the values, the results are:
Year
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
GDP
867.90 902.60 928.60 958.20 988.60 1025.40 1068.20 1108.50 1120.80 1080.80 1080.90
Budget Balance%
-0.027 0.194 0.030 0.310 0.058 0.147 0.297 0.308 -0.507 -1.183 -0.195
Actual Expenditure
891.33 727.50 900.74 661.16 931.26 874.67 750.94 767.08 1689.05 2359.39 1291.68
Government Debt
23.43 -175.10 -27.86 -297.04 -57.34 -150.73 -317.26 -341.42 568.25 1278.59 210.78
(8 marks) Using the data available, calculate the debt-to-GDP ratio for the same period.
RATIO % (DEBT/GDP)
2002 2003 2004 2005 2006 2007 2008 2009 2010
GDB to Debt Ratio
Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
GDP 867.90 902.60 928.60 958.20 988.60 1025.40 1068.20 1108.50 1120.80 1080.80 1080.90
Debt 23.43 -175.10 -27.86 -297.04 -57.34 -150.73 -317.26 -341.42 568.25 1278.59 210.78
GDP Debt Ration 0.027 -0.194 -0.03 -0.31 -0.058 -0.147 -0.297 -0.308 0.507 1.183 0.195
(10 marks) Based on your results only, do you think that Spain’s finances have been properly managed. Which political ideology you think your argument better aligns with?
The political ideology of Spain is a democracy.
In this regard, it is essential to note that the country’s government expenditure indicates that it has committed to spending money to enhance the welfare of the citizens, which is typical of a democracy. Furthermore, the country has been capable of ensuring that it registers consistent growth in its GDP, which is usually associated with a democratic form of government, although other ideologies also express growth. The countries debt is also indicative of democracy because it has been fluctuating, meaning that different government policies have resulted in increasing and decreasing debt.
Works Cited
Appelbaum, Eileen. “The labor market in post-Keynesian theory.” Unemployment and Inflation. Routledge, 2017. 33-45.
Hatton, Timothy J. “The outlines of a Keynesian solution.” The Road to Full Employment. Routledge, 2018. 82-94.
