The 2nd Assignment of Principles of Macroeconomics

ECON2003, 2nd sem, 2023-24

Question 1 (25 marks total)

Below is a summary of the labor market of Gotham City in 2020, with the headcounts measured in ‘000 persons:

a)    Calculate the Labor Force Participation Rate (LFPR, %) of Gotham City. Show your

steps and round your answer to two decimal places.                         (5 marks)

b)    Calculate the Unemployment Rate (%) of Gotham City. Show your steps and round your answer to two decimal places.      (2 marks)

c)    If soon after the table was compiled, Gotham City was hit by an epidemic which took away the lives of 20,000 adults, with all else remained the same. At the sametime the LFPR became 69%, How many of those who died were NOT in the labor force before the change?                                                       (6 marks)

d)    As a means to raise the living standard of the low skill workers, the government of

Gotham City decided to implement a minimum wage in the labor market. At the same time the government introduced the Foreign Talent Program, under which foreigners with designated professional backgrounds will be given special working permit to work in Gotham City. Will these policies combined have a likely effect that increases, decreases or holds constant the natural rate of unemployment? Explain.               (6 marks)

e)    Addressing the problem of low birthrate in the city, the government decides to subsidize birth-giving, and some families will respond to this new policy. How will this policy affect the LFPR and the u-rate in the coming few years? Explain.               (6 marks)

Question 2 (25 marks total)

In the country of Monesia, the central bank requires a minimum reserve ratio of 10%, and all the commercial banks always maintain the same reserve ratio as one another. The combined  T-account of all the commercial banks shows:

Half of the “Other assets” above are government bonds. The people of Monesia also hold some government bonds.

a)   Suppose the central bank purchases $25 billion worth of government bonds from the

commercial banks in order to increase the money supply. What will be the minimum possible increase of money supply in Monesia? Describe how it may happen, also find   out the excess reserves in the banking system after it happened.           (4 marks)

b)  Suppose the same action by the central bank as in Part a). What will be the maximum

increase of money supply in Monesa possibly achieved by this action of the central bank? Describe how it may happen, and show calculations.             (4 marks)

c)  Alternative to the above, suppose the central bank purchases $20 billion government

bonds from the Monesian people, for the same purpose of increasing the money supply. What is the minimum possible increase of money supply in Monesia? Describe how it   may happen.           (4 marks)

d)  Suppose the same action by the central bank as in Part c). What will be the maximum

increase of money supply possibly achieved by this action of the central bank? Describe how it may happen.        (4 marks)

e)   Continuing with Part d), draw the combined T-account of the all the commercial banks  after the events your described in Part d) have happened.                                   (5 marks)

f)   If the central bank wants to achieve the highest increase of money supply by open market operation, should it purchase government bonds from the banks or from the people?

Explain (you can draw hint from your answers above).                                     (4 marks)

Question 3 (25 marks total)

Currently in the country of Mokland, people hold $12 billion currency, and have bank deposits in the total of $600 billion. All the commercial banks in the country hold the same reserve ratio, and their total reserves are $75 billion.

a)  How much is the money supply currently Mokland currently?                           (3 marks)

b)  Suppose that one year later the money supply in Mokland increases by $40 billion, and the only reason for the change is that people there hold less currency; the banks keep the same reserve ratio as before. Find how much currency is still in circulation at that time   (i.e. one year later). Show calculations.                                   (5 marks)

c)   Suppose that two years later the people in Mokland completely stopped using currency; and the banks still keep the same reserve ratio as before. Find the money supply at that  time (i.e. two years later) in Mokland. Show calculations.            (4 marks)

d)  Continuing from Part a), suppose the central bank requires minimum reserve ratio of 10%, how much reserve in the banking system is required reserve, and how much is excess reserves. Show calculations.                         (2 marks)

e)   Continuing from Part d), but suppose that the banks all decide not to hold any excess

reserves anymore. There will be no open market operation by the central bank and people still hold the same amount of currency as before. How much will be the money   supply in Mokland? Show calculations.                      (4 marks)

f)   Show the combined T-account of all the banks in Mokland as described in Part e), further information needed is as follows: besides reserves and loans, the only other asset the banks have is $120 billion government bonds; the banks have total capital of $40 billion; and their leverage ratio is 22 times.                       (7 marks)

Question 4 (25 marks total)

Below are questions about Money Growth and Inflation. Answer each question with sufficient explanations.

a)  An economy experienced unexpected deflation in year 1. Provide a possible reason with sufficient explanation.    (4 marks)

b)  You have learned six costs of inflation. Identify if each cost occurs when we have unexpected deflation.                        (10 marks)

c)   To avoid unexpected deflation, the central bank of the economy decided to increase

money supply by 5% every year. However, there was less than 5% inflation in year 2. What could be a possible reason for this outcome? Explain these changes using the money supply-demand diagram.                         (3 marks)

d)  In year 3, the inflation rate was 5% as expected by the central bank and citizens. When the inflation is expected, do the costs of inflation still occur? What cost can be lower compared to when we have unexpected inflation? Explain for each cost.          (8 marks)