Assume the United States economy is in short-run macroeconomic equilibrium at an output level greater than potential output.

Answers

Answer 1

(a) An increase in government spending by $100 billion will shift the AD curve to the right.

(b) Household savings will decrease by $400 billion in the short run.

(d) An increase in the interest rate in the short run leads to a decrease in the prices of previously issued bonds

(e) An increase in the inflation rate in the United States relative to the inflation rate in the European Union will lead to a decrease in the demand for dollars in the foreign exchange market.

(f) If the Federal Reserve attempts to keep the value of the dollar constant in the foreign exchange market, it should sell dollars and buy euros.

How to calculate the value

The maximum change in real output can be calculated using the formula:

∆Y = ∆Spending × (1 / (1 - MPC))

where MPC is the marginal propensity to consume.

∆Y = $100 billion × (1 / (1 - 0.8)) = $500 billion

The maximum change in household savings can be calculated as follows:

∆S = -MPC × ∆Y

∆S = -0.8 × $500 billion = -$400 billion

If the Federal Reserve attempts to keep the value of the dollar constant in the foreign exchange market, it should sell dollars and buy euros. This is because the dollar has depreciated in the foreign exchange market, and selling dollars will increase the demand for dollars and raise its value.

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