Macroeconomics Answers

Popeye’s income declines and as a result, he buys more spinach. Is spinach an inferior or normal good? Illustrate what happens to Popeye’s demand curve for spinach.

Suppose you make a loan of $100 that will be repaid to you in 1 year. If the loan is
denominated in terms of a nominal interest rate, are you happy or sad if inflation is higher
than expected during the year? What if the loan instead had been denominated in terms of
a real return?

Assume that good A and good B are related goods and QB=1691-400PB+6PA-6Y. Suppose that PB=0.1 Birr, PA=0.3 Birr and Y (income) =10 Birr. Then compute.
- Price elasticity of demand for good B.
Income elasticity of demand for good B and
- explain nature of the good.
- Cross price elasticity of demand and state the nature of the goods whether they are substitute, complementary or unrelated.

“We can have the GDP path we want equally well with a tight fiscal policy and an easier
monetary policy, or the reverse, within fairly broad limits. The real basis for choice lies in
many subsidiary targets, besides real GDP and inflation, that are differentially affected by
fiscal and monetary policies.” What are some of the subsidiary targets referred to in the
quote? How would they be affected by alternative policy combinations?

What happens when the Fed monetizes a budget deficit? Is this something it should always
try to do? (Hint: Outline the benefits and costs of such a policy over time.)

What would the LM curve look like in a classical world? If this really were the LM curve that
we thought best characterized the economy, would we lean toward the use of fiscal policy or
monetary policy? (You may assume your goal is to affect output.)

What is crowding out, and when would you expect it to occur? In the face of substantial
crowding out, which will be more successful—fiscal or monetary policy?

3. What is a liquidity trap? If the economy was stuck in one, would you advise the use of mon-
etary or fiscal policy?

2. Discuss the circumstances under which the monetary and fiscal policy multipliers are each,
in turn, equal to zero. Explain in words why this can happen and how likely you think this is.