Document 6525326

UNIVERSITY OF ESSEX
DEPARTMENT OF ECONOMICS
ASSESSED WORK COVER SHEET
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UNIVERSITY OF ESSEX
SPRING TERM 2014
DEPARTMENT OF ECONOMICS
EC111 – INRODUCTION TO ECONOMICS
ASSIGNMENT 2
This assignment is to be handed in to Room 5B.209 before 12 noon on Monday 3rd March
2014. You will receive and electronic receipt. You should not hand in assignments to your
class teacher. Please note that the University has a zero tolerance policy on late submission of
coursework. Any assignment submitted after the deadline will receive a mark of zero (see
Undergraduate Economics Handbook).
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clearly on the front page of your assignment.
This assignment is divided into two sections. Each is worth 50 percent of the marks. You
should answer all the questions. Use diagrams or mathematical expressions where
appropriate.
Please limit your answers to a total length of not more than 5000 words or 10 pages
including diagrams.
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SECTION A (10 questions, 5 marks each)
State whether each statement is TRUE or FALSE giving a brief explanation in the space
provided. Use diagrams where appropriate. Your mark will depend on your explanation e.g.
even if the statement is correct, putting “TRUE” will get no marks unless you justify your
answer.
1. A direct tax is a tax paid on consumption goods.
2. An increase in the marginal propensity to save increases the value of the Keynesian
multiplier.
3. If the government increases its expenditure and its (lump sum) direct tax by the same
amount, there will be no increase in national income.
4. An increase in the interest rate reduces the present value of an investment project by
more the further in the future are the revenues from the investment.
5. In an IS/LM economy an increase in the indirect tax rate will reduce investment.
6. If the central bank raises the reserve requirements of the banking system the money
supply will fall.
7. An increase in national income, with a constant money supply, will reduce the price
of bonds.
8. If labour supply and labour demand are equal, there will be job vacancies but no
unemployment.
9. In the long run there is no trade-off between inflation and unemployment.
10. If the unemployment rate is higher than the Non-Accelerating Inflation Rate of
Unemployment (NAIRU) the price level must be falling.
SECTION B (2 questions, 25 marks each)
1. A closed economy with a fixed price level has the following relationships:
Consumption: C = 50 + 0.8Yd,
Investment: I = 150 – 10r
Government expenditure: G = 250
Direct tax: Td = 0.25Y
Real money demand: MD/P = 0.5Y – 20r
Money supply MS = 400
Y is national income; Yd is disposable income and r is the interest rate. The price level, P,
is fixed at P = 1.
a) [7 marks] Find equilibrium national income.
b) [6 marks] Now the consumption function shifts down to become: C = 0.8Yd. Suppose
that in order to maintain the original income level government could either increase
government expenditure or cut the tax rate. Find the necessary level of government
spending or tax rate. Which of these policies would be preferred and why?
c) [6 marks] With the consumption function as in (b) above, in the absence of fiscal
policy, would monetary policy be an effective alternative? By how much should the
money supply be increased?
d) [6 marks] Now suppose that wages and prices were perfectly flexible and full
employment national income is Y = 1000. With the money supply at the original
level, MS = 400, what is the effect of the downward shift in the consumption function
on investment and the interest rate? Compare this outcome with (c ) above and
explain.
2. Use economic analysis to answer the following questions with reference to the British
economy in the global financial crisis (GFC) and its aftermath.
a. [5 marks] What caused the GFC and how would you expect it to have affected the
money multiplier during and immediately after the crisis?
b. [5 marks] Comment on the Bank of England’s response in the first two years after the
crisis. What is meant by the ‘zero bound’ for interest rates? Does it mean that there is
no further scope for monetary policy to stimulate the economy?
c. [5 marks] Using IS/LM analysis show in a diagram what reaching the zero lower
bound for the interest rate implies about the effectiveness of fiscal policy.
d. [5marks] The government’s budget deficit rose substantially during the recession.
How would you identify how much of that increase was due to fiscal stimulus and
how much was due to the recession itself?
e. [5 marks] Most observers believe that the fiscal multiplier is low--less than 2, and
possibly around 1. Examine possible reasons for the low multiplier.