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Macroeconomics: Equilibrium GDP, Bond prices, and Aggregate Demand and Supply

1. Suppose the economy reaches equilibrium GDP at \$625,000 while potential GDP is at \$850,000.  Currently G=\$110,000 while taxes are equal to 0.1Y (where Y is the same as real GDP). (38 points)
a. How large is the recessionary gap in this economy?
b. At equilibrium GDP, is there a budget surplus or deficit?  Solve for the value of this surplus or deficit.
c. At the potential GDP, is there a surplus or deficit?  Solve for the value of the full employment surplus or deficit.
d. Does there exist a cyclical surplus or deficit?  Solve for its value.

2. Assume a given economy has an equilibrium GDP of \$725 billion.  (12 points)

a. If government spending and taxes both increase by \$25 billion, determine the new equilibrium GDP.
b. If both G and taxes increase by \$25 billion, what impact will these two changes happening at the same time have on the budget?  In other words, will these two changes cause a surplus, a deficit, or a balanced budget?
c. Solve for the numerical value of the balanced budget multiplier.

3. Suppose you are looking to buy a bond that promises to pay \$400,000 on the date of maturity in one year. (23 points)

a. If you bid for the bond and wind up paying a price of \$395,000, solve for the interest rate on this bond.  Round your answer to four decimal places.
b. If on the next day, you bid for the bond and pay a price of \$380,000, solve for the interest rate on the bond now.  Round your answer to four decimal places.
c. What is the relationship between the bond price and the interest rate on the bond?

4. Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are as shown in the following table: (18 points)

Amount of Real GDP Demanded    Price    Amount of Real GDP Supplied
\$  600                                         \$500                    \$1200
\$  700                                         \$400                    \$1000
\$  800                                         \$300                    \$  800
\$  900                                         \$200                    \$  600
\$1000                                        \$100                     \$  400

a. Use the above data to graph the aggregate supply and aggregate demand curves.
b. What are the equilibrium price and equilibrium level of real GDP?
c. When this economy reaches its equilibrium GDP in this example, is it also operating at potential GDP?  Explain why or why not.

5. Money and Prices (9 points)
a. If the price level rises from 1 to 1.25, solve for the value of the dollar.
b. What is the relationship between the price level and the value of the dollar?