Problem Set Homework



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  1. (a) How do Jeff’s taxes change during a recession when his income falls, as shown below.



Tax rate Income before recession Income during recession
30% $ 100,000 $ 90,000
Tax paid    



(b) Is this an example of an automatic stabilizer for the economy? Explain.



  1. What is a greater risk to the health of an economy, a cyclical budget deficit or a structural budget deficit? Decide, then explain.



  1. The table shown below records the marginal propensity to consume (MPC) at 5 different income ranges in a hypothetical economy. If the government needed to end a recession, which groups should it target as it decides on a proposal to cut personal income taxes? Explain using a discussion of the multiplier.



Income range ($’s) MPC
0-20,000 0.9
20,001-40,000 0.8
40,001-60,000 0.7
60,001-80,000 0.6
80,001-100,000 0.5



  1. A friend claims a nation should always have a balanced federal budget. Do you agree? Why or why not? Explain.





  1. Explain how the Fed takes steps to conduct an open market purchase of government bonds. Also, how is it using its “power” as a central bank in this case?


  1. What is the Fed’s dual mandate?


  1. (a) What action should the Fed take during a recession? Be specific. (b) What action is the Fed taking now? Explain in detail.


  1. Describe the main organizational features of the Fed.


  1. The central bank of “Northampton” uses monetary aggregates similar to those used by the Federal Reserve. Compute the following items for Northampton’s central bank given a reserve    requirement of 10% along with the following information:

Bank deposits held at the central bank = $200 m.

Currency held by the public = $150 m.

Currency in bank vaults = $100 m.

Checkable deposits =$ 500 m.

Travelers’ checks = $10 m.

  • What is the value for M1?
  • What is the value for the monetary base?
  • Are the commercial banks holding excess reserves?
  • Can commercial banks make loans and create new deposits? If so, by how much could total banking system deposits be changed?


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