Prof. Bryan Caplan

Econ 311

Fall, 1999

HW#3 (Please type all answers)

  1. For each of the following cases, draw TWO graphs: one showing the effect in an AD-AS diagram, the other showing the effect in a money supply-money demand diagram.
    1. The government increases the money supply.
    2. The government deregulates the supply of money substitutes.
    3. Wallets go out of fashion; men just carry around a small money clip instead.
    4. A ban on ATM fees leads banks to set up fewer convenient ATM machines.
    5. Rumors of bad banks lead people to withdraw their money from banks.
    6. The government raises reserve requirements.
  1. Draw two diagrams - one with real interest rates on the y-axis, the other with nominal interest rates on the y-axis. Assume that people initially expect 0% inflation. Then show the effect - on both diagrams - of an increase in inflation expectations to 5%. Note that this means that for each quantity of loanable funds, the nominal interest rate suppliers require is 5 percentage-points higher, while demanders are willing to pay 5 percentage-points more. (You should use graph paper to do this problem so it works out right).
  2. Suppose the government began paying interest on base money (by, for example, replacing paper money with government-issued smart cards that automatically calculate interest). Show the effect using a money supply-money demand diagram. If this happened, would interest rate changes still affect money demand? Why or why not? (2-3 sentences)
  3. Explain the effect of post-socialist money creation on: the money supply, the value of money, the price level, inflation, and nominal interest rates. (1 paragraph)
  4. Using AD-AS diagrams, show the effect of the following:
    1. The government raises taxes and spends the money on an unproductive program (leaf-raking).
    2. The government borrows and spends the money opening up government restaurants (which are less efficient than privately-run restaurants).
    3. The government prints up new money to pay Social Security recipients.
    4. The government shuts down the (unproductive) Bureau of Leaf-Raking and uses the savings to build new (productive) roads.
    5. Former socialist countries privatize half of government enterprises.
    6. The government makes safety regulations stricter.
  5. Using two supply-and-demand for loanable funds diagrams, contrast the effect of deficit and tax finance of government expenditure.
  6. Pick one of the 12 examples in Bastiat's essay "What Is Seen and What Is Not Seen." What effects does Bastiat say "are seen." What effects does Bastiat say "are not seen"? (1 paragraph)
  7. Find a modern policy similar to the example you picked in VII. What effects "are seen" by people today? What effects "are not seen"? How does this confusion make bad policy popular? (1 paragraph)