Question 1: Determine whether the following statements are true or false and provide a

brief explanation (include diagrams if applicable).

1. The central bank can simultaneously buy government bonds and reduce the
reserve requirement ratio to decrease the money supply.
=> False. Since Ms= mM*B. When the central bank buys government bonds, B
increases. Simultaneously, if the central bank reduces the reserve requirement
ratio, mM increases. Thus, the money supply Ms will increase.

2. In the short run, changes in fiscal policy affect the actual equilibrium output Yt
and the economy's inflation rate.
=> True. In the short run, changes in fiscal policy cause the aggregate demand
curve (AD) to shift to the left or right. This affects the actual equilibrium output
(YtY_tYt) and the inflation rate of the economy.

3. Fiat money has intrinsic value because it is used as a commodity.

=> False. Fiat money does not have intrinsic value because it is not a commodity;
its value is based on trust and government decree rather than inherent worth.

4. Inflation and deflation both refer to the increase in the general price level of the
economy.
=> False. Inflation refers to increasing prices, while deflation refers to decreasing
prices in an economy.

5. A government decision to increase the minimum wage will increase both

equilibrium output and the price level in the short run.
=> True. True. A higher minimum wage boosts consumer spending (increasing
demand) and raises business costs (decreasing supply). This typically leads to both
higher output and prices in the short run.

6. Expansionary fiscal policy increases the general price level and output of the
economy in the long run.
=> True. Expansionary fiscal policy, which involves increased government
spending and/or tax cuts to stimulate aggregate demand, can potentially increase
both the general price level (inflation) and output of the economy in the long run.

7. Inflation does not reduce the real purchasing power of people.

=> False. It erodes the value of money over time. When prices rise (inflation),
each unit of currency buys fewer goods and services, thereby reducing the real
purchasing power of money.
 8. If depositors tend to move funds from time deposits to checking accounts, M1
increases while M2 decreases.
=> False. M1 = M0 + Demand deposits accessible by checks. M2 = M1 + Time
deposits. Thus, if depositors shift their funds from time deposits to demand
deposits that can be accessed by writing checks, the M1 money supply will
increase while the M2 money supply remains unchanged. However, the amount of
time deposits will decrease by exactly the amount that M1 increases.

9. An increase in the Vietnamese stock market raises consumer wealth, shifting both
the aggregate demand and short-run aggregate supply curves to the left.
=> False. Stock market increase shifts aggregate demand right (not left) due to
increased wealth. It doesn't directly affect short-run aggregate supply.

10. An increase in the exchange rate E (VND/USD) will stimulate imports.

=> False. A higher exchange rate (VND/USD) means more Vietnamese dong per
US dollar, implying a weaker dong. This makes imports more expensive for
Vietnamese buyers, likely reducing imports rather than stimulating them./ It will
stimulate exports.

Question 2:
Assume the Vietnamese economy is in long-run equilibrium. Recently, the government
decided to increase the tax rate on consumer goods.
a. Using appropriate models, analyze the impact of this event on the price level,
output, and employment in the Vietnamese economy in the short run.
b. If policymakers decide to intervene to mitigate the negative effects of the tax
increase, how can they use fiscal policy to do so? Explain and illustrate using
appropriate models.

Question 3:
The economy has the following functions:
C = 180 + 0.5(Y-T)
I = 250
G = 350
EX = 200
IM = 0.15Y
T = 0.1Y
a. Determine the equilibrium output of the economy. Illustrate with a graph.
+) AD = C + I + G + X + IM = 180 + 0.5 (Y-T) + 250 + 350 + 200 – 0.15Y
= 980 + 0.5 (Y-0.1Y) – 0.15Y= 980 + 0.3Y
+) AD = Y => 980 + 0.3Y = Y => Y = 1400
Thus, the equilibrium output of the economy = 1400

b. If investment increases by 150, government spending increases by 200, and exports

decrease by 100, what is the new equilibrium output? Illustrate on the graph from part
(a).
I’ = I + 150= 250 + 250 = 400
G’ = G + 200 = 350 + 200 = 550
EX’ = EX – 100 = 200 – 100 = 100
AD’ = 1230 + 0.5 (Y - 0.1Y) – 0.15Y = 1230 + 0.3Y
AD’ = Y => 230 + 0.3Y = Y => Y = 1757.1
the new equilibrium output = 1757.1

c. How does the trade balance change at the new equilibrium output?
NX = EX’ – IM = 100 – 0.15Y = 100 – 0.15*1757.1= -163.565
=> Trade Deficit
KEY CONCEPTS
Chapter 6: The Monetary System
1. The Meaning of Money
- Barter System: Exchanging goods/services directly; requires a double coincidence of
wants.
- Money: Set of assets used for transactions; improves trade efficiency.
- Liquidity: Ease of converting an asset into the economy’s medium of exchange.
2. Functions of Money
- Medium of Exchange: Used to buy goods/services.
- Unit of Account: Yardstick for pricing and recording debts.
- Store of Value: Transfers purchasing power to the future.
3. Kinds of Money
- Commodity Money: Intrinsic value (e.g., gold, cigarettes).
- Fiat Money: No intrinsic value; value comes from government decree.
4. Money in the U.S. Economy
- Money Stock: Total money circulating.
- Currency: Paper bills and coins.
- Demand Deposits: Bank account balances accessible via check
5. Measures of Money Stock
- M1: Currency, demand deposits, traveler’s checks, other checkable deposits.
- M2: M1 plus savings deposits, small-time deposits, and money market mutual funds.
6. The Federal Reserve System
- Central Bank: Oversees banking system and regulates money quantity.
- The Federal Reserve (Fed): U.S. central bank, created to ensure banking system health.
7. Banks and the Money Supply
- Reserves: Deposits not loaned out.
- Fractional-Reserve Banking: Banks hold a fraction of deposits as reserves.
- Money Multiplier: Banks generate money from deposits; dependent on the reserve ratio.
8. Fed’s Tools of Monetary Control
- Open-Market Operations: Buying/selling U.S. government bonds.
- Fed Lending to Banks: Discount rate, term auction facility.
- Reserve Requirements: Minimum reserves banks must hold.
- Paying Interest on Reserves: Adjusting reserve ratio through interest rates.
9. Problems with Monetary Control
Precision: The Fed’s control is not exact; influenced by household and banker actions.
10. Bank Runs and the Money Supply
- Bank Runs: Depositors withdraw en masse due to financial fears.
- Impact: Affects fractional-reserve banking; complicates money supply control.
11. The Federal Funds Rate
- Definition: Rate for overnight loans between banks.
- Impact: Influences other interest rates; targeted by the Fed through open-market
operations.

Chapter 7: Money Growth and Ìnlastion

1. Inflation
- Definition: Increase in the overall level of prices.
- Deflation: Decrease in the overall level of prices.
- Hyperinflation: Extremely high inflation rates.
2. Historical Inflation Rates
Example periods:
2008-2018: Prices rose at an average rate of 1.5% per year.
1970s: Prices rose by 7.8% per year.
3. Classical Theory of Inflation
- Quantity Theory of Money: Long-run determinants of the price level and inflation rate.
- Money Demand: Depends on interest rates, average price levels, and financial
innovations like credit cards.
- Money Supply: Determined by the central bank and banking system.
- Equilibrium: Achieved when money supply equals money demand at a certain price
level.
4. Effects of a Monetary Injection
- Increased Money Supply: Leads to a decrease in the value of money and an increase in
the price level.
- Quantity Theory of Money: Money supply growth affects inflation rate.
5. Classical Dichotomy and Monetary Neutrality
Nominal Variables: Measured in monetary units (e.g., dollar prices).
Real Variables: Measured in physical units (e.g., real wages).
Monetary Neutrality: Changes in money supply only affect nominal variables, not real
variables (valid in the long run).
6. Velocity and the Quantity Equation
- Velocity of Money (V): Rate at which money changes hands.
- Quantity Equation: M*V = P*Y
+ M: money supply
+ V: Velocity of money
+ P: Price level
+ Y: Real GDP
7. Inflation Tax
- Definition: Revenue raised by the government through money creation.
- Effect: Decreases the value of money held by the public.
8. The Fisher Effect
- Real Interest Rate: Nominal interest rate adjusted for inflation.
- Nominal Interest Rate: Adjusts one-for-one with the inflation rat
9. Costs of Inflation
- Shoeleather Costs: Resources wasted as people try to minimize cash holdings.
- Menu Costs: Costs associated with changing prices.
- Relative-Price Variability: Distorts consumer choices and resource allocation.
- Inflation-Induced Tax Distortions: Exaggerates capital gains and interest income,
discourages saving.
- Confusion and Inconvenience: Reduces the real value of money as a unit of account.
- Arbitrary Redistributions of Wealth: Unexpected inflation benefits debtors at the
expense of creditors.
10. Deflation
- Potential Benefits: Can reduce the nominal interest rate and the cost of holding money.
- Potential Costs: Menu costs, price variability, wealth redistribution, and broader
economic problems.

Chapter 8: The Open Economy

1. Chapter Objectives
- Accounting identities for the open economy
- Small open economy model: what makes it "small"
- Determination of trade balance and exchange rate
- Impact of policies on trade balance and exchange rate
2. Imports and Exports as a Percentage of Output
Analysis of various countries' imports and exports relative to GDP (e.g., Canada, France,
Germany, etc.)
3. Open Economy Fundamentals
- Exports (EX): Foreign spending on domestic goods
- Imports (IM): Domestic spending on foreign goods
- Net Exports (NX): EX - IM (trade balance)
+ Trade surplus: NX > 0
+ Trade deficit: NX < 0
4. National Income Identity in an Open Economy
- GDP (Y) = C + I + G + NX
- Net Exports (NX) = Y - (C + I + G)
5. International Capital Flows
- Net Capital Outflows (NCO): S - I
+ Positive NCO: country is a net lender
+ Negative NCO: country is a net borrower
6. Another Important Identity
- NX = S - I
- Trade balance = Net capital outflows
7. Nominal Exchange Rate (e)
Definition: Price of domestic currency in terms of foreign currency (e.g., Yen per Dollar)
8. Real Exchange Rate (ε)
Definition: Relative price of domestic goods in terms of foreign goods (e.g., Japanese Big
Macs per U.S. Big Mac)
9. Net Export Function
- NX as a function of the real exchange rate (ε)
- Inverse relationship between NX and ε: As ε increases, NX decreases
10. Determination of the Real Exchange Rate (ε)
- NX = S - I: The equilibrium real exchange rate ensures this balance
- Neither S nor I depend on ε, making the net capital outflow curve vertical
11. Supply and Demand in the Foreign Exchange Market
- Demand: Foreigners need dollars to buy U.S. net exports
- Supply: Net capital outflow (S - I) represents dollars invested abroad
12. Four Experiments
- Fiscal Policy at Home: Fiscal expansion reduces national saving, decreases net capital
outflows, supply of dollars, increases real exchange rate, and decreases NX
- Fiscal Policy Abroad: Increase in world interest rate (r*), increases net capital outflows,
supply of dollars, decreases real exchange rate, and increases NX
- Increase in Investment Demand: Reduces net capital outflows, decreases supply of
dollars, increases real exchange rate, and decreases NX
- Trade Policy to Restrict Imports: Import quotas reduce imports, increase demand for
dollars, increase real exchange rate, and decrease exports without changing NX