6) What is the difference between the Federal Funds Rate and the Discount Rate? Please give the difference by providing an explanation of each rate and their purposes? (9 pointsTechnically, the federal funds rate is the interest rate that banks usually charge on other banks while lending money to them. But federal discount rate is the interest rate which is charged by the Federal Reserve on the commercial banks while lending money to them. Federal fund rate

Sometimes, the financial institutions want to lend more amount of money than it has so it borrows money from other financial institutions that has excess reserves in order to meet the loan/withdrawal demand. When one financial institution borrows money from other bank, the rate that is charged is said to be federal funds rate. The higher the federal funds rate, the more expensive it is to borrow money. Since it is only applicable to very creditworthy institutions for extremely short-term (overnight) loans, the federal funds rate can be viewed as the base rate that determines the level of all other interest rates in the U.S. economy.

Federal discount rate

Sometimes the sudden demand for withdrawal or high demand for loans may cause to decrease the required reserve amount. Under this situation the bank will try to borrow money other financial institutions, finally it tries to borrow money from lender of last resort that is central bank or Federal Reserve. This discount rate is higher than the Federal Funds Rate so its used as a last resort for banks needing some cash to boost their reserves.7.) Assume that the GDP deflator was 100 in 2008, 97.5 in 2009, and 96.8 in 2010. How much would a salary offer of $80,000 in 2010 have been worth in 2008? (3 points)

2009

96.8 97.5 / 97.5 * 80,000 = 574

The worth of the salary in 2009 would be equal to $79,426 (80,000 574)

2009

97.5 100 / 100 * 76426 = 1985.65

The worth of the salary in 2008 would be equal to $77,440.35 (79,426 1985.65)

8) If the CPI value for 1960 was 0.5 and 2.5 in 2010, and a GMC four-door sedan cost $2,500 and $20,000 in 2010, what conclusions can you draw? (hint: Be careful what you say!)

Consumer price index is a measure that examines the weighted average of prices of a basket of consumer goods and services. The value of consumer price index is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.The numerical value of CPI indicates that a positive change in value of CPI influence to increase the true value of money. So an increase in value of CPI from 0.5 in 1960 to 2.5 in 2010 caused to raise the GMC four-door sedan cost from $2500 in 1960 to $20000 in 2010. Please answer the next five questions as True, False, or Uncertain. Uncertain indicates that the statement may or many not be true (not that the respondent is uncertain). Feel free to provide a justification for your answer in the space provided, if you think that will be helpful.

9.) An increase in interest rates will cause a decrease in Aggregate Demand, and a slow- down in the economy. (2 points)

True

An increase in interest rates will create adverse effect on investment because investment will be costly. If investment fell down then other interrelated economic factors like employment opportunities and household income will also come down. Moreover, falling employment opportunities and income will pull down the aggregate demand through reduction in the consumption expenditure. Overall, decreasing demand wont encourage the economic activity instead it will slow down the economy.

10.) A decrease in interest rates will cause an increase in Aggregate Demand, and an expansion in the economy. (2 points)

True

A decrease in interest rates will create positive effect on investment because investment will be cheaper. If investment increases then other interrelated economic factors like employment opportunities and household income will also increase. Thus, positive change in employment opportunities will allow the individual to spend more and this attract the new investment and fasten the economic activities in the country.

11.) If the economy is not expanding, and the world interest rate is exogenous, an increase in the money supply will only cause an increase in current prices. (2 points)

Uncertain

If the economy is not expanding and the world interest rate is exogenous then an increase in money supply may or may not cause to increase the current prices because there will be movement of money from the domestic to international.

12.) The Consumer Price Index has difficulty accounting for changes in technology such as the developments in computers, while the chain-weighted GDP deflator does not. (2 points)

FalseConsumer price index is a measure that examines the weighted average of prices of a basket of consumer goods and services. The value of consumer price index is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Both CPI and GDP deflator have difficulty in accounting for changes in technology.

13.) In the US, over the last 50 years, the Consumption component of gross domestic product has been more volatile than the Investment component (2 points)

False

The components of GDP include consumption expenditure, investment expenditure, government expenditure and net export. The percentage of consumption expenditure is larger than any other components proportionate value. Last 50 years, the consumption is smoothly increasing and there is no volatility. However, the investment is highly volatile in past 50 years.

14) All else held equal, higher budget deficits should be associated with higher trade deficits.

TrueUsually economists believe that a large budget deficit will increase the value of the dollar. The logic is that higher budget deficits are believed to cause higher interest rates, which makes holding bonds and other dollar denominated assets more attractive. This is how a budget deficit can cause a trade deficit.-BONUS-

4.) What would a family who made $200,000 in 1995 make today? Use the 2012 index value for today. (4 points)

When should the Fed have increased the money supply according to this table? (4 points) Provide a detailed answer of how could they have increased the money supply. (12 points)

If gasoline had gone up at only the rate of inflation, how much would it have cost per gallon in 1994? Assume the price of gasoline today is $4.00 per gallon. (4 points)

Year CPI

1993 144.5

1994 148.2

1995 152.4

1996 156.9

1997 160.5

1998 163

1999 166.6

2000 172.2

2001 177.1

2002 179.9

2003 184

2004 188.9

2005 195.3

2006 201.6

2007 207.342

2008 215.303

2009 214.537

2010 218.056

2011 224.939

2012` 229.594