1. Suppose you deposit $5,000 in a savings account that pays a nominal interest rate
of 7% per year.
a. If the inflation rate in recent years has been 3% annually, what is your
expected real rate of interest?
b. What happens to your real rate of interest if inflation turns out to be 1%?
What is inflation turns out to be 5%. Which scenario do you prefer and
why?
2. In May of 1997 (the month your professor graduated from high school), the dollar
price of Canadian currency ($/F) was 0.72. In May of 2007 (your professor’s 10-
year high school reunion), the dollar price of Canadian currency ($/F) was $0.92.
a. Did the dollar appreciate or depreciate over this time? Why?
b. What affect will this appreciation or depreciation have on Canadian
purchases of American-made goods? Why?
c. What affect will this appreciation or depreciation have on American
purchases of Canadian-made goods? Why?
3. In your own words, explain why aggregate demand is inversely related to the
general price level. Why do the explanations for the inverse relationship between
the general price level and aggregate quantity demanded for the aggregate
demand curve differ from the reasons a demand curve for a specific good slopes
down? It is important that you understand this question and not just copy
the answer from the book and/or notes!!!
Homework continues on other side of sheet.
2
4. Explain how and why each of the following factors would influence current
aggregate demand in the United States. Illustrate each part by drawing the graph
and providing a brief explanation behind the logic of the graph.
a. Increased fear of recession
b. Increased inflation expectations
c. Rapid growth of real income in Canada and Western Europe
d. A reduction in the real interest rate
e. The dollar appreciates against foreign currencies
5. Construct the AD, SRAS, and LRAS curves for an economy experiencing:
a. Full employment
b. An economic boom
c. A recession
6. Consider an economy at long run equilibrium corresponding to full employment
that experiences an unexpected increase in the stock market.
a. Starting your graph from long run equilibrium, show the effect of the
increase in stock prices. What are the short-run effects on output, the
price level, and unemployment?
b. How does the economy adjust to restore long-run equilibrium? Explain
carefully.
c. Using the graph from part a, illustrate the economy returning to long-run
equilibrium. Looking at your graph, what are the permanent (long-run)
effects of the increase in stock prices?

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