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1) (Part # a) Today, the size of the US economy is estimated to be about $17 trillion. By the
end of 2008
it was estimated to be about $15 trillion. Assuming that about 33 % of full employment GDP was
lost during the Great Recession (say about $5trillion), use the concepts of the liquidity trap and
the Keynesian model (cross) to show and explain why managers accumulated inventories during
the Great Recession. (5 points)
(Part # b) Refer to Question 1. In response to the Great Recession, the Federal Reserve and the
US Government adopted expansionary monetary and fiscal policies. For example, the US
government spent about $700b at some point. Evaluate the effect of the fiscal stimulus on
national output if the relevant multiplier and full employment output are estimated to be 1.75?
an average CBO estimate?and $15 trillion respectively (1 Point). Given the average CBO
estimate of the multiplier, what is the marginal propensity to consume (MPC)? (1 points). What
could have been the contribution of the fiscal stimulus?ceteris paribus?to US recessionary
output in the first year? (3points). Refer to Question 1 for recessionary output.
2) What is monetary policy? (1Point). How did the Fed try to stabilize the US economy
during the Great Recession? (3 Points). Notwithstanding the efforts to stimulate the
economy, inbuilt risk-aversion and pessimism dampened the intended effects of monetary
policy. Suppose the US government had given a tax cut to the tune of $700 instead of
spending money, what would have been the impact on recessionary output if the relevant
multiplier is 0.75? (2 Points). Refer to Question 1 for recessionary output. Given the size
of the multiplier (0.75), what is the marginal propensity to save (MPS)? (2 points)
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