# Um-d econ 301 Exams

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Economics 301 Intermediate Macroeconomics Exam #1 Fall, 2013 Prof. Twomey

Please print your names on the back of the last sheet. Answer on these sheets, using the backs of the sheets if you need extra space. The weight of each question is indicated. Please ask for clarification if any question is unclear. Time: the entire class.

1. Identify the following with a sentence or at most two (20 points):

1. Endogenous variable

2. Classical dichotomy

3. National income accounts identity

4. (Distinguish between) Employment rate and the Labor Force Participation Rate

5. Fisher effect

2. (20 points) Consider the standard closed economy full employment model that we have studied – sometimes called the loanable funds model. Draw a graph illustrating the determination of the real rate of interest, as described by that model. Be sure to identify the names of each axis, and label the curves. Explain and illustrate on that graph what happens in the macro-economy if the level of government spending falls.

- In that circumstance, what happens to: (explain real briefly)

Real GDP

Consumption

Tax revenue

The real interest rate

Private sector Investment

The government’s Deficit

Unemployment

If in a slightly different world, private savings positively responds to increases in interest rates; will the effect on consumption be bigger or smaller?
3. (10 points) An economy initially has a monetary base of 1,000 one dollar bills. Calculate the money supply in each scenario:

1. All money Is held as currency

2. All money is held as demand deposits.

Banks hold 20 % of deposits in reserves.

1. People hold equal amounts of currency and demand deposits. Banks hold 20% of deposits as reserves.

4. (10 points) Suppose a country has a money demand function (M/P)d = kY, where ‘k’ is a constant parameter. The money supply grows at 15% per year, and real income grows by 5% per year.

a) What is the average annual inflation rate?

b. How would inflation be different if real income growth were higher? Explain briefly.

1. Suppose that instead of a constant money demand function, the velocity of money in this economy was growing steadily because of financial innovation. How would that affect the inflation rate? Explain briefly.

5. (10 points) Should each of the following events be expected to increase or decrease real GDP. In each case, do you think economic well-being will change in the same direction as real GDP? Why or why not?

1. A major power-outage forces Las Vegas to dis-continue gambling operations for a month.

2. The discovery of a new, easy-to-grow (and environmentally neutral) strain of wheat increases farm harvests.

3. Improved labor-management relations reduces the frequency of labor strikes.

4. More high school students drop out of school to take jobs mowing lawns.

6. (10 points) What are the three functions of money? Which of these functions do the following satisfy, and which not?

1. A credit card

2. A subway token

3. A painting by Rembrandt

7. (10 points) Suppose UM-D engineers develop a method of producing automobile engines that are much more efficient, and that this new method is adopted by U.S. automobile manufacturers, who build new factories to utilize it.

1. How will this affect the country’s demand for investments?

2. Explain, and show on a graph, how this will affect the real rate of interest, and the national level of saving.

8. (10 points) Explain how each of the following will affect the monetary base, the money multiplier, and the money supply.

1. The Federal Reserve decreases the interest rate it pays banks for holding reserves

2. Rumors about a computer virus attack on ATMs increase the amount of money that that people hold as currency, rather than demand deposits.

3. The Federal Reserve sells bonds in open market operations.

The median on this exam was 65; the high was 88.

Econ 301 Exam #2 Fall, 2013 Professor Twomey

Please print your name on the back of the last sheet. Answer on these sheets, using the backs of the sheets if you need extra space. Be sure to label each axis on your graphs. Each question is worth 20 points.. Please ask for clarification if any question is unclear. Time: the entire class.

1. Identify the following with a sentence or at most two: (20 points)

1. Pigou effect

2. Structural unemployment

4. Okun’s law

5. Monetary transmission mechanism

1. Consider a closed economy where the monetary authorities increase the money supply. Using both IS-LM and AS-AD graphs, explain and illustrate what happens to output, prices, and interest rates in the short and long runs.

What is meant by the term Liquidity Trap, and how is the above analysis changed when that exists? (no new graph needed).

1. A) The head of the alumni organization at TappaKegga High School did a study of what fraction of their alumni would lose their job in a given year, estimating it at 5%, and what fraction of their unemployed alumni would find a job in a given year, which turned out to be 25%. What is the average unemployment rate of TappaKegga’s alumni?

B) The point of departure for the short run aggregate supply curve is an asserted nominal wage rigidity. Identify and discuss real briefly three different explanations for that wage rigidity.

C) The textbook presents two standard interpretations of the causes of the Great Depression in the US in the 1930s. Identify those two hypotheses, mentioning in one sentence each what was the basic macroeconomic phenomenon that ‘caused’ each one.

1. Consider a short run IS* - LM* economy with floating exchange rates. Illustrate how the following phenomenon would move one or the other of those curves, explaining your answer in detail by reference to the graph of the underlying market in which it is derived – Keynesian cross or liquidity preference:

1. The demand for cash rises due to a perception of weakness in the supervision of banks

b. The country reduces its tariffs on imported products

c. World interest rates fall

5. We have studied two models of small open economies – the one in chapter 6 is referred to as a loanable funds market, while that from chapter 13 is a version of the IS-LM model. You can choose either model for this question, and your answer should state which one you’ve chosen.

• Suppose the government reduces its expenditures. The main question is, what will this do to net exports in the short run? Illustrate your answer with a graph, being sure to label each axis. Give a short explanation.

• In addition, what happens to the following variables in the short run? (Up, down, no change). No lengthy explanation necessary.
 Aggregate Demand Real GDP Unemployment Price level Real Interest Rate Exchange Rate Consumption Investment National Savings Private Savings

Finally, for citizens in this country, will the change in the exchange rate that you have described make overseas tourism cheaper or more expensive?
The median on this exam was 83; the high was 93.
Economics 301 Exam #3 Fall, 2013 Professor Twomey

Please PRINT your name on the BACK of the last sheet. Answer on these sheets, using the flip sides if you need space. Please ask for clarification of any unclear question. Time: whatever you need, which should be less than two hours.

1. Identify the following with a sentence or at most two: (20 points)

1. Cost-push inflation

2. Taylor Rule

3. Capital budgeting

4. Natural rate hypothesis

5. (The three corners of) The impossible trinity

2 (20 points) a. Demographers predict that the fraction of the population that is elderly and non-working will increase over the next twenty years. What does the life-cycle model predict would be the influence of this demographic change on the national (private) savings rate? Explain briefly

b. According to the rational-expectations approach, if everyone believes that policy makers are committed to reducing inflation, the cost of reducing inflation – the sacrifice ratio – will be lower than if the public is skeptical about the policymakers’ intentions. Explain briefly why this might be true. Graph optional.
3. (15 points) Does monetary policy have a greater impact on an economy under fixed exchange rates or flexible exchange rates? Explain – Graph helpful, but not necessary.

1. (20 points) a. It is an election year and the economy is in a recession. The opposition candidate campaigns on a platform of passing an investment tax credit, which would be effective the year after she takes office. What impact does this campaign promise have on economic conditions during the current year? Explain briefly.

b. Suppose the stock market plunges. What influence will that have on investment, consumption and aggregate demand? Why? Should the Federal Reserve respond? Why or why not? If so, how?

1. (15 points) According to the Ricardian view of government debt, how does a debt-financed cut affect public (government) saving, private saving, and national saving, and AD?

1. (10 points) According to the model of the housing market developed in our text, how would/did the relaxation of credit controls on subprime borrowers - households diplomatically referred to as having questionable credit histories – affect the price of new houses? Explain briefly and illustrate with a graph.

The median on this exam was 78; the high was 97.
Econ 301 Exam #1 Fall, 2012 Intermediate Macroeconomics Professor Twomey
Please PRINT your name on the BACK of the last sheet. Answer on these sheets, using the backsides if you need more room. The weight of each question is indicated. Please ask for clarification if the questions are unclear. Be sure to label the axes of your graphs. Time: the entire class. Good luck.

1. Identify the following with a sentence or at most two: (20 points)

2. Monetary neutrality

3. (What are the) three defining functions of money?

4. Fisher effect

5. Open market purchases

1. (15 points) Considering the loanable funds market in a classical model of a closed economy, explain and illustrate with a graph the effects of an increase in taxes, on the relevant macro variables, such as Y, C, S, r, prices, and I.

2. (10 points) Suppose the demand for money function takes the form (M/P)d = Y/(5i), where I is the nominal interest rate and Y is real GDP.

1. If Y grows at rate ‘g’ at what rate will the demand for real money balances grow (assuming I is constant).

2. What is the velocity of money in this economy?

3. If inflation is zero and nominal interest rates are constant, at what rate will monetary velocity change?

1. Suppose the neoclassical model is correct, that workers earn their marginal productivity. Consider the situation of two groups in the country, farmers and barbers. (10 points)

1. If farmers’ productivity has grown, what happens to their real wage?

2. Suppose barbers’ productivity is constant, as scissors and combs do not change much. If there is mobility between farms and barbershops, what should happen to the relative wages of farmers and barbers?

3. What does your answer to (b) imply for the price of haircuts relative to food.

4. Who benefits from technological progress in farming, farmers or barbers?

1. (15 points) What is the effect on the real exchange rate (appreciation or depreciation) if there is an increase in labor productivity in the export sector? What happens to NX, S, I, Y, r, and prices? Explain briefly, and illustrate with a graph.

6. (10 points) Suppose that after presidential elections, we have a drastic change in policy, and that the new president decides to tax checks written on bank deposits.

1. How should this ‘check tax’ affect the currency-deposit ratio?

2. With the textbook’s model of the money supply and money multiplier, how should this change affect the money supply? The money multiplier? Explain briefly.

1. (10 points) Consider a small open economy, in the textbook’s classical model. Suppose world interest rates fall. What should happen to this country’s net exports? Explain and illustrate with a graph.

1. (10 points) A farmer grows a bushel of wheat and sells it to a miller for \$1. The miller turns the wheat into flour, and sells it to a baker for #3. The baker uses the flour to make bread, which is sold to an engineer for \$6., and the engineer consumes it.

1. What is the value added by each person in this example?

2. What is the total contribution of this bread to GDP?

The median on this exam was 65; the high was 86.

Econ 301 Exam #2 Fall, 2012 Professor Twomey

Please PRINT your name on the BACK of the last sheet. Use the flip sides of these sheets if you need more space. The weights of each question are indicated. Please ask for clarification of any question that is unclear. On this exam, especially, it is important to label each axis on your graphs. Time: the entire class. Good luck!

1. Identify the following with a sentence or at most two: (20 points)

1. Efficiency wage

2. Okun’s Law

3. Liquidity trap

4. Monetary transmission mechanism

5. Impossible Trinity (draw the graph and identify the points)

2a.(15 points) Consider an isolated town where there is only one significant employer, and so all the local population works at this firm. Suppose that in any typical month, four percent of that firm’s workers lose their jobs, while twelve percent of those who are unemployed get a job. What is the equilibrium rate of unemployment?

b. In what direction will the equilibrium rate of unemployment change if there is introduced into this town an electronic service (e.g. Craig’s list) that improves information about employment opportunities? Explain briefly.
3.(10 points) The textbook discusses a few hypotheses/explanations of what caused the Depression of the 1930s. Identify and explain very briefly two (different versions) among these explanations.
4. (10 points) a. Suppose the government wants to raise investment but keep output constant (even in the short run). In the IS-LM model, what mix of monetary and fiscal policy will achieve this goal. Explain and illustrate.

b. In the early 1980s, the US government cut taxes (running a deficit) while the Fed pursued a tight monetary policy. In the short run, what effects will this combination of policies have? Explain and illustrate on a graph.

5. (10 points) Suppose the US is a closed economy, and that the Fed is considering two alternative monetary policies: (A) holding the money supply constant, while letting interest rates adjust, or (B) adjusting the money supply to hold interest rates constant.

If all shocks to the economy arise from shifts in the demand for money, which policy would better stabilize short run output? Explain and illustrate on a graph(s)

6. (20 points) Consider a small open economy using flexible exchange rates, where the monetary authorities decide to increase the money supply. Illustrate the short term impact of this action, with an IS* - LM* graph and an AS-AD graph. Indicate in this table how will this affect these variables: (Def is thegovernment deficit)

 Y C NX e r U Inv Def M/P W

7. (15 points) Suppose that as a result of an election, a candidate (and Congress) come to power who tighten environmental controls and reduce greenhouse emissions. Inevitably, such actions would have demand and supply impacts – but let’s focus on the impact of this ‘supply shock’.

Describe and illustrate the short run impact of this policy on an AS-AD graph.

Describe, and illustrate with a new graph or on the above graph, the options that are open to the government, in terms of removing the unwanted impacts of the new government’s policy.

The median on this exam was 68; the high was 91.
Econ 301 Intermediate Macroeconomics Exam #3 Fall, 2012 Prof. Twomey
Please PRINT your name on the back of the LAST SHEET. You will LOSE POINTS if your name is visible anywhere else.

Please answer on these sheets, using the backsides if you need more space. The weight of each question is indicated. Please ask for clarification if the question is not clear. Time: 90 minutes, or whatever you need. Good luck.

1. Identify the following with a sentence or at most two: (20 points)

A Secular Stagnation

B Capital Budgeting

C Ricardian Equivalence

D Lucas Critique

E Lean against the wind

1. Use the neoclassical model of investment to explain the impact of each of the following on the rental price of capital, the cost of capital, and therefore on investment. Explain each answer briefly. (10 points)

1. Laws prohibit the immigration of foreign workers, reducing the size of the labor force

2. Expansionary monetary policy lowers the real interest rate

3. Technological change makes home residences deteriorate more slowly.

1. (20 points) Describe the Life Cycle Hypothesis (LCH) of consumption (graph optional). In particular, how should a person’s MPC vary from the young age of just entering the labor force, to maturity, to retirement?

The textbook has a rather lengthy discussion of how empirical studies suggest that the LCH does not hold up well for youth and for elderly/retired people. Are the MPC’s of these groups higher or lower than predicted? Identify at least one explanation each that Mankiw offers for these two findings.

1. What is meant by the Taylor rule? It has been suggested that, even though it is not official policy, it might be a good indicator of current government policy? Is whatever branch of the US government it refers to, currently following what the Taylor rule advocates? Explain. (10 points)

1. (10 points) In the book’s discussion of information requirements for an efficient financial system, three problems are mentioned: asymmetric information, adverse selection, and moral hazard. Describe each one briefly.

Sam is trying to get a large advance to write a textbook. He knows, but the publishers don’t, that he did poorly on the writing portion of the SAT exam.

George has gotten a large advance to write a textbook. With the money in hand, he prefers to spend his time sailing rather than writing the book.

Brenda is buying a life insurance policy. She knows that members of her family tend to die young.

1. The textbook describes four motives, or reasons, for holding inventories. Describe three of them. (10 points)

1. (10 points) The textbook has an extensive discussion of the recent/current financial crisis in the U.S. Identify four people/institutions who Mankiw affirms should be blamed for this event.

Describe briefly the three policy responses to financial crises that are outlined in the book.

1. The media asserts that the US economy is facing a fiscal cliff, in that we have a law that obligates the government to have a balanced budget by next January 1, and if that goal is not achieved, there will be some automatic tax increases and spending cuts. The president is currently negotiating a solution with people from Congress. Presumably, part of the solution will be to ‘fudge the books.’ Another part of the solution will inevitably be some increases in taxes and reductions in expenditures. According to the Permanent Income Hypothesis, should we expect these latter changes to have large or small impacts on aggregate spending? Explain briefly. (10 points)

The median on this exam was 62; the high was 89.

Econ 301 Exam #1 Intermediate Macroeconomics Fall, 2011 Professor Twomey

Please PRINT your name on the back of the last sheet. Answer on these sheets, using the flip sides if you need more space. Questions are equally weighted. Please ask for clarification if any question is unclear. Time: the entire class. Good luck!

1. Identify the following with a sentence or at most two:

1. Fisher equation

2. Real money balances

3. Classical dichotomy

4. Constant returns to scale

5. The three defining functions of money

1. Consider the case of a Small Open Economy – let’s call it Korea. Now consider a before and after situation, where before they were protectionist (high tariffs), and after they adopted free trade. In the context of the SOE model as we have considered it, how would this action affect: domestic production, real wages, the real interest rate, consumption, investment, national savings, the real exchange rate, and net exports. Explain and illustrate your answer with one (or two) graphs.

3a. Economists distinguish between expected and unexpected inflation. Identify and explain real briefly two costs of expected inflation.

b. A technical issue for economists is the question of whether or not the CPI accurately measures inflation. Currently, many specialists believe that the CPI overstates inflation.

I. Why might it be the case that the CPI overstates inflation?

ii. Why might it be important to know if the CPI exaggerates inflation?

iii. What is Mankiw’s answer to the question, does the CPI overstate inflation?

4a State the assumptions for the model of the Small Open Economy

b. Consider the SOE called Winkman, where the velocity of money is initially constant, and the real GDP grows by 6% per year. If the stock of money grows by 14%, what is the rate of inflation?

If the real exchange rate is constant, what will happen to Winkman’s nominal exchange rate?

With that rate of inflation, and a world interest rate of 3 %, what is the nominal interest rate in Winkman?

If technological change allowed the velocity to increase at 2% a year, with GDP still growing at 6%, and money growing at 14%, what is the new rate of inflation in Winkman?

5a. In a small open economy, if the government raises taxes, what happens to national savings, the real interest rate, the real exchange rate, and net exports? Explain and illustrate your answer with a graph.

The median on this exam was 56; the high was 94.

Econ 301 Intermediate Macroeconomics Exam #2 Fall, 2011 Professor Twomey

Please PRINT your name on the BACK of the last sheet. Do NOT put your name on this page. Answer on these sheets, using the flip sides if you need more space. Ask for clarification of any unclear question. The weights for the questions are indicated. Time: the entire class. Good luck.

1. Identify the following with a sentence or at most two (20 points):

1. Impossible Trinity

2. Pigou effect

3. “insiders” and “outsiders”

4. Liquidity trap

5. Okun’s Law

1. Explain rigorously why in the Mundell-Fleming model, the AD curve has a negative slope. (10 points)

2. (20 points) A. Identify and explain briefly the three reasons usually given for rigidity of real wages, job rationing and structural unemployment.

B. Unemployment rates are typically higher in Europe than they are in the US. What might be some explanations of this fact, based on the search theory and frictional unemployment? Explain briefly.

1. Consider a closed economy. Suppose the central bank reduces the money supply by a significant amount.

1. Explain and show on an AS-AD graph the short run and long run equilibrium points of output and prices.

2. For the short run and the long run, what happens to the following variables? (The long run comparisons are relative to the initial situation. You can indicate your answer with an arrow, or words (up, down, no change).
 Short run Long Run Prices Output Unempl. r W/P wages

1. (10 points) Suppose that Michigan and Ohio were independent countries, but that they used currencies that were completely convertible – i.e. perfectly fixed exchange rates.

If Ohio suffers from a recession, should its state government use monetary or fiscal policy to stimulate their economy? Explain briefly. Graph optional.

1. (20 points) Suppose a small open economy with a floating exchange rate is in a recession, and also assume that it has balanced trade. If policymakers want to reach full employment while maintaining balanced trade, what combination of monetary and fiscal policy should they pursue? Explain and illustrate with a graph.

The median on this exam was 66: the high was 100.
Econ 301 Intermediate Macroeconomics Final Exam Fall, 2011 Professor Twomey

Please PRINT your name on the BACK of the last sheet. YOU WILL LOSE CREDIT IF IT IS VISIBLE ANYWHERE ELSE.

Answer on these sheets, using the back sides if you need more space. The for each question is indicated. Please ask for clarification if any question is unclear. Time Two: hours.

1. (20 points) Identify the following with a sentence or at most two:

1. TARP

2. Sacrifice ratio

3. Financial intermediation

5. Stock out avoidance

1. (15 points) One of the central changes in macroeconomics over the last few decades was the incorporation of expectations in our models.

1. What is the difference between rational and adaptive expectations?

2. How and why would should the adoption of the Taylor Rule by the Fed affect macroeconomic behavior?

3. icardian equivalence is often described as an extreme version of rational expectations. Explain the major message from Barro’s version of Ricardian equivalence, relating it to rational expectations.

(20 points) a. In a simple money multiplier model, suppose that the credit/deposit ratio is 0.2, and that the required reserve ratio is 0.05. What is the size of the money multiplier? If the central bank were to engage in an open market purchase of \$10 billion, by how much – and in what direction – would the money supply change? (If you didn’t bring a slide rule, leave your answer in the form of 6/2 or whatever)

b. According to the Baumol-Tobin model, how will the following affect the demand for money:

i an increase in personal income

Ii an increase in ‘shoe leather costs’ of trips to the bank

Iii an increase in interest rates on deposits in banks

1. (20 points) a. Let’s look at the MPC and the APC of retired people, who still have income from social security and interest on accumulated savings. According to the life cycle hypothesis, should their MCP and APC be high or low, compared to national average for all people? Explain

Empirical studies indicate that the above theoretical prediction is wrong. Identify and explain briefly two reasons that have been suggested to account for this.

b. Another well-substantiated empirical finding regarding consumption is that the cross sectional (everybody at the same time) MPC is less than the long term (entire group over time) MPC. Explain briefly how Friedman’s permanent income hypothesis can explain this finding.

5. (25 points) a. The neo-classical model of investment includes several variables that affect investment. Identify four, and state how an increase in that variable would affect investment.

b. According to the model described as Tobin’s q, how should an increase in the stock market affect business

investment? Explain real briefly.

According to the textbook model of the housing market, how will each of the following affect the price of houses?

The elimination of the tax deduction for interest payments on mortgages

An increase in interest rates on mortgages

A population boom, such as occurred in the US after WWII.

The median on this exam was 61: the high was97.

Econ 301 Intermediate Macroeconomics Exam #1 Winter, 2011 Professor Twomey

Please PRINT your name on the back of the last sheet. Answer the questions in the spaces provided, using the backs of these sheets if necessary. Please ask for clarification if the question is unclear. Questions are equally weighted. Be sure to label each axis on your graphs. Time: the entire class. Good luck!

1. Identify the following with a sentence or at most two:

1. Labor force participation rate

2. Cobb-Douglas production function

3. Public Savings

4. Marginal Product of Labor

5. Classical dichotomy

1. In our textbook’s chapter on closed economies, there is a graph containing data for Britain in the 19th century, of military spending/GDP compared to (nominal, but by assumption real) interest rates. The point of departure of the argument is that in periods of war, significant increases in military spending will increase overall government spending, causing deficits. Explain, and draw a graph of, the standard textbook analysis of the impact of increased government spending on interest rates. Did the data in the textbook’s graph support the theoretical analysis? Discuss.

1. According to the neoclassical theory of distribution, the real wage earned by any worker equals that worker’s marginal productivity. Let’s look at two groups – farmers and barbers.

1. Over the past century, the productivity of farmers has risen substantially because of technological progress. What should have happened to their wages?

2. In contrast, for a long time, barbers continued to use the same tools, so their productivity was constant. What should have happened to their real wages?

3. Suppose workers can move freely between being farmers and being barbers. What would this mobility imply for the wages of farmers and barbers?

4. What do these answers imply for the price of haircuts, relative to the price of food?

5. Who – if anybody – benefits from technological change in farming; farmers or barbers, both or neither? Explain.

1. What are the three defining functions of money?

There is significant interest in the harm, or cost of inflation. Economists distinguish between expected and unexpected inflation. What are the major costs of expected inflation?

Suppose the economy has a stable demand for money and a constant velocity of money, and that the money supply is growing at 10 percent per year, while real GDP (and output) are growing at four percent per year. What should be the rate of inflation? Explain.

1. Suppose that several foreign countries begin to subsidize investment by instituting an investment tax credit.

1. What happens to world investment demand as a function of the world interest rate?

2. What happens to the world interest rate?

3. Consider ‘our’ country, which is a small open economy. As a result of those external changes, what happens to investment in our country? Explain, and illustrate with a graph.

4. What happens to our trade balance?

5. What happens to our real exchange rate? Explain, and illustrate with a different graph.

The median on this exam was 77; the high was 98.

Econ 301 Intermediate Macroeconomics Exam #2, Winter 2011 Professor Twomey

Please PRINT your name on the BACK of the LAST SHEET. Answer on these sheets, using the flip sides if you need space. Please ask for clarification if any question is unclear. Questions are equally weighted. Be sure to label each axis on your graphs. Time: the entire class. Good luck!

1. Identify the following with a sentence or at most two: (20 points)

1. Pigou effect

2. Efficiency wage

3. Liquidity trap

4. Frictional unemployment

5. Dollarization

1. (20 points) Define the LM curve. Explain rigorously, using a graph, why the LM curve in a closed economy has an upward slope.

b. The textbook has a discussion of how the impact of an increase in government spending will depend on what type of monetary policy is being followed – the two options are: fixed money supply or fixed interest rate. Under which option will expansionary fiscal policy have the bigger impact? Explain, and illustrate with one or two graphs.

1. (20 points) For a closed economy, explain and illustrate with an IS-LM diagram the short-run and long-run effects on national income (real GDP), the interest rate, the price level, consumption, and investment, of the following:

1. A decrease in personal income tax rates

2. An increase in the money supply

4. (20 points) a. Empirical data indicate quite clearly that unemployment in western Europe is higher than it is in the US. Identify and explain briefly two different reasons that have been offered to explain this finding.

b. Suppose that the rate of job separation in an economy is 6%, and the rate of job finding is 12%. What is the steady state rate of unemployment?

1. (20 points). Use the Mundell-Fleming model of a small open economy to predict what would happen to aggregate income (GDP), the exchange rate, and the trade balance, under both fixed and flexible exchange rates, in response to the following shocks:

1. A unexpected decline in the supply of money

2. A decline in business taxes leads companies to want to invest more

3. As a result of an election, the party that comes to power is widely perceived to be more efficient than its corrupt predecessor, lowering this country’s risk premium (Answer only for flexible exchange rates).

The median on this exam was 54; the high was 85.

Econ 301 Intermediate Macroeconomics Third Exam Winter, 2011 Prof. Twomey

Please PRINT your name on the BACK of the last sheet. You will lose credit if it appears anywhere else.

Answer on these sheets, using the flip sides if necessary. Questions are equally weighted. Please ask for clarification if a question is unclear. Time: the entire class. Good luck!

1. Identify the following with a sentence or at most two: (20 points)

1. Hysterisis

2. High powered money

3. Lucas Critique

4. Transaction theories of money demand

5. Time inconsistency

1. Demographers predict that over the next twenty years, the fraction of the US population that is elderly will increase. What does the life-cycle model predict will be the impact of this demographic change on the personal savings rate? What would be the impact on government savings, and on the national savings rate?

b. Explain real briefly why in virtually all our models, we have long run monetary neutrality, but not in the short run.

1. A. The textbook’s discussion of countercyclical policy and the sacrifice ratio concludes: “These findings indicate that reducing inflation always has some cost but that policies and institutions can affect its magnitude.” Identify one policy and one institution that will have this effect, and explain why, briefly.

B . According to Barro’s modernization of the Ricardian view of government debt, how does a debt-financed tax cut affect public saving, private saving, and national saving?

1. According to the textbook’s model of the housing market, how will an increase in real GDP affect investment in new housing? (graphs optional)

According to the Tobin’s q model, how will an increase in stock market prices affect private sector investment?

In the neo-classical model of investment, what is the role of changes in real GDP and in the stock market affect investment?

Is the neo-classical model of investment fundamentally different from the first two mentioned models? Explain briefly.

1. Consider a model of the money multiplier, where the credit ratio is 0.2, and the required reserve ratio is 0.1, and banks do not keep excess reserves.

If the central bank engages in open market purchases worth \$40 billion, what will be the sign and magnitude of the impact on the money supply?

Illustrate the impact of this action by the Fed, on inflation and unemployment, under two opposite assumptions: the monetary action was announced and completely expected, and then when the monetary action was a complete surprise.

b. On an entirely different subject; the textbook mentions several measurement problems with regard to the government deficit. Identify and explain briefly two of them.
The median on this exam was 56; the high was 77.

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