Principles of Macroeconomics December 15th, 2005 name: Final Exam (100 points)

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1 EC Serge Kasyanenko Principles of Macroeconomics December 15th, 2005 name: Final Exam (100 points) This is a closed-book exam - you may not use your notes and textbooks. Calculators are not allowed. Please read instructions and questions carefully and attempt to answer all sections. You have 2 hours to complete the exam. Good luck! I. Multiple Choice Section (30 points). Select one correct answer. Answer all questions. 1. Real GDP is: A) the total value of goods and services net of exports. B) the total value of goods and services net of resources devoted to investment for future consumption. C) the total value of goods and services measured at current prices. D) the total value of goods and services measured at constant and/or prices corrected for inflation. E) the total value of goods and services net of federal taxes. 2. Net domestic product is equal to: A) the total of all money payments, plus indirect business taxes, made in the economy during the period in which the national income is produced. B) the total value of the nation's capital stock, plus consumption, minus indirect business taxes. C) the income of the government. D) the total earnings, before taxes, of all those who contributed to the production of national output. E) the total earnings, after taxes, of all those who contributed to the production of national output. 3. When the MPC is constant: A) the MPS is constant. B) an increase in income decreases saving. C) a doubling of income will double consumption. D) there is no break-even point; there is always positive saving. E) none of the above. 4. The multiplier-accelerator theory: A) follows from shocks to the aggregate demand curve. B) is one of the political theories of the business cycle. C) is an external theory of business cycles. D) is related primarily to fluctuations in the automobile industry. E) suggests that business cycles may be self-generating. 5. On the basis of the Keynesian model of output determination, equilibrium gross domestic product is described by all but which one of the following? A) Intended investment equals actual investment. B) Intersection of the C + I line with the 45-degree line. C) Intersection of the consumption-plus-saving schedule with the investment schedule. D) Intersection of savings schedule with the investment schedule. E) C + I spending equals production expenses, including profit. 6. In the simple Keynesian multiplier model national output moves up and down in response to: A) changes in the time of day. B) changes in the level of input prices. C) movements in aggregate supply. D) movements in aggregate demand. E) changes in the general price level

2 7. By purchasing government securities in the open market, the Federal Reserve authorities hope ultimately to accomplish: A) an equal increase in bank reserves and Federal Reserve notes. B) a decrease in bank reserves. C) an increase in Federal Reserve notes larger than the original purchases by the appropriate multiple. D) an increase in bank reserves by the amount of the original purchase. E) an increase in bank reserves larger than the original purchases by the appropriate multiple. 8. A recent graduate not yet employed but searching for work is considered: A) frictionally unemployed. B) not yet in the labor force. C) structurally unemployed. D) cyclically unemployed. E) none of the above. 9. Inertial inflation rises when: A) the aggregate demand curve moves upward. B) inertial inflation cannot be altered. 10. C) both aggregate supply and aggregate demand move steadily upward. D) the aggregate supply curve moves upward. E) there is an increase in the level of potential output. In addition to sticky wages and prices, what else causes the flatness of the AS curve outlined in the depression Keynesian model? A) The presence of unemployed resources. B) The presence of rapidly accelerating inflation. C) An economy producing above potential income. D) All of the above. E) None of the above. 11. Let the unemployment rate climb from 6.5% to an observed rate of 8%. Actual GDP must therefore: A) increase by 1.5 percentage points. B) increase by.75 percentage points. C) fall by 3 percentage points. D) fall by.75 percentage points. E) fall by 1.5 percentage points. 12. Real business cycle theory: A) focuses on the effect of fiscal policy on the business cycle. B) argues that household spending has the single biggest effect on the business cycle. C) argues that the vertical aggregate supply curve will shift due to changes in technology and the supply of labor. D) focuses on the effect of monetary policy on the business cycle. E) none of the above. 13. The real rate of interest is the rate of interest: A) paid on a loan inclusive of all other bank fees and charges. B) banks charge their largest and most credit-worthy customers. C) found by subtracting the inflation rate from the nominal interest rate. D) paid on a loan after all other bank fees have been deducted. E) banks pay on deposits over $100,

3 14. If the national output expands with $300 bl when the government increases its purchases with $100 bl than the MPC for this economy is: A) 1 B) 0.5 C) 2/3 D) 0.4 E) Suppose that the supply of money were fixed. An increase in the demand for money should be expected to cause: A) the equilibrium rate of interest to climb. B) the equilibrium quantity of money demanded to climb. C) the equilibrium rate of interest to fall. D) the equilibrium quantity of money demanded to fall. E) none of the above without some sort of accommodating Fed policy adjustment. 16. When economists talk about a random walk they mean: A) the unpredictable nature of changes in the money supply. B) the unpredictable nature of movements in stock prices. C) the unpredictable nature of changes in interest rates. D) all of the above. E) none of the above. 17. If American prices drift upward somewhat more rapidly than prices in the other economies, the probable result will be: A) a trend toward gradual depreciation of the dollar. B) gradual overvaluation of the dollar. C) tariffs or quotas. D) exchange controls. E) value-added subsidies to exports. 18. The most preferred direction for the Phillips curve to shift is: A) down and to the left. B) down and to the right. C) in the same direction as costs. D) up and to the right. E) up and to the left. 19. The quantity of U.S. dollars demanded by foreigners is likely to rise: A) if there is no inflation in the United States but there is inflation abroad. B) after foreigners devalue their currencies relative to the dollar. C) if there is more inflation in the United States than abroad. D) if it is anticipated that the dollar will be devalued. E) if the demand for U.S. exports falls. 20. Which of the following is a correct, likely sequence? A) M up, i up, I up, GDP up. B) M down, i up, I down, GDP down. C) M down, i down, I down, GDP down. D) M down, i down, I up, GDP up. E) M down, i up, I up, GDP up

4 II. True/False Section (15 points) Answer all questions. Determine whether the statement is true or false. For each question provide a short explanation (no more than 1-2 sentences) of your answer. Use equations if necessary. 1. (True/False) If the MPC equals 1/3, then the simple Keynesian multiplier for a closed economy with G = T = 0 equals (True/False) High interest rates encourage investment, since investors can earn more money. 3. (True/False) According to rational expectations, people are unable make accurate forecasts, thus the government is able to surprise them with its policies. 4. (True/False) For the existence of equilibrium in the multiplier model, the C + I + G + X schedule must have a slope steeper than the slope of the 45-degree line. 5. (True/False) Whenever the actual rate of unemployment is less than the NAIRU, upward pressure is exerted on the rate of inertial inflation

5 III. Definitions (10 points) Answer all questions. Provide a short definition of all three terms and explain the link between the first two terms and the third one, shown in bold. Use equations if necessary. 1. (i) Disposable Income, (iii) Marginal Propensity to Consume, (iii) Consumption Function: 2. (i) Foreign Exchange Market, (ii) Government Intervention, (iii) Fixed Exchange Rate: - 5 -

6 IV. Graphs (25 points) Use a separate diagram to answer each question. Label all axes, indicate initial equilibrium and show the direction of a change. Show the final state of the economy. If necessary, provide a short description for each graph. Answer all questions. 1. Using AS-AD diagram, show the short-run impact of higher oil prices on the aggregate price level and output. 2. Use multiplier model for the closed economy to show the effect of the lower private investments on the national output. 3. Show the response of the interest rates to the higher demand for money during the holiday shopping season (assume that the money supply is fixed). 4. Show the response of Euro/$ exchange rate is the European Central Bank tightens its monetary policy. (Use the demand for and supply of dollars graphs.) 5. Use Phillips curve to show the impact of an increase in the inflationary expectations

7 V. Essay (20 points) 1. You have two options in this section (Option B is on the next page). Answer one question only. Please provide a clear and concise answer. Use graphs and equations when necessary. You may use the back side of the page for your answer, if you need. A [5 points] The economy enters a period of high unemployment. The government attempts to stimulate output by using the fiscal policy. What are the instruments of the fiscal policy? How should the government use this instruments to achieve the desired change in output? 2. [5 points] Choose one instrument and show its effect on the economy by using both Keynesian Multiplier Model and AS-AD framework. (Your both graphs should accurately reflect the assumptions of the multiplier model.) 3. [5 points] Assume that the actual unemployment rate is 8% and the government wishes to reduce it to 6%. If MPC is equal to 3/4 and the actual output is $100 what is the necessary size of the fiscal policy instrument to achieve this target? Answer this question for both instruments - taxes and government spending. 4. [5 points] What are the consequences of this fiscal policy for the government budget? Are they going to have any long-term implications for this country? Why? - 7 -

8 1. [6 points] In a move to restrict inflationary pressure the Fed tightens monetary policy. Describe and illustrate the impact of this policy on the interest rate, investment, prices and output. B 2. [3 points] List all option the Fed can use to tighten money supply. Are all of them equally likely to be used by the Fed? Explain why. 3. [4 points] What is the cost (trade-offs) of this policy? What graphs do we use to represent this trade-off (plot the graph)? Should we observe this trade-off both in the short-run and long-run (explain why)? 4. [2 points] The Fed attempts to reduce inertial inflation by 1%. Measure the cost of this policy in terms of output and unemployment. 5. [5 points] What is the name of the theory that links price stability and monetary policy? What are the main assumptions, equations and conclusions of this theory? - 8 -