Principles of Macroeconomics Prof. Yamin Ahmad ECON 202 Spring 2007

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1 Principles of Macroeconomics Prof. Yamin Ahmad ECON 202 Spring 2007 Midterm Exam II Name Id # Instructions: There are two parts to this midterm. Part A consists of multiple choice questions. Please mark the answers to the multiple choice questions on the exam paper and fill in the relevant bubble on the Scantron sheet. Part A is worth 60%. Part B is worth 40% and consists of short answer questions. Please answer in the space provided. Please attempt both parts and turn the exam in at the end. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In the above figure, B is the current long-run aggregate supply curve and E is the current short-run aggregate supply curve. If there is an increase in the full-employment quantity of labor (L*), then the long-run aggregate supply curve and the short-run aggregate supply curve A) shift to A and D, respectively. B) shift to C and F, respectively. C) remain B and E. D) shift to A and F, respectively. B 1

2 Disposable income (dollars) Consumption expenditure (dollars) ) In the above table, savings are positive when income is greater than A) $300. B) $500. C) $100. D) zero. B 3) In the figure above, the multiplier equals A) 0.5. B) 2.5. C) D) some amount that cannot be calculated without additional information. C 4) The consumption function shows a A) positive relationship between disposable income and consumption expenditure. B) negative relationship between consumption expenditure and aggregate saving. C) positive relationship between an individualʹs wealth and his or her consumption expenditure. D) negative relationship between disposable income and consumption expenditure. A 2

3 Aggregate demand (trillions of 1996 dollars) Short-run aggregate supply (trillions of 1996 dollars) Long-run aggregate supply (trillions of 1996 dollars) Price Level ) The data in the above table show that when the price level is 120, as the economy moves from the short run equilibrium to the long run equilibrium, the A) long-run aggregate supply curve will shift leftward. B) short-run aggregate supply curve will shift leftward. C) long-run aggregate supply curve will shift rightward. D) short-run aggregate supply curve will shift rightward. 6) In the above figure, the short-run aggregate supply curve is SAS1. If the prices of resources fall, there is A) an upward movement along SAS1. B) a shift to SAS2. C) a shift to SAS0. D) a downward movement along SAS1. B 7) The marginal propensity to consume refers to A) the additional consumption expenditure that occurs out of an additional dollar of disposable income. B) the additional consumption expenditure that occurs out of an additional dollar of investment. C) the additional saving that occurs out of an additional dollar of disposable income. D) total consumption expenditure divided by total disposable income. A 3

4 8) An economy saves 20 percent of any increase in income and there are no income taxes or imports. Then, an increase in investment of $2 billion can produce a short run increase in real GDP of as much as A) $1.6 billion. B) $0.4 billion. C) $2 billion. D) $10 billion. 9) In the above figure, when disposable income is greater than $6 trillion, then A) savings are positive. B) the MPS is negative. C) savings are negative. D) the MPC is greater than 1. A 10) If the price level is constant and there are no income taxes or imports, a decrease in investment of $100 that occurs when the MPS = 0.25 leads to a decrease in real GDP of A) $25. B) $100. C) $800. D) $ ) The relationship between desired aggregate expenditure and real GDP is called the A) aggregate expenditure function. B) equilibrium function. C) dissaving function. D) consumption function. A 12) A lower price level combined with a decrease in real GDP occurs when the A) short-run aggregate supply curve shifts rightward. B) aggregate demand curve shifts leftward. C) short-run aggregate supply curve shifts leftward. D) aggregate demand curve shifts rightward. B 4

5 13) What is measured on the vertical axis of a diagram showing the aggregate supply curve? A) nominal income B) real national income C) the interest rate D) the price level 14) Which of the following shifts the aggregate demand curve rightward? A) an increase in the money supply B) a decrease in transfer payments C) a decrease in the price level D) a decrease in government purchases A 15) In the above figure, if real GDP equals $8 trillion, A) actual investment will decrease but planned investment will increase. B) consumption will decrease. C) unplanned inventories will increase. D) unplanned inventories will decrease. 16) If the level of real GDP exceeds potential GDP, A) there can be a short-run equilibrium with a recessionary gap. B) there is neither a long-run nor a short-run equilibrium. C) there is a long-run and a short-run equilibrium. D) there can be a short-run equilibrium with an inflationary gap. 5

6 17) In the above figure, the inflationary gap when AD2 is A) the difference between 110 and 100. B) AD1. C) LAS minus SAS at a price level of 100. D) the difference between $10.5 trillion and $10.0 trillion. 6

7 18) In the above figure the economy is initially at point A on aggregate expenditure curve AE0. Suppose firms expect profits to increase and decide to increase investment. As a result A) the AE curve shifts downward to a curve such as AE1. B) there is a movement along AE1 to a point such as B. C) there is a movement along AE1 to a point such as C. D) the AE curve shifts upward to a curve such as AE2. 19) If aggregate planned expenditures are less than the level of real GDP, A) output and income remain unchanged. B) output and income will either decrease or remain unchanged, depending on the MPC. C) output and income will increase. D) inventories will increase above their target level and real GDP will decrease. 20) An increase in the money wage rate shifts the short-run aggregate supply curve ; an increase in technology shifts the long-run aggregate supply curve. A) leftward; rightward B) leftward; leftward C) rightward; leftward D) rightward; rightward A 7

8 Solutions to MC Questions for other versions Question Yellow Version (Version B) White Version (Version C) 1 B D 2 D B 3 B B 4 D B 5 B C 6 B B 7 C A 8 C A 9 D B 10 B A 11 A C 12 B A 13 D B 14 C D 15 D C 16 B B 17 A D 18 A A 19 D B 20 B A 8

9 Part B: SHORT ANSWER QUESTIONS (40%) Write brief answers to the questions below being as succinct and clear as possible. Show any calculations as necessary in answering the questions. Remember, this part of the midterm is worth 40%. 21. (20%) Consider the AD-AS model below. The graph below depicts an initial long run equilibrium where real GDP equals potential GDP. Price LRAS SRAS 2 SRAS 1 E 3 E 2 E 4 P 1 E 1 AD 2 Figure 1. Y AD 1 Y a. (4pts) Suppose for this economy, the price of domestic goods and services become cheaper as compared to foreign goods and services (- we shall see later in the course that this is what happens when the exchange rate is said to depreciate ). As a result net exports rise. In the graph above, show the effect of this exchange rate depreciation by showing what happens to one (or more) of the curves. Draw in the new curve(s) with a continuous line (i.e. do not use dashed lines to represent the new curves) and label the new equilibrium point E 2. A change in NX affects Aggregate Demand: Y=C+I+G+NX. So when NX increase, the AD curve shifts out. E 2 represents the new short run equilibrium given by the intersection of the AD 2 and SRAS 1 curves. b. (4 pts) What happens to (domestic) prices in equilibrium? What happens to real GDP (Y) in equilibrium? Real GDP increases; domestic prices increase. 9

10 c. (4pts) Consider the Sticky Wage theory of the aggregate supply. Describe what happens in the labor market as the event in part (a) occurs by showing what happens in figure 2 below as we move to the new short run equilibrium. Show where the equilibrium point that corresponds to point E 2 above in part (a) lies on the graph in figure 2. (Label that point E 2 as well to show that it is the same corresponding point.) Real Wage L S 1 ω E 1 E 2 Figure 2. L * L d 1 Labor d. (2pts) What happens to the actual real wage (W/P) as compared to ω (the anticipated real wage)? What happens to employment, L (i.e. does it increase or decrease)? Given that prices came out higher than expected, the actual real wage (W/P) is lower than the anticipated real wage, ω. Employment is higher (i.e. it increases). e. (6pts) Go back to figure 1. Draw the effects of what occurs in the transition from the short run equilibrium to the long run equilibrium (in the absence of the any other factors changing in the economy, i.e. ceteris paribus). This time, use dashed lines to show where the curves are for this case. In addition, on the graph show where (i) the new long run equilibrium point is and label it E 3 ; (ii) the price level that people were originally expecting to occur before the exchange rate depreciated and label it E 4. Over time, wages gradually become unstuck. So workers negotiate higher nominal wages, W since they realize actual real wages came out lower than they expected. Thus, over time, firms real marginal costs rise, and they cut back on output. So the SRAS curve slowly shifts leftwards over time until we get back to potential GDP. Thus, E 3 is at the point where the LRAS curve intersects the new AD 2 curve. [Note: only the SRAS curve shifts since there has been no change in K *, L *, or technology.] The price that people expected originally, was at the intersection of the original SRAS 1 curve and the LRAS curve. 10

11 22. (20%) Consider a small open economy in which aggregate expenditures, AE, is the sum of consumption spending by households, investment spending by firms, government expenditures and net exports. You may assume that net exports are independent of GDP and taxes are lump-sum. a. (4%) For the table below, calculate the missing values, A and B. Government Net Aggregate GDP Consumption Investment Expenditures Exports Taxes Expenditures 1, A 1,500 B ,600 2,000 1, ,000 2,500 2, ,400 3,000 2, ,800 A = C+I+G+NX = = 1200 B = AE (I+G+NX) = 1600 ( ) = 1250 b. (4%) Use the table above to calculate the marginal propensity to consume. [Hint: Recall that the mpc is the additional increase in consumption arising from an increase in disposable income.] To calculate this, use any two sets of consumption and GDP pairs: e.g. when (Consumption,GDP) are (850,1000) and (1250,1500): ΔC MPC = Δ YD = = = 0.8 ( ) ( ) 500 c. (4%) Recall that the consumption function is written as C = C 0 + c 1 (Y-T) where c 1 is the mpc and C 0 is Autonomous Consumption. Use the table in part (a) and your answer to part (b) above to calculate Autonomous Consumption C 0. [Hint: Calculate induced consumption for any given level of disposable income, and use your answer to figure out C 0 ] Using any of the consumption, income and tax data, e.g. C=850, Y=1000, T=50: C 0 = C c 1 (Y-T) = ( ) = 90 d. (4%) Using a similar method to that in part (c), calculate autonomous expenditure, i.e. AE 0 in the aggregate expenditures equation: AE = AE 0 + c Y. Similarly, using any of the aggregate expenditure and income data: e.g. AE=2000, Y = 2000: 11

12 AE 0 = AE c 1 Y = = = 400 e. (4%) What is the value of the multiplier? 1 1 Multiplier = = = 1 Slope( AE) = 5 12