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1 Department of Economics University of Toronto at Mississauga ECO202Y5Y Macroeconomic Theory and Policy October 2002 Test One Instructor: Xinhua Gu Date: Friday, October 11, 2002 Time allowed: Two hours Aids allowed: Calculator Notes: This test consists of 12 multiple-choice questions in part I and 8 long questions in part II. Each multiple-choice question is worth 3 marks and each long question worth 8 marks. There is no partial mark for any multiple-choice question. Some part of a long question that is worth two marks may cover more than two small points; you will be given partial marks on the basis of the relative number of correct points that you will have made. It is important to hand in a complete test without missing page. Any missing page will be counted as zero mark. This test is worth 10% of your course grade Print last name: Solution Given name: Student number: Section number: Do not write on the space below, for markers only Questions Allocated marks Points Questions Allocated marks Total 100 Points 1

2 Part One 1. Suppose $Y in 1980 is less than Y in Then, we know with certainty that: (a) the GDP deflator in 1980 is greater than the GDP deflator in the base year (b) the GDP deflator in 1980 is less than the GDP deflator in the base year (c) Y in 1980 is less than Y in the base year (d) Y in 1980 is greater than Y in the base year 2. Suppose the GDP deflator equals 1.2 in year t and 1.35 in year t+1. The inflation rate between both years is (a) 0.15% (b) 15% (c) 12.5% (d) 1.125% 3. The Phillips curve illustrates the relationship between: (a) changes in the inflation rate and the unemployment rate (b) the unemployment rate and GDP growth (c) the unemployment rate and the labor force participation rate (d) the rate of change in the GDP deflator and the CPI 4. Which of following is (are) an endogenous variable(s) in the model of Chapter 3? (a) consumption and saving (b) government spending and consumption (c) investment and saving (d) taxes and the MPC (marginal propensity to consume) 5. A rise in the MPC will cause: (a) an increase in output and in the multiplier (b) a reduction in output and in the multiplier (c) an increase in output and a reduction in the multiplier (d) a reduction in output and an increase in the marginal propensity to save 6. A rise in fixed investment I will cause: (a) a reduction in output and in the multiplier (b) an increase in output and in the multiplier (c) an increase in output and no change in the multiplier (d) no change in the multiplier and, therefore, no change in output 7. Suppose that government purchases rise by $1 billion, which causes a series of increases in output equal to the following geometric series: The total change in production caused by this government spending change will be: (a) $20 billion (b) $10 billion (c ) $5 billion 2

3 (d) $15 billion 8. Suppose Y t =Z t in period t. This suggests that: (a) inventory investment is positive in t (b) inventory investment is negative in t (c) inventory investment is zero (d) production will increase in t+1 9. A central bank purchase of bonds will cause: (a) a reduction in the monetary base (b) an increase in the monetary base (c) a reduction in the price of bonds (d) an increase in the interest rate 10. A contractionary open market operation will cause: (a) a reduction in the money supply (b) a rise in the money supply (c) a rise in the monetary base (d) a fall in the interest rate 11. Which of the following events will cause a rise in the money multiplier? (a) a rise in the reserve ratio (b) a rise in the currency-deposit ratio (c) a fall in the reserve ratio (d) a rise in the monetary base 12. Suppose people hold no currency and the reserve ratio is The money multiplier is: (a) 1.33=1/(1-0.25) (b) 2.5 (c) 4 (d) 5 Part Two 13. An economy produces only three goods: steaks, eggs and wine. The quantities and prices of each good sold for two years are given by: 1992, quantity 1992, price 1997, quantity 1997, price Steak (kgs) 10 $ $11.50 Eggs (dozens) 10 $ $1.30 Wine (bottles) 8 $ $6.50 Calculate each of following for both years: (a) Nominal GDP (b) Real GDP, taking 1992 as the base year (c) GDP deflator (d) Growth rate and inflation rate between both years. 3

4 (a) $Y in 1992=$150, $ Y in 1997 =$ (b) Y in 1992 = $Yin 1992=$150 since 1992 is the base year, Y in 1997 =$144 (c) P in 1992=1, P in 1997=$168.9/$144=1.17 (d) g =( )/150=-4%, π=17% 14. An economy consists of just three firms, and information on their production is in the following: Steel company Lobster company Car company Sales revenue $400 $200 $1000 Expenses Wages Others $340 $160 $500 $400 (Steel purchase) Profits $60 $40 $100 (a) Calculate GDP using the final goods approach (b) Calculate the value added for each firm, and GDP using the value added approach (c) Calculate labor income, capital income, and GDP using the incomes approach (d) Do these approaches yield any different levels of GDP? If yes, explain why. (a) The value of final goods (car and lobster) =$200+$1000=$1200=GDP (b) The value added =$400 for steel, $200 for lobster, and $600 for car. So, the sum of the three numbers=gdp=$1200 (c) Total wages=$1000, Total profits=$200, the sum of both numbers=gdp=$1200 (d) All three approaches to GDP yield the same level of GDP 15. The table below includes information on real GDP (in billions, with 1992 being the base year) for Canada in 1996 and Consumption C Investment I Nonresidential Residential Government spending G Net export Export X Import Q Inventory investment I s (a) Calculate GDP for both years, and growth rate between both years (b) Calculate the rate of growth/decline in each of the GDP components (such as C, I, G, X, Q, I s ) (c) Calculate the share of each component in GDP for 1997 (d) What happened to the trade balance? Provide a brief comment. (a) Y in 1996=751.2, Y in 1997=779.9, growth rate=3.8% (b) Growth rates for (C, I, G, X, Q, I s ) are (4%, 14%, -12%, 8%, 13%, 667%) (c) Components shares for (C, I, G, X, Q, I s ) in 1997 are (60%, 17%, 21%, 38%, 37%, 0.9%) 4

5 (d) The trade surplus (X-Q) decreased from 19.6% to 7.6%. Both X and Q increased between both years, but Q increased more. 16. Consumption function is C= Y D, where Y D =Y-T and T=200. (a) What is the level of consumption if Y D =0. How does an individual pay for this consumption? (b) Suppose that Y increases from 1200 to What will happen to consumption following this income change? (c ) Write out the saving function for this economy. What is the level of saving S when Y D =0. Explain how and why this occurs. (d) Suppose that the marginal propensity to consume rises from 0.5 to 0.7. Then, what will happen to consumption for any given level of income? Illustrate this point by using a figure with C on the vertical axis and Y (rather than Y D ) on the horizontal axis. (a) C=200 if Y D =0. They consume by drawing down their savings, borrowing or receiving financial aid from others. (b) C=0.5 Y=0.5*( )=50 (c) S= Y D. S=-200 if Y D =0. This is the dissaving that pays for the consumption when disposable income is 0. (d) This change in MPC will change the consumption function from C= Y to C=60+0.7Y, which is illustrated as follows: C C=60+0.7Y C= Y Y 17. Suppose that an economy is represented by the following set of equations: Z=C+I+G C= Y D T=1000 I=200 Y D =Y-T G=2000 (a) Calculate the equilibrium level of output (b) Calculate the level of consumption after the equilibrium output has been attained. (c) Calculate the level of private saving given the above equilibrium (d) Calculate the new equilibrium output as a result of the decrease in autonomous consumption by 5

6 100 (or the increase in autonomous saving). Explain in brief. (a) Y= (Y-1000) = Y. This yields Y=16000 (b) C= ( )=13890 (c) S= ( )=1200 (d) Y= Y, yielding Y= As the desire to save rises, C falls and demand drops. This causes a reduction in Y. 18. An economy is expressed by Y t+1 =Z t C t =c o +c 1 Y Dt Z t =C t +I+G Y Dt =Y t -T c 1 =0.6 Suppose there is a $50 billion permanent increase in G in 2003:1 (a) Calculate the quarter-to-quarter changes in production, government spending, consumption and sales for the 4 quarters of Place your answers in the table below (b) Calculate the cumulative changes in Y, G, C and sales for the 4 quarters of Also, use the table to plug in numbers (c) What will be the ultimate cumulative change in Y in steady state (d) Draw a figure to show the process of adjustments to the new equilibrium. Explain it in words. Do not write too much. Just make points (a) Quarter Production Gov t spdg Consumption Sales 2003: : : : (b) Quarter Production Gov t spdg Consumption Sales 2003: : : : (c) λ=1/(1-0.6)=2.5, Y * =λ G=2.5*50=125. Y will rise by 125 in equilibrium. (d) 6

7 Z 45 o line ZZ ZZ Y Y * Y * The rise in G leads to a rise in demand, and thus to negative inventory investment. Then, firms increase output, and inventory investment becomes positive. The higher production leads to higher income, and hence higher demand. Then, the above procedure repeats itself but at a diminishing rate. 19. Use a figure to answer the following question: (a) The existing stock of money is M. How much money do people hold at the initial equilibrium interest rate? (b) Suppose there is a fall in the money supply (from M to M ). What effect will this have on the interest rate? (c) At the initial equilibrium interest rate, what is the demand/supply situation in the market when the fall in M takes place? (d) How will equilibrium be restored, and is the new equilibrium interest rate lower or higher? (a) As shown in the figure, they hold M initially. (b) After the fall from M to M, the M S curve shifts to the left, and the interest rate will rise. (c) After the fall from M to M, there is an excess money demand at the initial equilibrium interest rate in the market. (d) The interest rate must rise to eliminate the excess money demand. This adjustment is along the money supply curve until the new equilibrium interest rate is achieved. 7

8 i i M d M M 20. Use data: R=50, CU=250, D=500 to (a) calculate the reserve ratio, the currency-deposit ratio, and the size of monetary base (b) calculate the money supply and the money multiple (c) construct the balance sheets (assets & liabilities) for the central bank and private banks (plug in numbers obtained from above) (d) calculate the new amount of deposits and the new supply of money if the reserve ratio remains unchanged and the currency-deposit ratio changes to 0.2 (Still use: CU=250). (a) θ=50/500=0.1, c=250/500=0.5, H=250+50=300 (b) λ m =750/300=2.5, M= =750 (c) The value of assents is always equal to the value of liabilities for any balance sheet of the banking sector Central Bank Balance Sheet Banks Balance Sheet Assets Liabilities Assets Liabilities B 300 CU 250 R 50 R 50 B 450 D 500 (d) λ m =(0.2+1)/( )=4, D=H/( )=H/0.3, substituting to H=0.1D+CU=0.1H/ yields H=375. Then, D=375/0.3=1250, M=4*375=1500, R=0.1*1250=125 8