SOCIAL ANALYSIS 10 HOURLY APRIL 14, 2004

Transcription

1 Name Section Leader Section Time Harvard ID # SOCIAL ANALYSIS 10 HOURLY APRIL 14, 2004 This exam is 50 minutes long. Points per question are proportional to the time indicated. You will have 3 extra minutes (for a total of 53 minutes) to take this exam. Please write clearly; illegible answers will receive no credit. Label all graphs. Calculators are not allowed. 1. Write your name, your Harvard student ID number, your section leader's name, and your section time on this sheet. 2. Do not write your name on your bluebooks. To ensure anonymous grading, write only your Harvard student ID number, your section leader's name, your section time, and the bluebook number on each bluebook that you use. 3. Use three bluebooks for this exam. You may write on this exam, but you will only be given credit for answers written in the bluebook. 4. Use one exam booklet for each bluebook section of the exam. You must hand in all 3 bluebooks.

2 Bluebook I: How High Does Your Interest Rate? (16 minutes) 1. (9 minutes) There has been recent speculation that the Federal Reserve (the Fed) may raise the Fed funds rate before the end of the year to head off inflation. For parts (a) (c), assume all curves have the shapes we studied in section. Assume throughout that the public holds no cash. (a) (3 minutes) Name and explain three tools the Fed could use to affect the Fed funds rate, and specifically how each tool would be used to raise the Fed funds rate. Include one money market diagram in your discussion. (b) (0.5 minutes) Which of the three tools does the Fed most commonly use? (c) (2.5 minutes) Regarding the tool you listed in b: Using one diagram of the money market, explain how the interest-elasticity of money demand affects the size of the action necessary to increase the Fed funds rate by a given percentage. (Assume money demand is neither completely elastic nor completely inelastic). (d) (3 minutes) Assume now that banks hold excess reserves, and that the proportion of deposits they hold as excess reserves is inversely related to the interest rate. Regarding the tool you listed in b: Using one diagram of the money market, explain whether the action necessary to raise the Fed funds rate by a given percentage would have to be larger or smaller than if banks held no excess reserves. BLUEBOOK I CONTINUES ON NEXT PAGE

3 2. (3 minutes) (a) (1 minute) What are the two assumptions of the Quantity Theory of Money? According to the Quantity Theory of Money, what will be the long-run effect if the Fed decreases the money supply by 5%, and real GDP is growing at 3%? Explain. 3. (2 minutes) Explain with reference to income and substitution effects why consumption declines when the real interest rate increases. 4. (2 minutes) We learned at the start of Unit II that the majority of investment is financed by retained earnings (plowback of profits), and not through bank loans or bonds. Explain why investment financed through retained earnings is still negatively related to the real interest rate. END OF BLUEBOOK I PLEASE USE NEW BLUEBOOK FOR BLUEBOOK II QUESTIONS

4 Bluebook II: Oh! To Be in Econia, Now that Spring is Here! (16 minutes) 1. (10 minutes) Econia is a small nation whose economy is in long-run equilibrium. (a) (1 minute) On a well-labeled graph, show Econia s LRAS, SRAS, and AD curves as well as the equilibrium price and output. (b) (4 minutes) Suppose the Central Bank of Econia buys Econian government bonds from Econian citizens. Graph and explain any changes to the equilibrium price level and equilibrium output that occur as a result of this action in the short run. Explain what happens in the short-run to each component of aggregate expenditure. (c) (3 minutes) In the short run, would GDP deviate more from its potential (long-run) level if prices in the economy are more flexible or less flexible? Explain, using one graph to illustrate your answer. (d) (2 minutes) List and briefly explain three of the five reasons given in section as to why prices in an economy might be less flexible, i.e. more sticky, in the short run. BLUEBOOK II CONTINUES ON NEXT PAGE

5 2. (6 minutes) Econia trades with its neighbors, the countries of Governmentia and Sociologia. In Econia, the currency is called the econ; in Governmentia, the currency is called the gov; and in Sociologia, the currency is the soc. Nominal exchange rates are as follows: 200 econ = 1 gov 1 soc = ¼ gov 100 econ = 1 soc A good which is produced and consumed in all three countries is the Mack Burger. The price of Macks in the three countries is as follows: 1 Mack costs 2 govs in Governmentia, 16 socs in Sociologia, and 600 econ in Econia. From the perspective of Governmentia, calculate the real exchange rate in Mack Burgers between Governmentia and Sociologia, using the nominal exchange rates and prices listed above. Explain in words what the number you calculated means. If these three currencies can be freely traded, can the nominal exchange rates listed above persist over time? Why or why not? (c) (2 minutes) The economy of Econia enters a period of deflation. What will happen as a result of this to the capital account in Governmentia, Econia s main trading partner, in the short run? Assume nominal exchange rates are constant in the short run. Explain fully. END OF BLUEBOOK II PLEASE USE NEW BLUEBOOK FOR BLUEBOOK III QUESTIONS

6 Bluebook III: Summerstime is Just Around the Corner (18 minutes) 1. (6 minutes) According to President Summers: What are the two functions any economic system must perform? What are the two core ideas of economics? (c) (2 minutes) What are three requisites for a successful economy? 2. (6 minutes) Recall the Economist article Zero Inflation: How low is low enough? Why is it the case that if inflation were predictable, many of its deleterious effects could be avoided? (b) (4 minutes) What are two reasons that unforeseen inflation retards growth? Explain each carefully. 3. (2 minutes) Based on the article, Inside the Fed, Deflation Draws a Closer Look, what are two reasons that deflation is dangerous? BLUEBOOK III CONTINUES ON NEXT PAGE

7 4. (4 minutes) Consider the article McCurrencies from The Economist: What is the basic idea behind the concept of purchasing-power parity? What is one persistent deviation from the Big Mac PPP? What is a possible explanation for this? END OF BLUEBOOK III