ECO 209Y MACROECONOMIC THEORY AND POLICY

Transcription

1 Department of Economics Prof. Gustavo Indart University of Toronto December 7, 2011 ECO 209Y MACROECONOMIC THEORY AND POLICY Term Test #2 LAST NAME FIRST NAME STUDENT NUMBER Circle your section of the course: L0101 L0301 L0401 M 2-4 W 2-4 R 2-4 INSTRUCTIONS: 1. The total time for this test is 1 hour and 50 minutes. 2. Aids allowed: a simple, non-programmable calculator. 3. Use pen instead of pencil. DO NOT WRITE IN THIS SPACE Part I /36 Part III 1. /10 Part II /14 2. /10 3. /10 TOTAL /80 Page 1 of 10

2 PART I (36 marks) Instructions: Enter your answer to each question in the table below. Table cells left blank will receive a zero mark for that question. Each question is worth 3 marks for a maximum of 36 possible marks. No deductions will be made for incorrect answers Due to a reduction in consumer confidence, a hypothetical economy went into recession about six months ago. As a result, both output and the real interest rate decreased. The economy has now recovered and equilibrium output and equilibrium interest rate have both returned to their pre-recession levels. Which of the following is most likely to have happened? A) The central bank decreased the money supply. B) The central bank increased the money supply. C) The government did not intervene in the economy. D) The government increased its purchases of goods. E) The government increased taxes. 2. In a fixed-price model of a closed economy, a $1 increase in government expenditure will have the largest impact on the rate of interest when it is financed by A) raising taxes to the rich. B) raising taxes to the middle class. C) borrowing from the public. D) borrowing from the central bank. E) cutting other expenditure programs. Use this space for rough work. Page 2 of 10

3 3. Consider the fixed-price model of a closed economy. If the demand for real balances increases at each level of the market rate of interest, which one of the following statements is correct? A) The IS curve shifts up to the right and income increases. B) The IS curve shifts down to the left and the LM curve shifts down to the right. C) The LM curve shifts up to the left and income decreases. D) The LM curve shifts up to the left and the IS curve shifts down to the left. E) The LM curve shifts down to the right and income increases. 4. A policy of a balanced budget over the business cycle would A) require increasing government expenditures when revenues are rising. B) require increasing taxes when revenues are falling. C) call for substantial government infrastructure investments in periods of economic boom. D) allow for the implementation of countercyclical policies without affecting the level of the national debt. E) allow for the implementation of countercyclical policies without affecting the debt-to- GDP ratio. 5. Consider the IS-LM framework in a fixed-price model of the economy. An increase in the rate of interest will cause A) the IS curve to shift up to the right. B) the IS curve to shift down to the left. C) the LM curve to shift up to the left. D) the LM curve to shift down to the right. E) none of the above. 6. Consider the IS-LM framework in a fixed-price model of the economy. If investment spending is very sensitive to the interest rate, which one of the following statements is correct? A) The LM curve will be relatively steep and the IS curve relatively flat. B) The LM curve will be relatively steep. C) Both the IS and the LM curve will be relatively flat. D) The IS curve should be relatively flat. E) None of the above is correct. Use this space for rough work. Page 3 of 10

4 7. Suppose money and bonds are the only two assets in the economy. Assuming all else equal, if bond holders attempt to sell bonds in order to increase their money holdings, at the end of the process of adjustment A) the money held by individuals and businesses will increase by the same amount as their bond holdings will decrease. B) the money held by individuals and businesses will decrease by the same amount as their bond holdings will increase. C) individuals and business will reduce their bond holdings but will keep their money holdings unchanged. D) individuals and businesses will keep both their total money holdings and their total bond holdings unchanged. E) individuals and business will reduce both their bond holdings and their money holdings by the same amount. 8. Consider a fixed-price, IS-LM model of the economy. If there is a simultaneous tax cut and open market sale of bonds, which one of the following statements describes the most likely outcome? A) Both output and the interest rate will increase. B) The interest rate will increase but output could increase or decrease. C) Output will increase but the rate of interest could increase or decrease. D) The interest rate will increase while output will decrease. E) None of the above. 9. Although GDP figures for the third quarter of 2011 show that China s economy grew by an impressive 9.1 percent from a year earlier, growth was nonetheless lower than the 9.5 percent recorded in the second quarter. Which of the following statements correctly describe the reaction of Chinese authorities to the apparent slowdown of the economy? A) China s central bank is pursuing less restrictive monetary policy by loosening lending requirements. B) Chinese policy makers believe that inflation at about 6.1 percent is still a problem and are thus reluctant to ease monetary policy. C) Concerned about the European debt crisis, Chinese policy makers are reducing government expenditure and the fiscal deficit. D) China s central bank is now focusing on maintaining growth, rather than on tackling inflation. E) Both a) and d) are correct. Use this space for rough work. Page 4 of 10

5 10. In the Keynesian model of the economy, which one of the following statements better describes the difference between using monetary and fiscal policy to eliminate a recession? A) An expansionary monetary policy will leave the economy with a lower real interest rate than an expansionary fiscal policy. B) Monetary policy will eliminate a recession quicker than fiscal policy will. C) An expansionary fiscal policy will leave the economy with a lower real interest rate than an expansionary monetary policy. D) Fiscal policy will eliminate a recession quicker than monetary policy will. E) None of the above. 11. Suppose that average income per capita in Uruguay is 240,000 pesos per year and that the nominal exchange rate for Uruguayan pesos is Further suppose that a given consumption basket of goods and services costs $4,500 in the Canada and 75,000 pesos in Uruguay. Using the PPP exchange rate, income per capita in Uruguay is: A) $9,600. B) $12,000 C) $13,200 D) $14,400. E) $15, Chinese production of export-oriented goods has become more expensive over the last couple of years. In 2011 alone, minimum wages in most Chinese coastal provinces rose by more than 21% while the renminbi (i.e., the Chinese currency) continued to appreciate. Given this relative loss of competitiveness, which of the following statements correctly describes the changes observed in the Chinese economy over the last couple of years? A) Chinese firms are moving their labour-intensive operations to other Asian and African countries. B) The Chinese government is heavily investing in the infrastructure of inland provinces to lure the labour-intensive operations of successful coastal firms. C) Parts of China s manufacturing sector are now moving up the value-added chain by producing more capital-intensive and more skill-intensive goods. D) The Chinese government is making important investment efforts to rapidly deepen China s skills and technology base throughout the economy. E) All of the above are correct. Use this space for rough work. Page 5 of 10

6 PART II (14 marks) Consider the following model of the economy: C = YD 10i I = i Y G = TR = 100 TA = Y NX = Y L = 0.1Y 10i M = P = 1 a) What is the equation for the AE curve? What is the equation for the IS curve? [Note that these equations will be expressed as a function of.] (2 marks) b) What is the equation for the LM curve? [Note that this equation will be expressed as a function of.] (2 marks) c) What are the values of the expenditure multiplier (α AE ), the fiscal policy multiplier (β FP ), and the monetary policy multiplier (β MP )? (3 marks) Page 6 of 10

7 d) If equilibrium income (Y*) is 2800 and the equilibrium rate of interest (i*) is 5 (where 5 means 5 percent), what are the corresponding values of G and M? (3 marks) e) Suppose that at the present level of equilibrium income there is a recessionary gap of 200. If the government wants to eliminate this recessionary gap while maintaining the rate of interest at 5, what combination of an increase in G and an increase in M is required? (4 marks) Page 7 of 10

8 PART III (30 marks) Instructions: Answer all questions in the space provided. Each question is worth 10 marks. 1. Critically evaluate the following statement: The undervaluation of the renminbi (the Chinese currency) is the underlying cause of the large deficit in the U.S. trade account. Page 8 of 10

9 2. Critically evaluate the following statement: Expansionary monetary policy is very effective in reducing a recessionary gap when the interest sensitivity of the demand for real balances is very small. (Show your answer with the help of appropriate diagrams and explain the economics.) Page 9 of 10

10 3. Critically evaluate the following statement: Most economists believe that greater consumer and business confidence is needed to restore Canada s economic activity to pre-recession levels. In this regard, Canada s Finance Minister thinks that the biggest contribution his government can make to improve economic confidence is to reduce its own spending and debt. Page 10 of 10