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1 Econ Student Name(Please print): Fall2010 Instructor Wei Gao Final Legible handwriting is required. Read carefully and follow instructions of each question. Total points in this exam are 200 points. Manage your time wisely. Good luck! 1. Give examples. (20 points) a) Give two examples of goods that are complements. Suppose two goods, good A and good B, are complements. If you list good A and good B, that is only considered as one example. You need also to list another pair of goods. That s what it means by two examples. (5 points) b) Give one example of price floor. (5 points) c) Give two examples of commodity money. (5 points) d) Give two examples of an expansionary fiscal policy. (5 points) 2. Use the models we discussed in class to analyze the economic situation. (40 points) a) Prices for building materials such as lumber and brick greatly decrease. Show what happens to the market for house graphically. And also explain using economic intuition. (10 points) 1

2 b) Households decrease their expenditure on big ticket items, such as cars, flat screen TVs. Show what happens to interest rate graphically. And also explain intuitively what happens to savings and investment. (10 points) c) OPEC cuts back on the supply of oil, which causes the oil price to increase. Show graphically what happens to the price and output level in an economy. And also answer the questions: Does price increase or decrease? Does output increase or decrease? No need to provide an economic story for these two questions. (10 points) d) An expansionary policy shifts AD to the right. How does the self-correction mechanism return the output back to normal? Show what happens graphically and also explain with the economic intuition. (10 points) 2

3 3. Consider the following data for the town of Ada. Full-time job workers: Part-time job workers: 500. People who have no jobs but are looking for jobs: 500. Retiree: 700. People who have no jobs and are not looking for jobs: 300. Calculate the unemployment rate for Ada. (10 points) 4. Suppose CPI index in 2008 is 240, CPI index in 2009 is 250, and CPI index in 2010 is 275. What is the inflation rate in 2009? What is the inflation rate in 2010? (10 points) 5. Jessica is a personal finance expert who helps people to invest their money in the bond market. She always uses one example to show that she does great job helping her clients to make huge money in the bond market. Here is the example used by Jessica: in 1984, she helped one client to buy $25,000 bonds. In 1995, she helped the same client to sell the bonds bought in 1984 for $42,500. Do you think she helped her client to make a good return on the bonds in that example? The CPI index in 1984 is roughly 100 and the CPI index in 1995 is roughly 150. (10 points) 3

4 6. It is time for the undergraduate union and the SIU management to negotiate student workers job contract for the next academic year. Student workers are currently paid $8.5 per hour. (10 points) a) The undergraduate union asks for a 5% increase in the nominal wage rate. If SIU management agrees with the undergraduate union, how much will student workers be paid hourly next year? (5 points) b) Given that the productivity of student workers will remain the same in the next year, student workers real wage rate should not increase. If you are the SIU management, will you accept the term proposed by the undergraduate union in part a)? Explain. (5 points) 7. Fiscal policy and multiplier. Suppose marginal propensity to consumption (MPC) is 75%. (10 points) a) Calculate the multiplier. (5 points) b) If the government s goal is to raise output (Y) by 400, how much should the government spending (g) increase? (5 points) 4

5 8. Suppose the government believes that velocity is nearly stable with a growth rate of only 2%. Also assume that output is growing at a 4% rate. a) If the government wants to try to hit an inflation rate of 2%, what should it set the growth rate of money equal to? (5 points) b) Suppose velocity does not grow at a 2% rate but, in actuality, at a 1% rate. Given your answer in part (a), what will inflation equal? (5 points) 9. Briefly discuss the three types of unemployment. (5 points) 5

6 10. Unemployment and output move in different directions. When output goes up, unemployment goes down. When output goes down, unemployment goes up. Suppose you observe falling inflation but rising unemployment. Do you think that a decrease in financial wealth thereby decreasing household consumption or a fall in oil price to be most consistent with these observations? Explain. (10 points) 11. Inflation in China has been high in the last decade. Suppose the Chinese government wants to lower the inflation without changing real interest rate. (15 points) a) What combination of monetary and fiscal policy should it conduct to achieve these goals? (10 points) b) What is the downside of these policies? That is, what negative effects will occur? (5 points) 6

7 12. Explain how Open Market Operations conducted by the Fed affect net exports (NX). (10 points) 13. Usually when government spending (g) increases, aggregate demand (AD) increases. However, in some situation, AD remains unchanged even though g increases. Explain how this could happen. (10 points) 7

8 14. Recessions can be triggered by different factors. In some recessions, we observe rising price level. In other recessions, we observe falling price level. And we know that government s policies, either fiscal policy or monetary policy, fail to return both price and output back to normal in some case. Here is a statement: If it is the recession in which government policies can not return both price and output back to normal, it is impossible to see that price and output go back to normal simultaneously. Do you agree with the statement or not? Explain. (10 points) 8

9 15. Briefly discuss the following questions. (20 points) a) What does twin deficits refer to? You don t have to describe how twin deficits happens. (5 points) b)why does the US government want China to raise the value of Chinese currency, Renminbi? (5 points) c) The Fed reserve can create money. Who else can create money? By create money it means increase the money supply in the economy. (5 points) d) Why does the inflation rate calculated by using CPI index tend to overstate the actual inflation rate? (5 points) 9