Intermediate Macroeconomics 311 (Professor Gordon) First Mid-Term Examination Fall, 2007

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Circle the TA session you are attending:

Costel Friday 9AM Costel Friday 3PM Jerry Friday 9AM Jerry Friday 3PM

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1. The exam lasts 1 hour. 2. The exam is orth !" #oints in total: 3" #oints $or the three analytical %uestions& and 3" #oints $or the multi#le choice %uestions. 3. 'rite your ans ers to Part A (the multi#le choice section) in the *lan+s on #age 1. ,ou on-t get credit $or circled ans ers in the multi#le choice section. .. Place all o$ your ans ers $or #art / in the s#ace #ro0ided. 1. ,ou must sho your or+ $or #art / %uestions. There is no need to ex#lain your ans ers $or the multi#le choice %uestions. !. 2ood 3uc+4

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Ans er multi#le choice %uestions in the s#ace #ro0ided *elo . "'E (%PIT%) )ETTE#'* 1. 5+,55 2. 5+-55 3. 55/55 .. 55A55 1. 5+E55 !. 55655 7. 55A55 8. 5+%55 9. 5+E+5 1". 5+E55 11. 55/55 12. 5+,5 13. 55655 1.. 5 6+5 11. 5+(55 1!. 5+%55 17. 5+,55 18. 5+,55 19. 5+,55 2". 5+%55 21. 5+-55 22. 5+E5 23. 5+E55 2.. 5+(55 21. 5+-55 2!. 5+,55 27. 5 6 5 28. 5+E 5 29. 5+-55 3". 5+( 5

1) The output gap is 9ero hen (a) Actual real 26P : ;atural real 26P (*) Actual real 26P = ;atural real 26P (c) Actual real 26P < ;atural real 26P (d) ;atural real 26P = ". 2) Total ex#enditures on $inal #roduct are (a) C + = + 2 + =M. (*) C + > + T + ?@. (c) C + = + > + ?@. (d) C + = + 2 + ?@ A =M. 3) The lea+age and inBections a##roach im#lies that the go0ernment sur#lus is e%ual to (a) #ri0ate sa0ing less #ri0ate in0estment #lus net ex#orts. (*) #ri0ate in0estment less #ri0ate sa0ing #lus net ex#orts. (c) #ri0ate in0estment #lus #ri0ate sa0ing #lus net ex#orts. (d) ;one o$ the a*o0e .) =n national income accounting& (> + T) is (a) the #ortion o$ total income not consumed. (*) net national #roduct. (c) the go0ernment de$icit. (d) the $inal out#ut $irms a*sor* as in0estment. 1) >u##ose that in our economy: 2 = 11""& T = 9""& > = 1."& and ;@ = A9". Co much o$ our $inal #roduct is used $or in0estmentD (a) 11" (*) 2"" (c) 23" (d) 1" (e) 3" !) A change in nominal 26P sums u# changes in (a) #rices alone. (*) #hysical #roduction alone. (c) #hysical #roduction and hours o$ #roduction time. (d) #hysical #roduction and #rices. 7) =n the consum#tion $unction& hen dis#osa*le income is 9ero& consum#tion is (a) Ca. (*) AcT. (c) EcT. (d) ACa.

8) 'hich element o$ total #lanned ex#enditure is not included in Fautonomous #lanned s#endingDG (a) c, (*) AcT (c) ;@ (d) =# (e) Ca 9) The multi#lier is de$ined as the ratio o$ a change in income to the (a) marginal #ro#ensity to sa0e. (*) marginal #ro#ensity to consume. (c) change in the marginal #ro#ensity to consume causing it. (d) change in the marginal #ro#ensity to sa0e causing it. (e) change in #lanned autonomous s#ending causing it. 1") >hould autonomous consum#tion rise *y one dollar& the e$$ect o$ this on e%uili*rium income can *e o$$set i$ autonomous taxes are (a) raised *y one dollar. (*) lo ered *y one dollar. (c) raised *y c dollars. (d) lo ered *y c dollars. (e) raised *y (1Hc) dollars. 11) According to the $irst reading item (1I1) in contrast to the unconditional ad0ocacy o$ $ull em#loyment in the $irst t o decades o$ the #ost ar era& a$ter 197" the goal changed to (a) 9ero in$lation (*) $ull em#loyment until the in$lation rate goes u# (c) $ull em#loyment until the in$lation rate goes do n (d) steady in$lation neither going u# nor going do n 12) 'hich o$ the $ollo ing statements is true a*out =rish #oliticiansD (a) 'hen they *rag a*out their #olicies they re$er to 2;P (*) 'hen they *rag a*out their #olicies they re$er to 26P (c) 'hen they ant regional su*sidies $rom the ?J they re$er to 26P (d) ;one o$ the a*o0e 13) =n the consum#tion $unction C = Ca + c(, A T)& induced consum#tion is (a) Ca + c(, A T) (*) Ca + c, (c) c, (d) c(, A T)

1.) =n e%uili*rium& (a) income = #lanned ex#enditures. (*) unintended in0entory in0estment is 9ero. (c) ?# (#lanned ex#enditures) crosses the .1Idegree income line. (d) all o$ the a*o0e. 11) =$ the interest rate ere to $all& e ex#ect that (a) the su##ly o$ money ill $all. (*) the su##ly o$ money ill rise. (c) autonomous #lanned s#ending ill rise. (d) the demand $or money ill $all. 1!) The F0elocityG o$ money is (a) the ratio o$ real 26P to the real money su##ly. (*) the real money su##ly di0ided *y the real 26P. (c) the money su##ly di0ided *y the #rice le0el. (d) the money su##ly multi#lied *y the #rice le0el. 17) Along a do n ardIslo#ing money demand schedule& as the interest rate $alls (a) the %uantity o$ money demanded $alls. (*) the %uantity o$ money demanded rises. (c) real income rises. (d) real income $alls. 18) 'hen the demand $or money *ecomes less res#onsi0e to changes in income& the 3M cur0e *ecomes 55555555 and it also shi$ts to the 5555555. (a) $latter& le$t (*) $latter& right (c) stee#er& le$t (d) stee#er& right 19) =$ a gi0en $iscal #olicy is $ully accommodated *y monetary #olicy& then (a) 26P ill remain constant. (*) the interest rate ill remain constant. (c) 26P and the interest rate ill mo0e in the same direction. (d) 26P and the interest rate ill mo0e in the o##osite direction. 2") An increase in the real money su##ly ill ha0e its maximum e$$ect on the e%uili*rium le0el o$ 26P hen the (a) 3M cur0e is 0ertical. (*) 3M cur0e is hori9ontal. (c) => cur0e is 0ertical. (d) => cur0e is negati0ely slo#ed.

21) The article ad0ocating F2reen ;;PG argues that (a) 26P must *e adBusted do n ards $or the de#letion o$ natural resources (*) 26P must *e adBusted do n ards $or the de#reciation o$ #hysical assets (c) ;;P must *e adBusted do n ards $or the de#reciation o$ #hysical assets (d) A and / (e) A and C 22) An article re#orts that t o million men ha0e dro##ed out o$ the la*or $orce since 1991. As a counter#art o$ this: (a) More men are recei0ing disa*ility #ayments (*) More men are in #rison (c) More men are discouraged or+ers (d) A and / (e) A& / and C 23) The J.>. sa0ing rate as almost 9ero in 2""1I"7. At the same time (a) Cousehold net orth $ell (*) Cousehold net orth rose (c) >a0ing $ell as o ners o$ stoc+ #aid ca#ital gains taxes (d) Consum#tion $ell as o ners o$ stoc+ #aid ca#ital gains taxes (e) / and C ($) / and 6 2.) Com#lete Fcro dingIoutG descri*es the situation in the economy hen (a) $iscal #olicy is e$$ecti0e in changing out#ut. (*) the shi$t in the 3M cur0e *y monetary #olicy is Fim#otent.G (c) the shi$t in the => cur0e *y $iscal #olicy is Fim#otent.G (d) $iscal #olicy cro ds out monetary #olicy. 21) The three ays o$ reducing a go0ernment *udget de$icit are to (a) decrease go0ernment s#ending& reduce consum#tion& increase the tax rate. (*) increase go0ernment s#ending& decrease real income& reduce the tax rate. (c) decrease go0ernment s#ending& increase real income& reduce the tax rate. (d) decrease go0ernment s#ending& increase real income& increase the tax rate. 2!) 6omestic =ncome is e%ual to (a) 26PI=ndirect /usiness Taxes (*) 26PI=ndirect /usiness TaxesIde#reciation (c) 26PI=ndirect /usiness TaxesIde#reciationI>ocial security contri*utions A cor#orate taxes (d) none o$ the a*o0e

27) =n the =>I3M Model& a reduction in go0ernment #urchases o$ goods and ser0ices (2) tends to (a) raise e%uili*rium in0estment (*) cro d out in0estment (c) reduce e%uili*rium out#ut (d) A and C 28) 'hich o$ the $ollo ing concerns may limit the amount *y hich the Fed reduces interest rates to deal ith the su*I#rime mortgage crisis (a) Fear o$ higher in$lation (*) Fear o$ higher unem#loyment (c) Moral ha9ard (d) Fear o$ $alling household ealth (e) A and C ($) / and 6 29) 'hen the Economist argues that it-s Fa good time $or a s%uee9eG& ho does it su##ort its #ositionD (a) Pro$its ha0e *een high $or years so com#anies ha0e lots o$ cash (*) American consumers are de*tIladen and are *eing *attered *y $alling house #rices (c) ?merging mar+ets (less de0elo#ed countries) ha0e large $oreign exchange reser0es (d) A and C (e) / and C 3") According to the Business Week article FKur Cidden >a0ingsG hich o$ the $ollo ing is not trueD (a) K0er the #ast decade J. >. stoc+ #rices ent u# $ar more than in ?uro#e or Ja#an (*) 3o J. >. sa0ing re%uires *orro ing $rom $oreigners (c) The J. >. s#ends less on higher education than in ?uro#e or Ja#an (d) The J. >. has a lo er national sa0ing rate than ?uro#e or Ja#an (e) LM6 s#ending is not counted as #art o$ 26P

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Nuestion 1. (1" #ts) China is 0ery $ast gro ing economy today. The 26PH#erson $or China is O3&"""& it is gro ing at 8P #er year& on the other side& J.> 26PH #erson is 3"&"""& and it-s gro ing at .P #er year. >o ho many years does it ta+e $or China to sur#ass J.>D 'hat i$ J.> 26PH#erson is gro ing at 1P #er yearD './/ose it ta0es (x) 1ears and G-P at t2at time is G, so 0*03 4 )$(G53000)5x 0*06 4 )$(G530000)5x 'ol7es t2ese t8o e9.ations, 8e :et& ;4 <7*= 1rs If "*' G-P :ro8s at <> /er 1ear, ;47=*3 1rs ;ote 1: This is su##osed to *e a 0ery easy %uestion& es#ecially a$ter Pro$essor has recommended that you loo+ at the gro th rate $ormula. /ut = don-t understand hy so many #eo#le ha0e $ailed in this %uestion. =n my im#ression& a*out 2H3 o$ the students ha0e #ro*lem in this %uestion. ;ote 2: >ome students hate the natural log ay o$ sol0ing %uestion. They resorted to common sense& such as: 3""" Q ( 1E"."8) n R 3"""" Q ( 1 E ".". ) n & /y this ay you ill get slightly di$$erent ans er li+e !1 yrs and 82 yrs& although = #re$er the standard solution& = don-t ant to *e considered too sti$$& so = ga0e this solution 8"P o$ the score. ;ote 3: i$ you do any attem#t hich = thin+ is serious& no matter ho rong you are& = ill gi0e you 1I3 #oints& =$ you rite do n the correct e%uation and $ail to sol0e it& = gi0e you .I7 #oints de#ending on ho close you are. =$ you are almost correct *ut only #oints. 7 rong at the last num*er& = ill gi0e 7.1 A 8 (1) (2)

;ote .: >ome students rite do n the correct e%uation *ut $ail in go through the #rocess such as #ut FlogG on *oth sides o$ the e%uation& = thin+ it is a 0ery 0ery #ity thing. = suggest them go *ac+ to their math manual and seriously #ractice some *asic math.

Nuestion 2. (1" #ts) Consider an economy descri*ed *y the $ollo ing e%uations: ( 4 (% ? c( @ T) c 4 *6 (% 4 3000 @ 20r T4<00?*2 I/ 4 1000 @ 10r G 4 1<00 $; 4 100 @ *12 (M5P)d 4 *2 @ 60r Ms5P 4 10 %) 6eri0e the => and 3M cur0es. (2 #oints) 0415(*=A(1-*2)?*2?*12)41*2<4<56 %/43000-20r -*6A(<00)?1000-10r?1<00?1004<600 -30r I'& 41*2<A(<600-(20?10)r) so& I' (.r7e 4 =7<0 @ 37*<r or r 4 130 @ (1537*<) 4 130 - *02==7 )M& 10 4 *2 @ 60r so& )M (.r7e 4 <0 ? 200r or r 4 -(152<) ? (15200) 4 -*2< ? *00<

;ote 1 : 3M cur0e is 0ery easy to sol0e. => cur0e is not hard either& many #eo#le mainly $ail to get correct A# or +. Mostly i$ you Bust ma+e numerical error & = only deduct ".1 #oints& *ut since this directly a$$ect your ans er in %uestion (*) & so in $act #eo#le ho ma+e numerical %uestion su$$er 1.1 #oints o$ loss. ;ote 2 : some #eo#le include , in A#& this is 0ery serious crime& so = deduct 1 #oint $rom that error. ;ote 3 : some #eo#le rite A# R 1."" ( excluding 3"r)& hich is $ine *ecause it is only #rocess o$ calculating => cur0e.

,) Find the e%uili*rium real out#ut and interest rate& res#ecti0ely ,1 and r1. (2 #oints) 4 =7<0 @ 37*<r -( 4 <0 ? 200r) 0 4 17<0 @ 237*<r 'o, r1 4 23*210< 1 4 <=B2*11 ;ote 1: As long as you rite do n the e%uation& you normally get 1 #t& *ut as = ha0e said& i$ you ma+e a numerical mista+e& = can only gi0e 1#t.

() >u##ose that consumer con$idence #lummets and causes CA to dro# *y !"& ceteris #ari*us. ;o su##ose the go0ernment is considering ta+ing action to restore out#ut in the economy to the le0el you com#uted in #art *& (i.e. *e$ore the negati0e shoc+ to consumer con$idence). 6etermine the magnitude and direction o$ change in the $ollo ing #olicy 0aria*les needed to restore out#ut to its desired le0el. Also com#ute the ending interest rate (r2)& that is& the #re0ailing interest rate a$ter the go0ernment has ta+en action. (i) Autonomous Taxes (TA) (3 #oints) $eed to ma0e %/ 4 <600 a:ain* 'o& <600 4 (3000-=0) @*6A(<00?CT%)?1000?1<00?100 'o,

CT% 4 -1<0 r is .nc2an:ed Deca.se 8e are E.st s2iftin: t2e I' c.r7e Dac0 to its ori:inal /osition, so& r2423*210< Magnitude o$ Change in Taxes (TA) R 1<0 6irection o$ Change R dro/ ?nding =nterest rate (r2) R 23*210< ;ote1: grading #olicy is : i$ you get right magnitude& 1 #t =$ you get right direction& 1#t =$ you get right interest rate 1#t& ( e0en you get a rong num*er& i$ you can #oint out that r is the same as in *& you get $ull #oints in this #art)

(ii) Leal Money >u##ly (MsHP) (3 #oints) $e8 I' (.r7e& 4 1*2<A(<600-=0 @ 30r), 4 ==7< @ 37*<r -esired !.t/.t m.st lie on t2is ne8 c.r7e& <=B2*11 4 ==7< @ 37*<r, so ne8 r m.st De& r242=*210< 'o $e8 )M c.r7e m.st De defined D1& 10 ? C(Ms5P) 4 *2A(<=B2*11) @ 60A(2=*210<) 'o, C(Ms5P) 4 ?30 Magnitude o$ Change in Taxes (MsHP) R 30 6irection o$ Change R increase ?nding =nterest rate (r2) R 2=*210< ;ote1: grading #olicy is the same as the a*o0e one.

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Nuestion 3: (1" #ts) The li%uidity tra# Ja#an as once the economic star o$ Asia& *ut during 199"s and early year this century it su$$ers the longest economic stagnation in history. (see Ta*le 1) Kne #ossi*le ex#lanation is the li%uidity tra#.

Ta*le 1 26P gro th and annual nominal interest rate in Ja#an $rom 1991 to 2""3 Leal 26P gro th 1991 1992 1993 199. 1991 199! 1997 1998 1999 2""" 2""1 2""2 2""3 3.8 1." ".3 ".! 1.1 3.9 2." I2.1 ".2 2.8 ".. I".3 2.1 Annual nominal interest rate ( in #ercentage) 1.!3 3.!9 2.31 1.71 1."2 ".1" ".1" ".1" ".1" ".1" ".23 ".1" ".1"

(a) 3oo+ing at the interest rate sho n in Ta*le 1& is there a natural lo er limit L " o$ nominal interest rateD ?x#lain. (2#ts) es, ( 0*< /t) nominal # cannot De ne:ati7e, #0 4 0, ( 1 /t) Peo/le cannot /a1s to D.1 a Fero interest Dond, t2e1 8o.ld rat2er s/end it toda1* (0*< /t) ;ote1: #eo#le mostly are con$used *y the num*er ta*le& ho e0er& thin+ a*out this& i$ you are go0ernor o$ /and o$ Ja#an and = *ring a #iece o$ the ta*le in $ront o$ you& do you really *elie0e you cannot lo er interest rate than ".1D =$ you try to #ersuade me& you at least should #ersuade yoursel$. ;ote 2: = admit that in real li$e& it is #ossi*le that ".1" or "."1 or any small num*er could *e the limit o$ a s#eci$ic central *an+ can achie0e at a certain time& *ut it is not natural

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one. =$ e li0e under a military dictatorshi#& it might e0en *e #ossi*le that e are $orced #ay national *an+ to de#osit. /ut it is not natural. ;ote3: the #oint o$ #utting 26P there is to sho that lo er interest really $ail to generate sustained 26P gro th& = didn-t mean to con$use you guys. (*) >u##ose (MHP)d R 1HL& a##roaching L"D (1#t) hat ould ha##en $or money demand $unction hen L is

If 7ertical axis is # , and 2oriFontal axis is M5P, t2en t2e f.nction 8ill Decome flat 82en # a//roac2 0, M5P 8ill a//roac2 ?infinit1* ;ote 1: =$ you correct recogni9e that (MHP)d ill increase& you get ".1 #ts. (c) 'hat ha##ens to the 3M cur0e i$ interest rate is 0ery close to L"D (2#ts) G2en # is close to Fero, )M c.r7e 8ill De 7er1 flat* (onsider t2is, for # a//roac2in: #0, 5#4(M5P)s is 7er1 lar:e, so # 4 (15 (M5P) ) A is a linear c.r7e 8it2 slo/e a//roac2in: Fero* 'o )M c.r7e is flat* ;ote: i$ you read Pro$essor-s *oo+& this %uestion is 0ery easy. (although detailed reasoning needs more or+). >omeone said: F3M cur0e is shi$ting rightG& *ut this is an un arranted ans er& *ecause 1) e as+ing a static thing hen e%uili*rium L is small instead o$ mo0ing L . 2) e0en e are mo0ing L& e are not necessarily mo0ing 3M. Peo#le ho ans er something li+e this *ut correctly mention 3M is $lat some here else in the exam& = ill count that you actually +no hat the ans er is& and = gi0e you 1#t. For someone ho ne0er sho s that heHshe +no s the ans er& = am sorry a*out that. (d) Ta+e your 3M cur0e o*tained in (c)& su##ose that interest rate is 0ery close to L "& and the central *an+ increases the su##ly o$ money. 'hat ha##ens to the interest rate at a gi0en le0el o$ incomeD Interest rate 8ill 2old almost t2e same* ( it act.all1 dro/s 7er1 little Dit in t2eor1) (e) >u##ose => cur0e is linear $unction ith negati0e slo#e& can an ex#ansionary monetary #olicy alone increase out#ut hen the interest rate is already 0ery close to L"D /rie$ly ex#lain. $oH If )M c.r7e is nearl1 flat, t2en mo7in: )M c.r7e ri:2t8ard 8onIt increase m.c2, in extreme case, if )M is /erfectl1 2oriFontal, mo7in: )M ri:2t8ard 8onIt ma0e difference at all*

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($) ;o can you #ro#ose any #olicy that might sa0e the country out o$ tra#D ( Cint: consider => cur0e no ) "se ex/ansionar1 fiscal /olic1 to mo7e I' c.r7e ri:2t8ard to increase o.t/.t, and ind.ce inflation*

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