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Grade /100 Midterm Exam Fall 2016-2017 Supervisor

Date: Wednesday, January 18th 2017. signature
Course Title: Introduction to Macroeconomics
(BCOR 240)
Duration: 2 Hours
Groups: G1...G12
Number of pages: 6

INSTRUCTIONS
1. Books and notes are not permitted.
2. Calculators are not allowed.
3. Cell phones are not allowed.

Exercise 1 (15 points)

For the next Multiple Choice Questions, circle the right answer.
1. Most economists use the aggregate demand and aggregate supply model primarily to analyze
a. short-run fluctuations in the economy.
b. the effects of macroeconomic policy on the prices of individual goods.
c. the long-run effects of international trade policies.
d. productivity and economic growth.

2. Which of the following is correct?

a. Short run fluctuations in economic activity happen only in developing countries.
b. During economic contractions most firms experience rising profits.
c. Recessions come at irregular intervals and are easy to predict.
d. When real GDP falls, the rate of unemployment rises.

3. According to classical macroeconomic theory, changes in the money supply affect

a. unemployment and the price level.
b. unemployment but not the price level.
c. the price level, but not unemployment.
d. neither the price level nor unemployment.

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 4. Other things the same, when the price level falls, interest rates
a. rise, so firms increase investment.
b. rise, so firms decrease investment.
c. fall, so firms increase investment.
d. fall, so firms decrease investment.

5. Refer to Figure 1. If the economy starts at Y, then a recession occurs at

a. V.
b. W.
c. X.
d. Z.

6. Refer to Figure 1. Suppose the economy starts at Y. If aggregate demand increases from AD2 to
AD3, then the economy moves to
a. V.
b. W.
c. X.
d. Z.

Figure 1

7. Pessimism: Suppose the economy is in long-run equilibrium. Then because of corporate scandal,
international tensions, and loss of confidence in policymakers, people become pessimistic regarding the
future and retain that level of pessimism for some time.

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 Refer to pessimism defined above, which curve shifts and in which direction?
a. aggregate demand shifts right.
b. aggregate demand shifts left.
c. aggregate supply shifts right.
d. aggregate supply shifts left.

8. Financial crisis: Suppose that banks are less able to raise funds and so lend less. Consequently,
because people and households are less able to borrow, they spend less at any given price level than
they would otherwise. The crisis is persistent so lending should remain depressed for some time.

8.1 Refer to financial crisis defined above; what happens to the price level and real GDP in the
short run?

a. both the price level and real GDP rise.

b. the price level rises and real GDP falls.
c. the price level falls and real GDP rises.
d. both the price level and real GDP fall.

8.2 Refer to financial crisis defined above; in the long run, if the Fed does not respond, the
change in price expectations created by the crisis shifts

a. aggregate demand right.

b. aggregate demand left.
c. short-run aggregate supply right.
d. short-run aggregate supply left.

9. Shifts in the aggregate-demand curve can cause fluctuations in

a. neither the level of output nor the level of prices.
b. the level of output, but not in the level of prices.
c. the level of prices, but not in the level of output.
d. the level of output and in the level of prices.

10. In USA, monetary policy is determined by

a. the president and Congress and involves changing government spending and taxation.
b. the president and Congress and involves changing the money supply.
c. the Federal Reserve and involves changing government spending and taxation.
d. the Federal Reserve and involves changing the money supply.

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11. In USA, fiscal policy is determined by
a. the president and Congress and involves changing government spending and taxation.
b. the president and Congress and involves changing the money supply.
c. the Federal Reserve and involves changing government spending and taxation.
d. the Federal Reserve and involves changing the money supply.

12. If businesses and consumers become pessimistic, the Central Bank can attempt to reduce the impact
on the price level and real GDP by
a. increasing the money supply, which raises interest rates.
b. increasing the money supply, which lowers interest rates.
c. decreasing the money supply, which raises interest rates.
d. decreasing the money supply, which lowers interest rates.

13. Suppose there is an increase in government spending. To stabilize output, the Central Bank would
a. increase government spending.
b. increase the money supply.
c. decrease government spending.
d. decrease the money supply.

14. Refer to Figure 2. Suppose the economy is currently at point A. To restore full employment, the
Central Bank should
a. purchase government bonds, which will increase the money supply.
b. purchase government bonds, which will reduce the money supply.
c. sell government bonds, which will increase the money supply.
d. sell government bonds, which will reduce the money supply.

Figure 2

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Exercise 2 (15 points)
2.1
a. Take the (natural) logarithm of the quantity equation MV = PY.
b. Now, totally differentiate this logarithmic version and derive the percentage change rule for
small percentage changes: % change in M + % change in V = % change in P + %change in Y.

2.2
Suppose that the money demand is represented by the equation (M/P) = 𝐢−𝟎.𝟏 Y.
d

Use calculus to compute the income elasticity of money demand, which is the elasticity
𝒅
𝐝(𝐌/𝐏) 𝐝𝐘
of the quantity of money demanded with respect to output Y: 𝒅 / 𝐘
.
(𝐌/𝐏)

PROBLEM I (35 points) Introduction to economic fluctuations

1. In their 2015 paper, C. El Andari and R. Bouaziz from University of Tunis show that the
Okun’s law holds in Tunisia. They use data covering the time period 1990-2014.
1.1 Define the Okun’s law given that it specifies the relationship between two major
macro variables.
1.2 The authors estimate the Okun’s coefficient (or the slope) to -0.758%. Interpret this
value.
1.3 The authors also find that the intercept of the relationship between the two macro
variables is 0.126%. Write down the equation of the Okun’s law and interpret the
value of the intercept.
1.4 Does the Okun’s law describe the short run? The long run? Or both?
2. In order to analyze the economic fluctuations in Tunisia after the revolution, plot an
aggregate demand-aggregate supply graph and explain the effect on the output, the price
level and the unemployment in the short run and in the long run for each one of the
following shocks:
2.1 Terrorist attacks if considered as a demand shock and not a supply shock.
2.2 Phosphate crisis: the Tunisian mining output dropped sharply since 2011.
3. How could the Central Bank of Tunisia react to the shock in 2.2 in order to prevent a
reduction in output? What is the cost of this policy? Use an aggregate demand-aggregate
supply graph to justify your answer.
4. Define the natural level of output. Give one factor that could impact the natural level of
output.

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PROBLEM II (35 points) The IS-LM model
1. The fiscal policy in Chile.
Chile has stood out from its Latin American neighbors for the last 25 years, enjoying
political stability and faster economic growth. You are asked to analyze the role of fiscal
policy in achieving such an outstanding success.
1.1 Define the Keynesian cross.
1.2 The fiscal policy multipliers in Chile are estimated to about +2 for the government-
purchases multiplier and about -1 for the tax multiplier. Show why the government-
purchases multiplier is higher than 1 and why the tax multiplier is negative.
1.3 Use an IS-LM diagram to find the impact the expansionary fiscal policy adopted by the
Chilean government. Interpret in words your findings.

2. The monetary policy in Japan: The liquidity trap or the zero lower bound.
Abenomics refers to the economic policies advocated by Shinzō Abe, the Prime Minister
of Japan since 2012 in order to stimulate the economy. You asked to use the insights
from the Keynesian theory represented by the diagram below to understand Japan’s
economy.
Do you think that a standard expansionary monetary policy (or increase in money supply)
is a useful Abenomics policy? Use a graph to explain your answer.

GOOD LUCK