UNIVERSITY OF BRISTOL

Sessional Examination for Schools in Economics

MAY/JUNE 2009

EXAM PAPER NUMBER ECON10011

INTRODUCTION TO MACROECONOMICS
(Module No. ECON10011)

Time Allowed: THREE hours

Answer ALL the questions in Section A and TWO questions from Section B.

Only thirteen questions will be marked – all those in section A and the first
two questions you answer in section B. Should you attempt a question and do
not wish it to be marked then delete it clearly.

TURN OVER
 SECTION A

For questions 1-10 write clearly in your answer book the number of the question and
the letter (a, b, c or d) that you think corresponds to the correct answer. In each
case write down only ONE letter. You are not asked to explain your answers to
questions 1-10.

1. In March 2009 the US short-term interest rate was 0.37% p.a. In Japan it was
0.57%; in China 1.27%; in the UK 2.05%; and in Poland 4.4%. Given this
information which of these statements is most likely to be true?

a. The foreign exchange market expects the UK currency to appreciate

against the US currency but depreciate against the Chinese currency;
b. The foreign exchange market expects the US currency to appreciate
against the Chinese currency by (1.27/0.37)%;
c. The foreign exchange market expects the UK currency to approximately
double in value against the Polish currency;
d. The foreign exchange market expects the Japanese currency to appreciate
faster against the Polish currency than against the UK currency.
[2½ marks]

2. In 2008 one UK pound bought two US dollars. In early 2009 one UK pound
bought 1.4 US dollars. Which of the following effects is this change most likely
to cause in the medium to long run?

a. Shift the US IS curve to the right and the UK IS curve to the left;
b. Shift both countries’ LM curves to the right;
c. Shift the US IS curve to the left and the UK IS curve to the right;
d. Shift both countries’ IS curves to the right.
[2½ marks]

3. An economy’s one-year bond is redeemable at the end of the year for £100.
At the beginning of the year its price is £88.5. The economy’s general
(consumer) price level, P, at the beginning of the year is 1. What should the
general price level be at the end of the year if bondholders are to earn a real
rate of interest of 4%?

a. 1.09;
b. 1.90;
c. 9.00;
d. 0.81. . [2½ marks]

4. Economy A has the consumption function C = 25 + 0.75(Y-T) where C is

consumption expenditure and Y-T is disposable income. Economy B has the
consumption function C = 10 + 0.8(Y-T). In both countries taxes are given by
the function T = 2 + 0.2Y. Which of these statements is therefore true?

a. The two economies’ average propensities to consume out of disposable

income will be equal when B’s disposable income is 15 units higher than
A’s;
b. The two countries’ marginal propensities to consume out of disposable
 Income become closer as the two economies’ income levels increase;
c. When disposable income in both countries is less than 100 then in both
countries the average propensity to consume out of disposable income is
greater than 1;
d. The two countries’ average propensities to consume out of disposable
income will be equal when Y = 377.5.
[2½ marks]

5. Assume two countries which are identical except that in country A the demand
for money responds much less to changes in real income than it does in
country B. Which of these statements follows from this?

a. In response to a decrease in their respective money supplies the LM curve

of country A will shift vertically upwards more than will the LM curve of
country B;
b. Country A’s LM curve is steeper than country B’s;
c. In response to an increase in their respective money supplies the LM curve
of country A will shift further to the right than will the LM curve of country B;
d. A rightward shift in the IS curve will lead to a greater change in equilibrium
aggregate demand in country B than it will in country A.
[2½ marks]

6. Assume a closed economy with the following features:

 Desired investment expenditure, I = 125;
 Desired government expenditure, G = 75;
 Desired consumption expenditure, C = 50 + 0.6(Y-T), where Y is real
income and T is taxes;
 T = 20.
If the government were to increase both G and T by 10 units then the
equilibrium level of aggregate demand would:

a. Rise by 10 units;
b. Rise by 25 units;
c. Remain unchanged;
d. Fall by 6 units.
[2½ marks]

7. An economy’s demand for money function is given by Md/P = 0.5Y-200i, where

Md is nominal holdings of money, P is the price level, Y is real income, and i is
the nominal rate of interest on a bond redeemable for £100 in a year’s time,
where an interest rate of 5% implies i = 0.05. The economy’s price level is 1
and its quantity of money 100. The price of bonds fluctuates between 85 and
98. What fluctuations in Y are required to ensure equilibrium in this economy’s
money market?

a. Between 203 and 258;

b. Between 208 and 270;
c. Between 220 and 225;
d. Between 185 and 198.
[2½ marks]
TURN OVER
8. A firm is considering buying machines X, Y and Z, each of which is worthless
after 3 years. The economy’s nominal rate of interest is 5% and there is no
inflation. Machine X offers profits of £200 at the end of year 1, £50 at the end
of year 2 and a final £25 at the end of year 3. Equivalent numbers for Machine
Y are £100, £100 and £75; and for Machine Z are £50, £150 and £75. What
will the firm’s ranking (best first) of these three machines be?

a. X, Y, Z;
b. X, Z, Y;
c. Z, X, Y;
d. Z, Y, X.
[2½ marks]

9. Assume an economy where the quantity of high-powered money fluctuates

between 90 and 110, where the public’s ratio of cash to total money holdings
fluctuates between 0,05 and 0,075, and where the banks’ cash to deposits
ratio fluctuates between 0.01 and 0.02. What is the possible range of
fluctuations in this economy’s quantity of money?

a. 963 to 1513;
b. 1513 to 1849;
c. 963 to 1849;
d. 1176 to 1513.
[2½ marks]

10. An economy’s wage bargaining equation can be written W/P e =1-5u+2z where
W is the nominal wage; Pe the expected price level; u the proportion of the
workforce unemployed; and z the proportion of the workforce belonging to a
trade union. Firms set prices by marking up their costs by 10%. If z is 0.1 what
is this economy’s natural level of unemployment?

a. 0.049;
b. 0.058;
c. 0.063;
d. 0.027.
[2½ marks]

11. Explain why the Aggregate Demand curve is downward sloping, i.e. why a fall
in the general price level leads to an increase in the equilibrium level of real
aggregate demand. Briefly explain why in the liquidity trap the AD curve
becomes vertical.

[25 marks]
 SECTION B

12. In early 2009 the Bank of England began a policy called “quantitative easing”,
which involved it buying government bonds. Using a formal model of the
money supply explain in detail how such a policy will affect the UK’s quantity
of money and what determines the size of the effect of any given sale of
bonds.
 People’s willingness to sell the bonds
 People’s expectation towards monetary policy
[25 marks]

13. Use the IS-LM analysis to explain how an increase in government expenditure
affects aggregate demand. In the light of your analysis discuss the claim that
such an increase cannot in fact affect aggregate demand because the
government bond sales required to finance it must come from reduced private
consumption or reduced investment expenditure.
[25 marks]

14. “To offset the effects of the credit crisis on aggregate demand a number of
governments have introduced tax cuts which are planned to be temporary.
The Keynesian consumption function predicts that such cuts have a significant
effect on consumption expenditure whereas the Permanent Income
Hypothesis predicts that they will not.” Explain this statement and give your
assessment of which hypothesis is likely to be correct.
[25 marks]

15. Use the Aggregate Supply and Demand model to explain the role of workers’
expectations of the price level in determining the length of any recession
caused by a drop in aggregate demand.
[25 marks]

16. One effect of the financial crisis has been a large drop in the value of the UK
pound. Explain the likely short-run and long-run effects of this on the UK
current and capital accounts of the balance of payments, and on aggregate
demand in the UK.
[25 marks]
short run: dep UK pound -> increase current account , aggregate demand decrease
(X-M), (J-curve), capital outflow
long run: AD increase (J-curve)

END OF EXAM