Indian Institute of Foreign Trade

Kolkata Campus

M.A. in Economics (2020-22)

Mid Term Exam

Macroeconomic Theory

Time 2 Hours Total Marks: 40

Other Instructions:

1. The students have to write the answers in pen and paper and upload the answer sheets in
Campus360

2. All workings should be mentioned in the document itself.

Section A (SM)

All questions are compulsory in this section

1) Assume that Nominal interest rate is low enough to make people indifferent between holding
money and other assets. And, therefore, they are willing to change their money holdings
without any change in the interest rate.

a) In this situation, what is the shape of the AD Curve? If prices are completely flexible, is
aggregate demand irrelevant to output?

b) Now suppose, planned expenditure is also dependant on real wealth. In this situation, if we
assume that prices are completely flexible, is aggregate demand irrelevant to output? What
happens to the aggregate supply curve? (5+5)

2) In a neo-classical framework, suppose that nominal wages are fully flexible but follows AEH
in price adjustment. What would happen

a) to the AD and AS curve and to the long run equilibrium if the Government undertakes a
bond-financed rise in public spending?

b) to the AD and AS curve and to the long run equilibrium if the Government buys bonds in
the open market to influence the money supply? (5+5)
 Section B (BRC)

Answer any two questions from the following

3) Suppose that the government introduces a tax on interest earnings. That is, borrowers face a real
interest rate before and after the tax is introduced, but the lenders receive a net interest rate of

(1 – xt)rt on their savings, where xt is the tax rate on interest income in period t.

(i) Show the effects of inclusion of this tax rate on a consumer’s two period budget constraint.

(ii) Now if the government reduces tax rate on interest income in the first period and increases the
tax on interest earnings in the second period will Ricardian Equivalence hold? Assume that the
government’s consumption path remains unchanged.

(2+8)

4) In the Ricardian Equivalence with altruistic household case done in the class if there is a bequeath
tax (not inheritance tax). Implying the tax has to be paid at the time bequest is made that is at the
end of second period. Everything else remains same. Now if the income tax is reduced in the first
period and bequeath tax is increased in the second period (Ricardian Experiment) show the impact
on consumption of old, young and amount of bequest.

(10)

5) Answer the following

(2+2+4+2)