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Multiple Choice: 40 points (2 points each) 1. According to the Solow growth model, in an economy with no population growth or technological progress, the formula for steady-state consumption per worker (c*) as a function of output per worker and investment per worker is: A) c* = f(k*) – δ k*. B) c* = f(k*) + δ k*. C) c* = f(k*) ÷ dk*. D) c* = k* – δ f(k)*. 2. If an economy with no population growth or technological change has a steady-state MPK of 0.125, a depreciation rate of 0.1, and a saving rate of 0.225, then the steady-state capital stock: A) is greater than the Golden Rule level. B) is less than the Golden Rule level. C) equals the Golden Rule level. D) could be either above or below the Golden Rule level. 3. Assume two economies are identical in every way except that one has a higher population growth rate. According to the Solow growth model, in the steady state the country with the higher population growth rate will have a ______ level of total output and ______ rate of growth of output per worker as/than the country with the lower population growth rate. A) higher; the same B) higher; a higher C) lower; the same D) lower; a lower 4. One explanation for greater economic development in moderate versus tropical climates is that institutions established by colonial settlers in moderate climates ______, while institutions established by colonists in tropical climates ______. A) were based on English common law; were based on the Napoleonic Code B) were based on the Napoleonic Code; were based on English common law C) protected property rights; were extractive and authoritarian D) were extractive and authoritarian; protected property rights

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10. T. B) supply of real balances exceeds the demand. both prices and output 6.5. and M. The intersection of the IS and LM curves determines the values of: A) r. Y. C) market for real balances clears. only output B) only output. D) demand for real balances increases. C) up. If the short-run aggregate supply curve is horizontal. thereby decreasing investment. D) up. Page 2 . C) r and Y. and M. 9. thereby decreasing investment. C) Central Bank A should keep the quantity of money stable whereas Central Bank B should increase it. then a change in the money supply will change ______ in the short run and change ______ in the long run. If a central bank accommodates an adverse supply shock. T. more 7. more B) less. and this increase drives the interest rate: A) down. only prices D) both prices and output. B) Central Bank A should increase the quantity of money whereas Central Bank B should keep it stable. output falls ______ and prices rise ______ than they would if the central bank does nothing. A) only prices. thereby increasing investment. M. 8. less C) more. the: A) demand for real balances exceeds the supply. B) r. thereby increasing investment. given G. An interpretation of why the IS curve slopes downward and to the right is that as income rises. and P. and P. Y. B) down. given G. T. If the interest rate is above the equilibrium value. national saving rises. D) both Central Bank A and Central Bank B should keep the quantity of money stable. If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output at its natural level. given G. less D) more. A) less. and P. only prices C) both prices and output. then in response to an exogenous increase in the price of oil: A) both Central Bank A and Central Bank B should increase the quantity of money.

increase D) increase. B) 400. a(n) ______ in money demand. T. but leaves it unchanged in the long run. B) in the short run. and M. while lowering investment. but leaves both unchanged in the long run. Page 3 . 14. B) 200. The Pigou effect suggests that falling prices will increase income because real balances influence ______ and will shift the ______ curve. IS 15. G is 100. and T is 100. and a(n) ______ in the equilibrium interest rate. D) and the interest rate in both the short and long runs. decrease 13. In a small open economy with a floating exchange rate. IS D) government spending. decrease. decrease B) increases.75 (and there are no income taxes but only lump-sum taxes) when T decreases by 100. but leaves it unchanged in the long run. 11.6(Y – T). increase. and planned investment is 100. increase. LM C) consumer spending. C) in the short run. decrease. if the consumption function is given by C = 100 + 0. 16. increase C) decrease. a(n) ______ in total income. decrease. 12. increase. the exchange rate will depreciate if: A) the money supply is decreased. then equilibrium Y is: A) 350. A) money demand. In the IS-LM model. LM B) the money supply. An increase in government spending raises income: A) and the interest rate in the short run. a decrease in government purchases leads to a(n) ______ in planned expenditures. while lowering consumption. C) 300. C) 600. given G. D) 400. increases. A) decrease. then the IS curve for any given interest rate shifts to the right by: A) 100. If MPC = 0.D) p and Y. D) 750. decrease. In the Keynesian-cross analysis.

decrease D) smaller. the greater the proportion. A) greater. increase B) smaller. C) government spending is increased. D) is most variable but prices are most stable. 17. increase C) greater. decrease C) depreciate. other things being equal. of firms that follow the sticky-price rule. s. According to the Mundell-Fleming model. decrease 20. the real exchange rate will ______. remain unchanged C) remain unchanged. In the Mundell-Fleming model. After examining international data. increase B) increase. increase B) appreciate. increase 18. Page 4 . and net exports will ______ to restore the economy to its natural rate. A) appreciate. C) is most stable but prices are most variable. the ______ the ______ in output in response to an unexpected price increase. remain unchanged D) remain unchanged. A) increase. increase D) depreciate. then in the long run the price level will fall. if the economy is operating below the natural level of output in the short run. decrease 19. the economist Robert Lucas found that aggregate demand has the biggest effect on output in countries where aggregate demand: A) and prices are most stable. import restrictions in an economy with flexible exchange rates cause net exports to ______ and in an economy with fixed exchange rates import restrictions cause net exports to ______. According to the sticky-price model. B) and prices are most variable. D) taxes are increased.B) import quotas are imposed.

each final answer should be a number rather than a formula. where y is output per effective worker and k is capital per effective worker. What is the steady-state level of consumption per effective worker? __________ d. The saving rate is 12 percent. What is the steady-state level of output per effective worker? __________ c. a.Mathematical Analysis: 20 points Write your final answers on the blanks provided. What is the steady-state level of capital per effective worker? __________ b. Show your work in the white space.5 percent. (8 points) Assume that an economy’s production function is y = k3/4.5 percent. 21. and the rate of technological progress is 1. With the exception of question 23(c). the rate of population growth is 3 percent. What is the steady-state growth rate of capital per worker (Y/L)? __________ Page 5 . the depreciation rate is 3.

22.5 percent: IS* curve: Y = 400 + 3G – 2T + 3NX – 200r LM curve: Y = 200r – 200 + 2(M/P) NX curve: NX = 200 – 100e P = 1. NX.0 G = 100 T = 100 M = 100 What are the short-run equilibrium values of Y. (6 points) Assume the following model for a small open economy with a floating exchange rate. and e? Y = __________ NX = __________ e = __________ Page 6 . with the world real interest rate (r*) equaling 2.

5% – [2 * change in unemployment rate] c. If the Phillips curve was instead π = π –1 – 0.23.) __________ Page 7 . (6 points) Assume that an economy has the Phillips curve π = π –1 – 0. lower.9(u – 0. How many percentage point years of cyclical unemployment are needed to reduce inflation by 3 percentage points? __________ b.06). Based on the version of Okun's Law used in class (provided below) and your answer to part (a). or the same as your answer in part (b)? (Note that it is not necessary recalculate parts (a) and (b) to answer this.06).8(u – 0. a. would the sacrifice ratio be higher. what is the sacrifice ratio for this economy? __________ Okun's Law: % change in real GDP = 3.

the initial steady-state levels of capital and output. Use the Solow growth model of Chapter 8 to graphically illustrate the impact of a permanent government deficit reduction on the steady-state capital-labor ratio and the steady-state level of output per worker. and the direction that any curve(s) shifts. (4 points) Suppose a government is able to permanently reduce its budget deficit.Graphical Analysis: 40 points 24. or stays the same: capital per effective worker (k = K/(LE)): __________ growth rate of total output (Y): __________ Page 8 . the ending steady-state levels of capital and output. b. the curves. (2 points) Comparing the initial steady-state values to the ending steady-state values. indicate whether each of the following variables increases. decreases. a. Be sure to label the axes.

or stays the same: real interest rate __________ real money balances __________ Page 9 . the initial equilibrium values. b. Be sure to label the axes.25. decreases. the ending equilibrium values. (4 points) As an economy moves into a recession. (2 points) State whether each of the following variables increases. income falls. a. Illustrate graphically the short-run impact of a decrease in income on the equilibrium interest rate using the theory of liquidity preference and the market for real money balances. the curves. and the direction that any curve(s) shifts. Label the initial equilibrium point as “A” and the ending equilibrium point as “B”.

(4 points) How can the Fed keep the economy from falling into a recession if the budget deficit is reduced? Use the IS-LM model to illustrate graphically the short-run impact of both the fiscal policy reducing the deficit and the monetary policy. Label the initial equilibrium point as “A” and the ending equilibrium point as “B”. decreases. and the direction that any curve(s) shifts. the initial equilibrium values. (2 points) State whether each of the following variables increases. the curves. Be sure to label the axes.26. which prevents output from falling. or stays the same: real interest rate __________ money supply __________ Page 10 . b. a. the ending equilibrium values.

and the direction that any curve(s) shifts. the curves. the initial equilibrium values. (2 points) State whether each of the following variables increases.) Label the initial equilibrium point as “A” and the ending equilibrium point as “B”.27. b. a. Be sure to label the axes. decreases. Use the Mundell-Fleming model to illustrate graphically the short-run impact of an increase in the world interest rate on the exchange rate and level of output in a small open economy with a floating-exchange-rate system. the ending equilibrium values. or stays the same: exchange rate __________ output __________ Page 11 . (4 points) Economic expansion throughout the rest of the world raises the world interest rate. (Hint: you must consider two shifts.

or stays the same: From initial equilibrium to new LR equilibrium: price level __________ From initial equilibrium to new LR equilibrium: output __________ From SR equilibrium to new LR equilibrium: inflation __________ From SR equilibrium to new LR equilibrium: unemployment __________ Page 12 . and the long-run equilibrium point as “C”.28. b. label the initial equilibrium point as “A”. Illustrate graphically the short-run and long-run effects on price and output using the model of aggregate demand and aggregate supply (using the upward-sloping short-run aggregate supply curve) and the short-run and long-run effects on inflation and unemployment using a Phillips curve diagram. the initial equilibrium values. (4 points) State whether each of the following variables increases. (12 points) Assume that an economy is initially operating at the natural rate of output when a reduction in government spending produces a budget surplus. decreases. a. Be sure to label the axes. and the direction that any curve(s) shifts. the short-run equilibrium point as “B”. In each graph. the ending equilibrium values. the curves.

035 + 0. 2. 10.8 = 1. Lower. D D C A A 21.5% points of real GDP)/(–3% points of inflation) = 2. 20.5) – 200 + (2)(100/1) = 500 – 200 + 200 Y = 500 From IS* curve: 500 = 400 + (3)(100) – (2)(100) + 3NX – (200)(2.67 = 200 – 100e 100e = 33.Answer Key 1. The Phillips curve would be steeper.5) = 400 + 300 – 200 + 3NX – 500 3NX = 500 NX = 166. From Okun’s Law: 3.5)4 = 5. 14. C A C C B 16. 4.12/(0.75 percentage point years of cyclical unemployment => 7. A B C C B 6.5 k* = (1.03)/( –0. 7.0375 or 3.0625)3/4 = 3. a. 19.67 From NX curve: 166. 13. π – π –1 = –0.375 c.33 e = 1/3 or 0.8) = 0. 15. 3.8(u – 0. 12.06) = (–0.75 percentage point years b.015) = 0. so any given reduction in inflation would be associated with a smaller change in unemployment.88)(3.12/0.8(u – 0.0375 cyclical unemployment needed = (u – un) = 0.03 + 0. Page 13 .06). a. 17.03 = – 0. In steady state. 9.97 d. y* = f(k*) = (k*)3/4 = (5. growth rate in Y/L = g = 0.33 23.5 percentage points of real GDP lost sacrifice ratio = (–7. A C B B C 11.0625 b. 18.375) = 2.5 c. 8.015 22. From LM curve: Y = (200)(2. c* = (1 – s)y* = (0. In steady state: k*/f(k*) = s/(δ+n+g) k*/(k*)3/4 = (k*)1/4 = 0.06) (u – 0. π = π –1 – 0. 5.

a. b. steady-state level of k* increases steady-state growth rate in Y = (n+g) and neither n nor g changes.24. so stays the same 25. b. a. Page 14 . real interest rate decreases real money balances stays the same 26. a.

Point B should be down and to the right along the same Phillips curve such that u2 > u1 and π2 < π1.b. From the short-run to the long-run. AD-AS graph: I could not find a suitable pre-made Phillips curve graph. people revise their expectations of inflation downward. a. real interest rate decreases money supply increases 27. shifting the Phillips curve downward such that Point C should be at u3 = u1 = un and π3 = π1. Page 15 . so here is a description: Point A should be at u1 = un and π1 = π1e. exchange rate decreases output increases 28. IS* curve: r* increases => quantity of investment decreases => IS* shifts left LM* curve: r* increases => economy moves up and right along the LM curve (not the LM* curve) => LM* curve shifts right b. a.

b. Initial to new LR: price decreases Initial to new LR: output stays the same SR to new LR: stays the same SR to new LR: unemployment decreases Page 16 .

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