Principles of Macroeconomics D

Fall 2022
Midterm Exam 2
You have 40 minutes to write this exam. Try to solve as many of 5 exercises as you can. It is
important to show all the work and to present solutions clearly. No credit will be given to
unjustified answers/solutions (even if they are correct).
Good Luck!

Exercise 1 [20 points, 4 points per question]

1.1. In an open economy, the source for the demand for loanable funds is
a. national saving.
b. national saving + net capital outflow.
c. domestic investment.
d. domestic investment + net capital outflow.

1.2. When the Central Bank sells bonds the supply of money
a. increases and so aggregate demand shifts right.
b. decreases and so aggregate demand shifts left.
c. decreases and so aggregate demand shifts right.
d. increases and so aggregate demand shifts left.

1.3. When the interest rate increase, the opportunity cost of holding money
a. increases, so the quantity of money demanded increases.
b. increases, so the quantity of money demanded decreases.
c. decreases, so the quantity of money demanded increases.
d. decreases, so the quantity of money demanded decreases.

1.4. Monetary policy

a. must be described in terms of interest-rate targets.
b. must be described in terms of money-supply targets.
c. can be described either in terms of the money supply or in terms of the interest rate.
d. cannot be accurately described in terms of the interest rate or in terms of the money supply.

1.5. If taxes
a. increase, then consumption increases, and aggregate demand shifts leftward.
b. increase, then consumption decreases, and aggregate demand shifts rightward.
c. decrease, then consumption increases, and aggregate demand shifts rightward.
d. decrease, then consumption decreases, and aggregate demand shifts leftward.

Exercise 2 [25 points]

Suppose that the Government enacts legislation that provides a tax rebate to businesses that purchase
capital goods. Assume other countries make no policy changes.

1
a. [7 points] In the market for loanable funds which curve shifts and which direction does it shift?
b. [8 points] What happens to the interest rate and net capital outflow?
c. [10 points] What happens to the real exchange rate, and net exports?
Show your answers graphically

Exercise 3 [20 points]

a. [10 points] What does an increase in the money supply do to the real interest rate in the short
run? Explain.

2
 b. [10 points] What does an increase in the money supply do to the real interest rates in the
long run? Explain

Exercise 4 [30 points] [No explanation is needed for this question]

3
The following events have their initial impact on which of the following: aggregate demand, short-
run aggregate supply, long-run aggregate supply, or both short-run and long-run aggregate supply?
Do the curves shift to the right or left?
a. [5 points] The government repairs aging roads and bridges.
b. [7 points] OPEC raises oil prices
c. [8 points] The government raises unemployment benefits, which raises the natural rate of
unemployment
d. [10 points] People feel more secure in their jobs and become more optimistic

Exercise 5 [5 points]
Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips curves and
show the possible position of the economy if expected inflation is 3% and the actual inflation rate is 2%.

4
5