Winter Quarter 03 STUDENT NAME: .. Economics 301 Honors Professor Michael G.

Hadjimichalakis Final Exam ANSWER ALL QUESTIONS 1. 20 Points Suppose that because of concerns about U.S. corporate governance and the integrity of U.S. accounting practices, the American public becomes more risk averse in the sense that wealth holders increase their demand for money. With the help of two separate ISLM-BP diagrams: a. (8 points) Explain what will be the effect on the (U.S.) interest rate, i, national output, Y, and the international value of the U.S. dollar if the exchange rate, e, is freely flexible. b. (8 points) Explain what will be the effect on the same economic variables if the United States is committed to a fixed exchange rate. c. (4 points) What policy implication can you infer from your answers to a and b above? 2. 15 Points Suppose that foreign interest rates rise, say, because foreign countries pursue expansionary fiscal policies. With the help of an IS-LM-BP model applicable to the United States, explain how the U.S. interest rate(s), the U.S. national output, and the exchange rate will be affected if the exchange rate is flexible. 3. 15 Points Suppose that because of geopolitical concerns, the animal spirits of U.S. entrepreneurs fall. With the help of appropriate IS-LM-BP diagrams, explain and compare the effects of such a shock on (i, Y, e) in the United States under fixed and under flexible exchange rate regimes.

4. 20 Points a. Suppose that because of tensions in the Middle East, the price of both imported and domestic oil in the United States rises. With the help of IS-LM &AD-AS diagrams, explain the impact on the U.S. interest rate and price level. b. Suppose that the economy starts at full-employment equilibrium and then consumer and business confidence fall. With the help of an AD-AS diagram and any other necessary diagram, explain why the move back to full-employment equilibrium will be a crawl rather than a gallop. 5. 20 Points (Note that the following parts are unrelated.) a. Explain what is meant by real interest rate parity and how you can combine the concepts of nominal interest rate parity and the real exchange rate to derive real interest rate parity. b. Respond to the following statement with the help of appropriate graphs: Since money is neutral, there is no point at all in the Fed trying to use monetary policy to affect output. c. Explain when and under what conditions fiscal expansion causes complete crowding out. 6. 10 Points With the help of an IS-LM diagram, explain why it is better to target (keep unchanged) the interest rate rather than the quantity of money when the economy is prone to LM-sector shocks.

STUDENT NAME: .. Economics 301 Honors Professor Michael G. Hadjimichalakis ANSWER ALL QUESTIONS

Exam #1 February 11, 2003

1. 20 Points Suppose that there is a bubble in the stock market and the bubble bursts. A bursting bubble can be both an IS-sector shock and an LM-sector shock. With the help of two separate IS-LM diagrams, explain how the shock would work its way through the economy in each case (that is, in your answer, be specific about the channels through which this shock affects the economy.) Assume there is no change in monetary policy. 2. 20 Points a. (8 points.) Explain in words the following concepts. Be clear about the economic policy with which they are associated: (i) Crowding out of investment; (ii) Crowding out of net exports. b. (12 points. With the help of an IS-LM diagram, explain the economic policy you identified in part a. 3. 15 Points With the help of an appropriate IS-LM diagram, explain why the mix of monetary and fiscal policy matters (beyond its immediate effects on national output.) 4. 20 points Suppose that (i) the tax rate on corporate profits is reduced and (ii) the animal spirits of entrepreneurs improve (rise.) a. With the help of a model (diagram) of a profit-maximizing firm, explain the effects of these two shocks will have on investment demand. b. With the help of an IS-LM diagram, explain the effects of these shocks on the interest rate and national output.

5. 10 points With the help of an IS-LM diagram, explain the liquidity effect and the real-income effect of an open-market purchase of U.S. Treasury securities by the Fed. (Question # 6 on next page) 6. 15 Points The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in $billions and i as a percentage. For example, if i were 6 percent, it would appear as 6, not as 0.06.) Real (IS) Sector C = 800 + 0.85YD YD = Y - TA + TR TA = 200 + .25Y TR = 600 I = 100 10i G = 1,400 NX = -250

Consumption Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

Financial (LM) Sector Md = 700 0.20i + 0.10Y (Real) Money Demand Ms = 350 + 14NBR + 4i (Real) Money Supply NBR = 70 (Real) Nonborrowed Reserves Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real) investment, I. Show your work and explain it using graphs.

Spring Quarter 02 STUDENT NAME: .. Economics 301 Honors Exam #1 Professor Michael G. Hadjimichalakis May 7, 2002 ANSWER ALL QUESTIONS 1. 10 Points a. The U.S. Labor Department announced this morning that labor productivity rose 8.6 percent last quarter, the fastest pace in 19 years. Explain the difference between labor productivity and multi-factor productivity (also called total factor productivity.) b. Also explain what factors can make labor productivity increase.

2. 20 Points a. Use the national income and product accounting identities to answer this part of the question : Assume that the government increases its level of purchases by $60 billion. As a result, the budget deficit increases by $20 billion, savings fall by $10 billion, disposable personal income increases by $15 billion, and the trade (current account) deficit increases by $5 billion, or, the current account surplus falls by $5 billion. By how much have the following variables changed? (a) national income, (b) investment, (c) consumption? Show all your calculations. b. With the help of an IS-LM diagram (as well as any other necessary relationship), (i) first, derive the effects of an increase in government expenditure on the interest rate and the level of income, and (ii) second, confirm the effects on Y, I, and NX you derived, or, in the case of NX, that was given to you in part (a). Hint: Use part b as your guide to the accuracy of your answer to a. 3. 20 Points Suppose that the goods and services market is currently in equilibrium at the fullemployment level of output (potential output) and that the government is running a budget surplus. a. (13 Points) Now suppose that a terrorist attack reduces consumer confidence and the animal spirits of entrepreneurs. With the help of an IS-LM diagram, explain the effect on the equilibrium levels of the interest rate, and output. b. (7 Points) Explain what will be the effect on the government budget balance. Characterize such an effect. 4. 15 Points With the help of an IS-LM diagram, explain why you agree or disagree with the statement: The mix of monetary and fiscal policy does not matter if the alternative mixes all result at the full-employment level of national output.

5.

15 Points Suppose that at the end of 2002, the Federal Reserve decides to use open market operations to reduce nonborrowed reserves. a. Explain what action the Federal Reserve must take to reduce nonborrowed reserves. b. With the help of an IS-LM diagram, explain the liquidity effect and the real income effect of a reduction in nonborrowed reserves.

6. 20 Points The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in billions and i as a percentage. Percentages are written in this format: For example, if i were 5 percent, it would appear as 5, not as 0.05.) Real (IS) Sector C = 700 + 0.85YD YD = Y TA + TR TA = 200 + 0.25Y TR = 600 I = 250 10i G = 1,200 NX = - 100

Consumption Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

Financial (LM) Sector Md = 750 0.20i + 0.10Y (Real) Money Demand Ms = 400 + 14NBR + 4i (Real) Money Supply NBR = 70 (Real) Nonborrowed Reserves Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real) investment, I. Show your work and explain it using graphs.

STUDENT NAME: .. Economics 301 Honors Professor Michael G. Hadjimichalakis ANSWER ALL QUESTIONS 1. 20 Points

Final Exam June 10, 2002

Consider the United States the home country and suppose that nominal interest rate parity holds. Now, suppose that because of concerns about the integrity of U.S. accounting practices and corporate governance, international investors consider U.S. assets (say, bonds) riskier. Use the IS-LM-BP model applicable to the United States to explain the effects of this shock on the (U.S.) real GDP, the nominal interest rate, and the international value of the dollar. 2. 15 Points Suppose that as a result of September 11, the marginal productivity of labor falls because firms have to divert resources to security, which is an intermediate, not a final, good. a. Use an IS-LM, AD-AS model with a short-run aggregate supply curve to explain the effect on real GDP, the price level and the interest rate b. Suppose the Fed wants to return output to its original level. Explain what the Fed must do and what the effect on the price level will be. Illustrate the result of the Fed action graphically.

3. 20 Points Recently, the U.S. stock market has been falling because of concerns about the accounting practices of U.S. firms and the accuracy of reported corporate profits. a. Explain the channels through which a fall in the stock market affects the demand for goods and services. b. Use your results in part a and a standard IS-LM, AD-AS model to explain the effects of the fall in the stock market on real GDP, the price level, and the interest rate. 4. 15 Points Suppose that the animal spirits of entrepreneurs rise and, in addition, the president and the U.S. Congress agree on a reduction in the tax rate on business profits. a. Use a model of a profit-maximizing firm to explain the effects of these shocks, each examined separately, on investment in plant and equipment. b. Incorporate the results of your answer in part a into an IS-LM-BP model to explain the effects on real GDP, the interest rate, and the exchange rate.

5. 15 Points Suppose that by 2003 the U.S. economy returns to full employment. Suppose it also faces inflationary pressures, forcing the Fed to embark on a tightening monetary policy. With the help of one IS-LM-BP graph, explain the effects on the economy of Hong Kong, which pegs the Hong Kong dollar to the U.S. dollar, and on the economy of Thailand, which permits the Thai baht to float. 6. 15 Points Note that parts a and b are not related. a. Explain when (under what circumstances) money is neutral by examining an increase in nonborrowed reserves in an AD-AS model. b. Give and explain three reasons why wages may be rigid, resulting in involuntary unemployment.

Autumn Quarter 01

STUDENT NAME: .. Economics 301H Final Exam Professor Michael G. Hadjimichalakis December 14, 2001 ANSWER ALL QUESTIONS 1. 20 Points Recently (a) the Fed has been increasing nonborrowed reserves and (b) energy prices have been falling. With the help of AD-AS, IS-LM diagrams (one set of graphs for each shock), explain the differences and similarities between these two shocks. 2. 15 Points The price level is falling in Japan, that is, there is deflation in Japan. Real GDP is also falling in Japan. a. With the help of an AD-AS diagram, explain the difference between "bad deflation" and "good deflation." Include in your answer a discussion of the type of shocks that cause each type of deflation. b. There is some debate in Japan about whether the ongoing deflation is of the good or bad type. Which type of deflation (on net) do you think Japan is experiencing, the good or bad type? What evidence supports your conclusion? 3. 15 Points Respond to the following statement with the help of the appropriate graph or graphs: "Since money is neutral, there is no point at all in the Fed trying to use monetary policy to affect output." 4. 20 Points Suppose that because of increased uncertainty in financial markets, U.S investors move to safer and more liquid assets thereby increasing the U.S demand for money. With the help of an IS-LM-BP diagram applicable to the United States of today, explain how this change in the portfolio preferences of the public will affect the interest rate, the exchange rate, and the real GDP. Under these circumstances, explain what the Fed should do and why. 5. 15 Points Recently the U.S. policymakers have been using both monetary and fiscal policy to jumpstart the economy. With the help of an IS-LM-BP diagram applicable to the United States of today, compare the international effects (i.e., on e and NX) of an increase in the money supply versus tax cuts.

6. 15 Points Recently the Fed has been pushing down the federal funds rate. With the help of an IS-LM-BP model, explain the effect on a small country (or region, such as Hong Kong,) that pegs its currency to the U.S. dollar.

STUDENT NAME: .. Economics 301H Exam # 1 Professor Michael G. Hadjimichalakis November 6, 2001 ANSWER ALL QUESTIONS

1. 20 Points Currently, the U.S. economy is operating below potential (below full employment.) Suppose the goal of policymakers is to return the economy to full employment. With the help of an IS-LM model, compare the effects on the following variables of using monetary policy (to return the economy to full employment) versus using income tax cuts for households: consumption, investment, net exports. 2. 20 Points A fall in the stock market, caused by an increased perception of risk of investing in stocks and bonds, can directly affect both the IS and LM curves, that is, it can be both an IS and LM shock. Explain how. Then, explain how each of these shocks affects i and Y. HINT: Answer the question by examining two cases (shocks). First, an increase in the (perceived by the public) risk of investing in stocks and bonds. Second, a fall in the market value of stocks and bonds. 15 points a. (5 points) Explain the difference and the similarity between a debt buyback by the U.S. Treasury and an open market purchase of Treasury securities by the Fed. b. (10 points) In the context of the IS-LM model, what difference does it make if the U.S. Treasury uses the budget surplus to reduce taxes as opposed to buying back the debt? 15 Points Suppose that the U.S. Congress approves (passes) President Bushs proposed cut tax on business profits. a. Use a model of the profit-maximizing firm to explain what will happen to the demand for plant and equipment by firms (that is, investment). b. With the help of an IS-LM diagram, explain what will happen to the equilibrium levels of the interest rate and national output.

3.

4.

5. 15 Points Suppose that the economy is prone to real-sector shocks, say, in consumer confidence and animal spirits of entrepreneurs. Explain whether it is better for the Fed to target (keep fixed) the interest rate or the quantity of securities it holds, i.e. BF. 6. 15 Points

The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in billions and i as a percentage. For example, if i were 5 percent, it would appear as 5, not as 0.05.) Real (IS) Sector C = 900 + 0.80YD YD = Y TA + TR TA = 250 + 0.25Y TR = 650 I = 220 10i G = 1,100 NX = - 80

Consumption Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

Financial (LM) Sector Md = 600 0.25i + 0.10Y (Real) Money Demand Ms = 200 + 15NBR + 4i (Real) Money Supply NBR = 65 (Real) Nonborrowed Reserves Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real) investment, I. Show your work and explain it using graphs.

Economics 301H 6. 20 Points Exam # 1 Economics 301 Honors Final Exam The Michael equations describe ProfessorfollowingG. Hadjimichalakis an economy. (Think of 6, 2001 NX, etc., as February C, I, G, being measured Hadjimichalakis Professor Michael G.in billions and i as a percentage. For example, 12, 2001 5 percent, March if i were it would appear as 5, not as 0.05.) Real (IS) Sector ANSWER ALL QUESTIONS 1.C = 950 + 0.80YD 20 Points Consumption 1. 20 Points Proponents TAincome tax cuts for households argue that income tax cuts will stimulate YD = Y - of + TR Disposable Income a sluggish (slowingin the Wall Street in much on February 1,that the Kennedy-Johnson The lead article down) economy Journal the same way 2001 asserted that a fall taxin the animal spirits theentrepreneurs isin the early of (the reason for) the Fed's cut 200 stimulated KennedyTA = cuts + 0.25Y of U.S. economy at the root 1960s. But during Taxes Johnson years the U.S. was bound by the Bretton-Woods Agreement to a fixed recent move to lower interest rates. exchange rate, while now model of a profit-maximizing exchange rates. effect of a a. With TR = 600 the help of a we are in Payments floating firm, explain the Transfer regime of Financialin of appropriate IS-LM-BP diagrams, explain and compare the effects of With the help animal spirits on investment demand. fall (LM) Sector income With the on the national product, interest rate, and the exchangein animal spirits I b. 250 - 10i help of an IS-LM diagram, explain the effect of a fall rate in the case = tax cuts Investment Md = on the0.251 rate, and (real) national product. 550 - interest of a large country: + 0. l 0Y (Real) Money Demand (Assume that, originally, the a. economy was operating at the full-employment level.) committed to a flexible exchange rate, and G = 1,000 Government Purchases Ms = 150 + 15NBR +IS-LM diagram, explain what the Fed must do to restore c. Using the same 4i (Real) Money Supply a. b. national output fixed Net Exports interest rate, i, and real GDP, Y. Show your Calculate the equilibrium level of the original level. NX = - committed to to its exchange rate. 60 work65 explain it using graphs and 2.NBR = 20 Points (Real) Nonborrowed Reserves b. Suppose that the consumption equationeach regime works. Note: Your answer should make clear how changes to C=850+0.80YD The stock market has fallen considerably in recent months. With the help of an ISLM diagram, explain the effect of a fall in the stock market on the interest rate After explaining what may have caused this change, and national output. In your answer you should be specific about the channels through which a fall in the stock market affects aggregate demand. Answer the 3. 20 Points following without making any numerical calculations: Suppose that there are two alternative proposals for economic policy designed to restore national output to its original in the(the level you found in your answer to a, Suppose that because of turmoil level financial sector, the demand for securities above): and the demand for money rises. With the help of an IS-LM diagram, explain falls whether it is better for the Fed to target (i.e., keep fixed) the quantity of money or The first is interest rate. You answer the U.S. Congress to change of the to target thefor the Administration andshould include an explanationincome tax rates. appropriate actions of the Fed in each case. The second 4. 10 Points alternative is for the Fed to use monetary policy. Explain each of of U.S. Treasury their respective Fed will the composition of "A one-time salethese policies and securities by theeffects onresult in a liquidity aggregate a real income effect." NX.) effect and demand (i.e., on I and Explain 10 Points "A reduction in consumer confidence has a cyclical effect on the budget surplus." Explain Winter Quarter 01

5.

b. Explain what is meant by real interest rate parity and how you can combine the concepts of nominal interest rate parity and the real exchange rate to derive real interest rate parity.

2.

15 Points

According to a front-page article in The Wall Street Journal, on February 1, 2001, the animal spirits of U.S. entrepreneurs have fallen recently. With the help of an IS-LMBP model applicable to the U.S., explain the effects that a fall in the animal spirits will have on the national output, the interest rate, and the exchange rate. 3. 20 Points "Expansionary demand management policies always increase nominal GDP but not real GDP." Explain the meaning of this statement with the help of AD-AS diagram(s.) Your answer should include the meaning of neutrality of money and complete crowding out, and, of course, whether and under what circumstances these results occur. 4. 15 Points In a press release after the FOMC meeting on January 31, 2001, the Federal Reserve stated that "consumer confidence has eroded further, exacerbated by rising energy costs." With the help of one AD-AS diagram, explain how these shocks affect the economy. 5. 15 Points Since 1995, there has been a considerable increase in labor productivity in the U.S. With the help of an IS-LM-AD-AS model, explain the effects of an increase in the marginal productivity of labor on national output, the price level, and the interest rate. 6. 15 Points a. Explain three reasons why it might be to a profit-maximizing firm's interest to pay its workers above-market clearing wages.

Spring Quarter 2000 STUDENT NAME: . Economics 301 Honors Final Exam Professor Michael G. Hadjimichalakis June 5, 2000 ANSWER ALL QUESTIONS 1. 20 points In June 1999, the Federal Reserve began raising U.S. interest rates in an effort to cool down an overheated (in its view) U.S. economy. With the help of IS-LM-BP curves, explain the effect that the change in U.S. monetary policy would have: a. On small countries that let their currencies float against the U.S. dollar; b. On small countries that peg their currencies to the U.S. dollar. 2. 20 points Suppose that the animal spirits of entrepreneurs in the United States fall. With the help of an IS-LM-BP graph applicable to the United States, explain the effects on the interest rate, output, and the exchange rate. 3. 20 points a. In his Humphrey-Hawkins testimony on February 17, 2000, Alan Greenspan said: "An increase in the overall rate of inflation in 1999 was mainly a result of higher energy prices." With the help of an IS-LM--AD-AS diagram, explain the effect of higher energy prices on real GDP, the price level, and the interest rate. b. Greenspan went on to say that "total unit labor costs increases were extraordinarily low.." What factors affect unit labor costs? Why, do you think, did unit labor costs decline in the second half of the year, as Greenspan indicates in his remarks? 4. 20 points Suppose that because of utterances by Fed chairman Greenspan, the American public becomes more risk averse in the sense that wealth holders increase their demand for money and reduce their demand for securities. With the help of IS-LM, AD-AS diagrams, explain the effects on the interest rate, output, and the price level. 5. 20 points It has been established that in recent years the Beveridge curve has shifted inward and that the asymmetry in the wage (and price) response to excess demand and excess supply has become less pronounced. a. What factors have most likely shifted the Beveridge curve inward? Explain in detail. b. What factors have caused the reduction in the asymmetry of the wage and price response to excess demand and excess supply? Explain in detail. c. What is the economic significance of these changes?

STUDENT NAME: . Economics 301 Honors Exam #1 Professor Michael G. Hadjimichalakis May 2, 2000 ANSWER ALL QUESTIONS 1. 20 points a. A fall in the stock market can directly affect both consumption and investment. Explain how. b. Suppose the economy is currently at full employment and the goal of the Fed is use open market operations to maintain full employment. With the help of an ISLM diagram, explain how the Fed would respond to a large fall in the stock market. 2. 20 points With the help of an IS-LM diagram, explain why you agree or disagree with the following statement: "The mix of monetary and fiscal policy does not matter if the alternative mixes all result in the same level of output." 3. 20 points Suppose that the tax rate on business profits is reduced. a. Use a model of the profit-maximizing firm to explain what will happen to the demand for plant and equipment by firms (that is, investment). b. With the help of an IS-LM diagram, explain what will happen to the equilibrium levels of the interest rate and national output. 4. 20 points "If the economy is prone to real-sector shocks, the Fed should target (keep fixed) the quantity of money, but it should target the interest rate if the shocks are expected to come from the money sector." Explain whether you agree or disagree with the statement. Continued on back

5. 20 points The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in billions and i as a percentage. For example, if i were 5 percent, you would write i = 5) Real (IS) Sector C = 850 + 0.80YD YD = Y -TA + TR TA = 200 + 0.2Y TR = 800 - 0.05Y I = 200 - 10i G = 800 NX = -50

Consumption Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

Financial (LM) Sector Md = 500 - 0.25i + 0.10Y (Real) Money Demand Ms = 100 + 12NBR + 4i (Real) Money Supply NBR = 75 a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show and explain your work. b. Suppose that the government reduces the lump-sum component of total taxes from 200 to 150. Calculate and explain the effect on the equilibrium level of: (1) the budget surplus or deficit; and (2) investment.

Autumn Quarter 1999 STUDENTS NAME: Economics 301 Honors Final Exam Professor Michael G. Hadjimichalakis December 10, 1999

ANSWER ALL QUESTIONS 1. 20 points In October 1999 Robert Mundell received the Nobel Prize in economics for his research on how macroeconomic policies work in a global economy. Among Mundell's contributions were the results that: a. In a small country with free capital flows and flexible exchange rates, fiscal policy is powerless to affect output. b. In a large country with free capital flows and flexible exchange rates, fiscal policy is less potent than in a closed economy. With the help of appropriate graphs explain these results.

2. 20 points Suppose that in the year 2000 the U.S. economy unexpectedly weakens and in response, the Fed pushes down U.S. interest rates. With the help of IS-LM-BP curves, explain the effect that the change in U.S. monetary policy would have: a. on countries that peg their currencies to the U.S dollar; b. on countries that let their currencies float against the U.S. dollar. 3. 20 points a. Suppose that the Fed believes that productivity has increased. If the Fed's goals are price stability and full employment, explain with the help of an AD-AS diagram what it should do. b. Suppose that the Fed turns out to be wrong and productivity has not increased. Explain with the help of an AD-AS diagram what will be the consequences of its policy actions. 4. 15 points a. In the last few years the U.S. economy has been operating at close to full employment with very low inflation rates. Give and explain three possible reasons for such performance.

b. What is meant by efficiency wages? Combine the concept of efficiency wages with the concepts of adverse selection, loyalty, and shirking to explain involuntary unemployment. 5. 15 points Suppose that money demand rises because wealth holders become more risk averse. With the help of IS-LM, AD-AS diagrams, explain the effects on the interest rate, output, and the price level. 6. 10 points Two goals of monetary policy in the United States are price stability and full employment. Are these goal always consistent (compatible) with each other? Explain with the help of AD-AS graphs.

STUDENTS NAME: Economics 301 Honors Exam #1 Professor Michael G. Hadjimichalakis November 2, 1999 ANSWER ALL QUESTIONS 1. 20 points Suppose that the Japanese government decides to cut the income tax rate in Japan, as some American economists, notably Martin Feldstein, have recommended. a. With the help of an IS-LM diagram explain the effect of the tax rate on the interest rate and the level of output in Japan. b. Explain the two types of "crowding out" that would result from a tax cut. 2. 10 points Explain whether you agree or disagree with the statement: "A balanced-budget amendment mandating annually balanced budgets can turn a minor downturn in the economy caused by a fall in consumer confidence into an accelerating recession." 3. 15 points a. With the help of a Keynesian-Cross diagram, explain the channels through which a fall in the stock market would affect aggregate demand and the equilibrium level of output. b. Extend your analysis in (a) by using an IS-LM diagram to explain the effect of a fall in the stock market on the interest rate and real income (output.) 4. 15 points There is widespread belief that because of Y2K fears currency in circulation will rise in the fourth quarter of 1999. a. With the help of an equation of the money supply process, explain what will happen to the money supply if currency in circulation rises and the Fed does not intervene. Also, use an IS-LM diagram to explain the effect on the interest rate and output. b. In recent comments on this issue, Federal Reserve governor Edward Kelly said: "We [the Federal Reserve] will, of course, be ready if people want to hold more cash on New Year's Eve 1999 and we will be prepared to lend whatever sums may be necessary through the discount window or to provide needed reserves to the banking system's open market operations." With the help of an equation of the money supply process, explain how the Fed would provide the reserves to which Governor Kelly refers. Also explain how this action by the Fed will affect the economy.

5. 20 points Suppose that the "animal spirits" of entrepreneurs fall. a. With the help of a model of a profit-maximizing firm, explain the effect of this fall on investment demand. b. With the help of an IS-LM diagram, explain the effect on the interest rate and (real) national product. c. With the help of an IS-LM diagram, explain why in such case it is better for the Fed to target (keep fixed) the quantity of money than to target the interest rate. 6. 20 points The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in billions and i as a percentage. For example, if i were 5 percent, you would write i = 5.) Real (IS) Sector C = 850 + 0.80YD where YD = Y TA + TR TA = 160 + 0.2Y TR = 500 I = 240 10i G = 850 NX = - 40 Financial (LM) Sector Md = 450 0.25i + 0.10Y Ms = 970 + 5i

Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

(Real) Money Demand (Real) Money Supply

a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show and explain your work. b. Suppose Congress and the Administration agree to raise G to 910. (1) Calculate the effects on the interest rate and real GDP and illustrate graphically. (2) Calculate and characterize the effect on investment in plant and equipment, I.

Winter Quarter 1999 STUDENTS NAME: Economics 301 Honors Final Exam Professor Michael G. Hadjimichalakis March 19,1999 ANSWER ALL QUESTIONS 1 15 points Hong Kong, a small country with fixed exchange rates, (the Hong Kong dollar is pegged to the U.S. dollar) is currently in recession. With the help of IS-LM-BP graphs, explain whether monetary or fiscal policy would work to jump-start the economy. 2. 20 points In his Humphrey-Hawkins testimony in February 1999, Fed Chairman Alan Greenspan pointed out that there was an increase in demand for money by the U.S. public in 1998 because of a desire for safer and more liquid assets (because of increased uncertainty in financial markets.) With the help of an IS-LM-BP diagram applicable to the United States, explain how this change in the portfolio preferences of the public will affect the interest rate, the exchange rate, and real GDP. Under these circumstances, explain what the Fed should do and why. 3. 15 points Official data indicate that between 1996 and 1998 the U.S. economy has experienced a "significant" increase in the marginal productivity of labor. With the help of an ISLM, AS-AD diagram, explain how this increased productivity affects the interest rate, the real GDP, and the price level. 4. 10 points How can you explain a situation in which both the interest rate and real GDP are falling? 5. 15 points Explain the effect of an inward shift of the Beveridge curve on NAIRU and the associated inflation rate. 6. 15 points a. What is nominal interest rate parity? When does it hold? b. Explain how you can combine the concepts nominal interest rate parity and the real exchange rate to establish real interest rate parity. Define the terms you use. 7. 10 points Give and explain three reasons why wages may be rigid, resulting in involuntary unemployment.

STUDENTS NAME: Economics 301 Honors Exam #1 Professor Michael G. Hadjimichalakis February 16,1999 ANSWER ALL QUESTIONS 1. 20 points The following equations describe an economy. (Think of C, I, G, NX, etc., as being measured in billions and i as a percentage. For example, if i were 5 percent, you would write i = 5.) Real (IS) Sector C = 850 + 0.80YD where YD = Y TA + TR TA = 220 + 0.2Y TR = 820 0.05Y I = 100 10i G = 900 NX = - 30 Financial (LM) Sector Md = 550 0.25i + 0.10Y Ms = 150 + 12NBR + 4i NBR = 77

Disposable Income Taxes Transfer Payments Investment Government Purchases Net Exports

(Real) Money Demand (Real) Money Supply Nonborrowed Reserves

a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show and explain your work. b. Suppose that money demand changes to Md = 586 - 0.25i + 0.10Y (1) First, explain what may have caused this change. (2) Second, find the new levels of i and Y. (3) Find and characterize the effect on the budget surplus/deficit. Again, show and explain your work. 2. 20 points The U.S. economy is currently operating at full employment and the goal of monetary policy is to maintain full employment with price stability. With the help of an IS-LM graph, explain how the Fed, using open market operations, would have to respond to an increase in consumer confidence in order to achieve its goal.

3. 20 points Suppose that, while the economy is operating at full employment, the U.S. Congress and the Administration agree to reduce income tax rates across the board. With the help of an IS-LM graph, explain what the Fed will do if its goal is to maintain full

employment with price stability. Also, explain whether such a "policy mix" is good for the U.S. economy. 4. 15 points Use a model of a profit-maximizing firm to explain how investment demand will be affected in each of the following cases, considered separately: a. Pre-tax business profits rise. b. The tax rate on business profits rises. c. The "animal spirits" of entrepreneurs fall. 5. 15 points Suppose that in the near future the economy is prone to money demand shocks due to volatility in domestic and foreign financial markets. With the help of an IS-LM graph, explain why targeting (keeping fixed) the interest rate is a better monetary policy than targeting the quantity of money. 6. 10 points Suppose that because of Y2K fears currency in circulation rises. Assuming that the Fed does not react, explain what will happen to money supply.