Econ 305: Final Exam
December 2004
D. Andolfatto
Name
Instructions. Please limit your answer to the space provided below each question. Label all diagrams
clearly. If a question asks you to answer in words only, then do not use any math, symbols or diagrams.
1. [5 Marks]. Over the last century, real wages have increased dramatically and yet the average amount
of time spent working (per capita) has remained relatively stable. Is this observation consistent with
neoclassical theory? Explain.
2. [5 Marks]. The income-expenditure identity states that Y ≡ C + I + G + N X. Does this identity imply
that an increase in G must lead to an increase in Y ? Explain.
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3. [5 Marks]. True/False/Uncertain and Explain. Government policy should be designed in a way that
maximizes GDP.
4. [5 Marks]. True/False/Uncertain and Explain. The socially optimal unemployment rate is equal to
zero.
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5. [10 Marks]. Conventional thinking asserts that when the economy begins to ‘overheat,’ the central bank
should increase the nominal interest rate. What is the rationale that underlies this logic? Provide a
critique of this view. Explain in essay form (i.e., use words only).
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6. [20 Marks]. Consider a small open economy populated by a representative household with preferences
1/2
1/2
for (c1 , c2 ) given by U (c1 , c2 ) = c1 + c2 , so that M RS = (c2 /c1 )1/2 . Let R denote the gross real
rate of interest. Assume that the household has a nonstorable endowment (y1 , y2 ).
D
(a) Write down the mathematical conditions that describe the consumer demand functions (cD
1 , c2 ).
(b) Solve for the consumption function cD
1 . How is consumer demand predicted to respond to an
exogenous increase in R? Explain.
(c) Economic data shows that there is a positive correlation between c1 and y2 . Does this correlation
imply that an increase in consumer demand leads to an increase in future GDP? Explain.
(d) Use your solution in (b) to solve for the consumption-output ratio (cD
1 /y1 ). Explain how econometricians might use this ratio to forecast future growth in GDP (y2 /y1 ).
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7. [10 Marks]. Imagine that an economy is hit by some ‘shock’ that results in an increase in the current
account deficit. Can we deduce that economic welfare must have declined simply by looking at how
the current account position has changed? Explain.
8. [10 Marks]. State the conditions under which the Ricardian Equivalence Theorem holds and provide a
statement of the theorem.
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9. [10 Marks]. Suppose that the government needs to increase its purchases temporarily (say, to fight a
war). Assume that taxes are distortionary (i.e., not lump-sum). The government is debating whether
it should finance this spending with some combination of higher taxes and/or new debt. What advice
would you give them (and why)?
10. [10 Marks]. Are government budget deficits necessarily inflationary? Describe the circumstances under
which they may or may not be (Use words only).
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