Form X Midterm 3: Econ 102, Principles of Macroeconomics University of Michigan, Department of Economics April 14, Thursday, 6 PM-8 PM Last Name: ___________________________________ First Name: ___________________________________ UMID: ___________________________________ GSI: _____________________________ Section Time: ___________________________ DO NOT OPEN THIS TEST OR LOOK AT THE SHORT ANSWER QUESTIONS UNTIL YOU ARE INSTRUCTED TO DO SO. Complete your identifying information above. You only need a pen or pencil, and a basic, scientific, or graphing calculator. Put everything else away, including papers, notes, smart phones, smart watches, etc. There are blank pages at the end of this exam for scratch paper. This exam has two parts: a multiple choice section consisting of 30 questions, where each question is worth 2 points, and a long analytic type question where your answers will be written into this exam. Submit your scantron and completed exam when you have finished. Before exam time starts, you must bubble in the following four pieces of information on your scantron. Bubble in: 1. your name 2. that you have been given EXAM FORM: X 3. your section number, as given in the adjacent table 4. your UMID number You will have a total of 110 minutes for this midterm. Section number 101 102 103 104 105 106 107 108 109 Good luck! DO NOT WRITE IN THE AREA BELOW: Multiple-Choice: _________ / 60 Long Question: _________ / 20 Total Points: __________ / 80 Section time Fri, 2:30 Fri, 11:30 Fri, 1 Fri, 10 Fri, 2:30 Fri, 10 Fri, 1 Fri, 11:30 Th, 4 GSI Pinghui Wu Kimberly Conlon Pinghui Wu Kimberly Conlon Sreyoshi Das Thomas Brosy Ting Lan Thomas Brosy Ting Lan Form X Multiple-Choice Section (2 points per question) For each multiple-choice question, read all possible answers before choosing the best possible one. There is no additional penalty for incorrect multiple-choice answers. 1. If the interest rate falls, the quantity of money held by households a. rises. b. stays the same. c. falls. d. is set to 0. 2. Assume that Okun's law holds for the economy, and initially the unemployment rate is at NAIRU. Using monetary policy, the Federal Reserve is able to raise the unemployment rate by 0.5%. If potential GDP is growing by 2%, then actual GDP is growing by a. -0.25% b. 0.75% c. 2.5% d. 1.25% 3. Assume the Federal Reserve raises interest rates. In the short run, this results in a a. movement right and down along the short run Phillips curve. b. movement up and left along the short run Phillips curve. c. outward shift in the short run Phillips curve. d. inward shift in the short run Phillips curve. 4. Assume the simple version of the government spending multiplier. The MPC=2/3, and now the government would like to combine the monetary policy with fiscal policy to increase the aggregate demand by $170 billion. Suppose the government decides to increase its spending by $50 billion. In this case, the Fed should ____________ a. sell bonds b. expand the money supply c. increase the required reserve ratio d. do nothing 5. Assume the simple version of the government spending multiplier. The MPC=2/3, and the government increases spending by $10 billion. Overall, aggregate demand will shift out by a. $10 billion b. $20 billion c. $30 billion d. $66.6 billion Form X 6. Assume the simple version of the government spending multiplier, but in addition, include only the interest rate effects (or complications). If the MPC=3/4, and the government increases spending by $10 billion. Overall, aggregate demand will shift out by a. more than $40 billion b. less than $40 billion c. exactly $40 billion d. uncertain, depending on the size of the interest-rate effect. 7. Assume the simple version of the government spending multiplier, but in addition, include only the investment accelerator effects (or complications). If the MPC=3/4, and the government increases spending by $10 billion. Overall, aggregate demand will shift out by a. more than $40 billion b. less than $40 billion c. exactly $40 billion d. uncertain, depending on the size of the investment accelerator effect. 8. In an interest rate death spiral, the interest rates of bonds continuously _____________ , and interest payments on government debt continuously _________. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease 9. In 2015,the Gross Domestic Product (GDP) in the United States increased by 1.4% since last year, while the unemployment rate decreased by 0.9%. In 2015, according to Okun’s law the potential GDP growth is ______________ a. 0.5% b. -0.85% c. 1.76% d. 3.65% 10. Which of the following statements is FALSE? a. Okun’s law is derived from empirical facts. b. Animal spirits could lead to the overheating of an economy. c. According to the permanent income hypothesis, a lump-sum tax cut leads to an immediate increase of consumption. d. The multiplier effect on aggregate demand is not restricted to changes in government purchases only, it applies to any event that alters spending on any component of GDP. Form X The next three multiple-choice refer to the AD/AS diagram below. Consider each multiple-choice separately. 11. If the economy is initially in LR equilibrium, which series of points correctly tracks the economy’s response to firms suddenly increasing their investment in machines and tools? a. A, B, C b. A, E, C c. C, E, A d. C, B, A 12. The economy is initially at point A, and then immediately moves to point C (in the SR). Which of the following two simultaneous events could explain this SR movement? I. A decrease in nominal wages II. an increase in the money supply III. A decrease in government expenditures a. I and II b. II and III c. I and III d. none of the above 13. The economy is initially at point B, which of the following statements is true? a. For the sticky-price theory, over time, firms with higher menu costs will eventually increase their prices b. In the long run, without any policy interventions, this economy will eventually go to point C c. For the sticky wage theory, over time, firms will begin making less profit/unit d. Expected prices are increasing Form X 14. During a boom, the aggregate demand curve shifts further because of a wave of irrational exuberance. Those who favor a policy that "leans against the wind" or dampen booms, would advocate that the Federal Reserve a. buy bonds b. decrease the interest rate c. increase the required reserve ratio d. increase lending at the discount window 15. An expansionary monetary policy will lead to __________in the short run and ___________ in the long run. a. P increase, Y increase ; P increase, Y increase b. P increase, Y increase; P unchanged, Y unchanged c. P increase, Y unchanged; P increase, Y unchanged d. P increase, Y increase; P increase, Y unchanged 16. An exogenous decrease in the price level leads to a _______ in the interest rate, and the aggregate demand curve ________. a. increase; shifts out b. decrease; shifts in c. decrease; shift out d. decrease; does not shift 17. Suppose the government imposes an expansionary fiscal policy. In the short run, this causes a _________ the short run Phillips curve. When transitioning from the short run equilibrium to the long run equilibrium, we _________ the short run Phillips curve. a. movement along; shift in b. movement along; shift out c. movement along; do not shift d. shift in; shift in 18. Which of the following would not affect the Long Run Aggregate Supply curve? a. An increased amount of immigration into the economy b. Political instability in the Middle East which causes a temporary increase in the expected price of oil c. A tornado destroys factories and plants in the Midwest d. A decrease in the natural rate of unemployment 19. Determine whether the following two statements are true or false: I. Suppose that all firms in the economy transition to shorter wage contracts. This would lead to the Short Run Aggregate Supply curve which is more elastic. II. Every time an economy has an inflationary gap the Long Run Aggregate Supply Curve shifted to the right. a. I False; II True b. I False; II False c. I True; II True d. I True; II False Form X 20. If prices suddenly decrease more than expected, firms with sticky wages will initially _________ output, and eventually wages in nominal contracts will _________. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease 21. If there is a decrease in consumer confidence, firms with relatively low menu costs will __________ their prices, and will change their output by a __________ amount. a. increase; large b. increase; small c. decrease; large d. decrease; small 22. Stagflation poses a dilemma for policymakers because a. If AD is reduced to combat inflation, output will rise, risking another inflationary gap. b. If a stimulus is given to AD to combat unemployment, the price level will fall, risking deflation. c. It forces the central bank to choose between addressing either high unemployment or high inflation d. It forces the central bank to begin massive stimulus measures, which further raise price expectations. 23. Hayek, a prominent 20th century philosopher and economist, a. developed the fundamentals of much of our introductory macroeconomics b. argued that government spending should be kept to a minimum c. agreed with Keynes on many issues, as evidenced by the video shown in class d. argued that the government should spend heavily during times of recession 24. Other things the same, an increase in the price level makes consumers feel a. less wealthy, so the quantity of goods and services demanded falls. b. less wealthy, so the quantity of goods and services demanded rises. c. more wealthy, so the quantity of goods and services demanded rises. d. more wealthy, so the quantity of goods and services demanded falls. 25. Other things the same, as the price level falls, a country's exchange rate a. and interest rates rise. b. and interest rates fall. c. falls and interest rates rise. d. rises and interest rates fall. Form X 26. When taxes increase, consumption a. decreases as shown by a movement to the left along a given aggregate-demand curve. b. decreases as shown by a shift of the aggregate demand curve to the left. c. increases as shown by a movement to the right along a given aggregate-demand curve. d. increases as shown by a shift of the aggregate demand curve to the right. 27. Other things the same, an unexpected fall in the price level results in firms with relatively high menu costs having a. lower than desired prices which increases their sales. b. lower than desired prices which depresses their sales. c. higher than desired prices which increases their sales. d. higher than desired prices which depresses their sales. 28. The government builds a new water-treatment plant. The owner of the company that builds the plant pays her workers. The workers increase their spending. Firms from which the workers buy goods increase their output. This type of effect on spending illustrates a. the multiplier effect. b. the crowding-out effect. c. the Fisher effect. d. the wealth effect. 29. If at some interest rate, the quantity of money supplied exceeds the quantity of money demanded, people will want to _________ interest-bearing assets, causing the interest rate to _____________. a. buy; increase b. buy; decrease c. sell; increase d. sell; decrease 30. Removed Form X Long Question Section: " Another S/AD Story" (30 Points) 1. Arborland is initially in long-run equilibrium. Suddenly, there is a decrease in the price of oil. a. (6 points) Use an AD/AS diagram to show what happens to output and the price level as a result of the oil price decline, in the short run only. Label the initial equilibrium (E1), short run equilibrium (ESR), and circle one of the answers concerning the unemployment rate below. No explanation needed for this part. The unemployment rate is [Circle one: greater than/less than/equal to] NAIRU in the short run. Form X Now assume that you are currently at the short run equilibrium, ESR, and suppose you are the Chair of the Federal Reserve. Suppose you're considering two separate policy options. Option 1: Option 2: You want to bring short run output back to potential GDP using monetary policy. You take no action, and decide to let the economy return to the long-run equilibrium on its own. b. (8 points) For option 1, determine if you would buy or sell bonds. Draw a money market graph to illustrate whether interest rates will increase or decrease as a result of your monetary policy. In your diagram from part (a), label this equilibrium as point B. Explain. Circle one: [buy bonds / sell bonds] Circle one: interest rates [increase / decrease] Since YSR>YLR, the economy is overheating, and in order to bring the economy quickly to long-run equilibrium, the Fed should conduct contractionary monetary policy by selling bonds. In the SR money market graph, this would shift the MS curve inwards, raising interest rates. As interest rates rise, C, I, and NX, would all decrease, which would result in a shift inwards of aggregate demand, as labeled in the graph as point B. Form X c. (6 points) Draw a new AD/AS diagram, continuing to assume that the price of oil has decreased and illustrate this in your new diagram. For option 2, carefully explain how the economy would transition from ESR to the long-run equilibrium, which will be labeled as point C in your new diagram. Explain intuitively, and include the concept of a wage-price spiral. Starting from ESR, there will be a wage price spiral. Since prices decreased, this will exert downward pressure on wages, which will then result in further decrease in prices as illustrated from SRAS 2 to SRAS5. Also note that starting from ESR, since prices have decreased, E[P] have also decreased, leading to an outward shift in the SRAS. For the sticky price theory, firms with high menu costs (Italian restaurants), will further lower their prices as their menu costs become more flexible over time, which will result in more Y. For the sticky wage theory, nominal wages and contracts decrease as E[P] decreases, so that a firms profit per unit increases, which will result in more Y. However, as the SRAS further shifts out, the unemployment rate continues to drop, so that the labor markets become very tight. This eventually puts upward pressure on wages, which will then begin shifting the SRAS back inwards, so that in the long run, point C is the same as E 1. [see pp 449 of textbook]
