EC1080
UNIVERSITY OF WARWICK
MOCK EXAM Examinations 2020/21
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Macroeconomics 1
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NEW RUBRIC FOR 2020-2021.
Time Allowed: 3 Hours
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Answer ALL questions in Section A (50 marks total) and TWO questions in Section B (25
marks each)..
AM
Read carefully the instructions on the answer book provided and make sure that the particulars
required are entered on each answer book. If you answer more questions than are required and do
not indicate which answers should be ignored, we will mark the requisite number of answers in the
order in which they appear in the answer book(s): answers beyond that number will not be
considered.
EX
Section A: Answer ALL questions, 10 marks each
1. Compare the impact of a temporary tax cut on consumption on the Keynesian consumption
function and on the permanent income hypothesis.
K
(100 words max)
OC
2. Assuming that the Marshall-Lerner condition holds, illustrate graphically and explain what
effect a real appreciation will have on output, exports, imports, and net exports.
(100 words max)
M
3. Given the linear wage setting equation wW S (yt ) = B + α(yt − ye ) + zw in which B is a
constant reflecting the unemployment benefit and the disutility of work, and zw is the set of
wage-push factors, and using the price-setting rule P = (1 + µ)W/λ in which µ is price
mark-up and λ is productivity. Consider an increase in employment above the equilibrium
level due to a positive aggregate demand shock. Explain (mathematically) how this shocks
affects inflation. Are the assumptions you made in this derivation realistic? Explain.
(100 words, 1 equation = 1 word)
(Continued overleaf)
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4. On February 9, 2018, an article in the Financial Times indicated the following:
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“UK inflation is already well above the BoE’s target, thanks to the Brexit-related fall in
sterling. This has squeezed households’ real incomes and depressed savings rates and
consumer spending. Until recently, policymakers were willing to tolerate higher inflation, in
order to support jobs and activity after the shock of the referendum. But the BoE now sees
clear evidence of wage growth that will feed inflation even as the effects of the depreciation
dissipate. As a result, they expect to raise interest rates “somewhat earlier and by a
somewhat greater extent” than they had previously signalled.” “[UK Exporters] are enjoying
near-perfect conditions as [...] sterling is down some 20 per cent against the euro. [...]
Despite this, exporters are no more inclined to invest in extra capacity than other companies.”.
AM
Explain the reasons behind this decision and why the Bank of England may be concerned
about this.
(100 words max)
K
EX
5. Consider the two-period inter-temporal choice model. A household decides to consume all of
its disposable income in the second period only. The characteristics of the household are
given by:
Y1
Y2
t
r
=
=
=
=
12.500
1.12Y1
0.2 (tax rate)
0.12 (real interest rate)
OC
What is the household’s total disposable income in terms of period 1 consumption? What is
the consumption of this household in periods 1 and 2? If the interest rate increases, do we
observe a positive or a negative income effect on the consumption of period 1?
(100 words max)
M
(include ***all*** the steps of your calculations, equations are not counted in the word limit)
(Continued overleaf)
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Section B: Answer TWO questions
Please use a separate booklet
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6. Assume that an economy is described by the IS curve Y = 3, 600 + 3G − 2T − 150r and the
LM curve Y = 2M/P + 100r. The investment function for this economy is 1, 000 − 50r.
The consumption function is C = 200 + (2/3) (Y − T ). Equilibrium output for this economy
is 4, 000. The price level is 1.
AM
(a) Assume that government spending is fixed at 1, 200. The government wants to achieve
a level of investment equal to 900 and also achieve Y = 4, 000. What level of r is
needed for I = 900? What levels of T and M must be set to achieve the two goals?
What will be the levels of private saving, public saving, and national saving? (5 marks)
(show all the steps of the calculation)
EX
(b) Now assume that the government wants to cut taxes to 1, 000. With G set at 1, 200,
what will the interest rate be at Y = 4, 000? What must be the value of M ? What will
I be? What will be the levels of private, public, and national saving? (5 marks)
(show all the steps of the calculation)
K
(c) Explain which “policy mix” encourages investment most and, under which conditions,
would the central bank change interest rates after the increase in government spending.
(15 marks) (200 words max)
OC
7. In the Monetary Policy Committee (MPC) meeting held in February 2019, the Bank of
England (BoE) retreated from plans for multiple interest rate rises. The BoE cut its forecast
for UK growth to 1.2 from 1.7 per cent for 2019. This is considered one of the largest
near-term forecast revisions since the 2016 EU referendum. The inflation rate in January
2019 was down to 1.8% according to figures from the Office for National Statistics.
M
Using the 3-equation model, explain how central banks set interest rates and illustrate where
the UK economy is in February 2019 and why the Bank of England decided to keep interest
rates unchanged. Under which conditions do you think the Bank of England will move towards
a more contractionary monetary policy? Give some examples of the alternative scenarios.
(300 words max, excluding graphs)
(Continued overleaf)
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8. Use the 3-equation model to discuss whether contractionary fiscal policy should be used in
the case of a positive shock to aggregate demand from improved consumer confidence and
provide alternative policy solutions.
M
OC
K
EX
AM
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(300 words max)
(End)
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