MGEB05 Sample Final Questions
These are some of the past Final exam questions I gave to my students. These questions are
collections from different exams (the total marks do not add up to 100) and are for your
reference only. You should also practice the review and assignment questions again
assigned throughout the term.
Instructions:
 Answer all questions.
 Point form is acceptable.
 You must submit the questions along with your answer booklet; otherwise, you will
receive a grade of ZERO for the whole exam.
 No credit will be given if you do not show your work.
 Label your graph; otherwise, marks will be subtracted.
 If the question has more than one part, label each part of your answer. Latter part(s) of
the question will not be graded if you failed to label your answer.
 Do not write exchange rate increases/decreases, you should state whether the currency
appreciates or depreciates.
 Your answer should be structured in a way that even those with limited knowledge in
economics will understand your argument/answer
Question 1 (15 points)
The economy is currently in its long-run equilibrium. However, there are evidences indicating
that there is an increase in (autonomous) consumption.
a) According to the long-run classical model of a closed economy, what would happen to the
economy’s output, real interest rate and investment? Support your answer by an appropriate
diagram. (6 points)
b) Suppose the government finds the change in real interest rate in part (a) undesirable and
wants to maintain the real interest rate at the initial level, what policy would you recommend
the government to pursue? Explain how the recommended policy could achieve the goal of
the government. Also, how does this recommended policy affect the country’s output, real
interest rate, and investment? Use the diagram your drew in part (a) to support your answer
and discuss the magnitudes of changes of the above macroeconomic variables after your
recommended policy is implemented (compare your answer in part (b) to your answer in part
(a)) (9 points)
Question 2 (15 points)
“The quantity theory of money states that given a constant velocity, there is a one-to-one
relationship between monetary growth rate and inflation rate, even if the growth rate of labour
remains constant.” True/False/Uncertain, explain.
MGEB05 Sample Final Questions
© Iris Au
1
Question 3 (10 points)
a) Between December 2002 and December 2003, total employment increased by 427 400
workers, but the number of unemployed declined by only 182 600. How are these numbers
consistent with each other? Why might one expect a reduction in the number of people
counted as unemployed to be smaller than the increase in the number of people employed?
Explain. (5 points)
b) Statistics Canada announced that in December 2000, of all adult Canadians, 14 974 500 were
employed, 1 015 300 were unemployed, and 8 459 400 were not in the labour force. What
was the labour-force participation rate? What was the unemployment rate? (Keep your
answer in percentage terms and keep 1 decimal point) (5 points)
Question 4 (15 points)
Some labour economists argue that it is useful to think of the labour market as being divided into
two sectors: a primary sector, where “good” (high-paying, long-term) jobs are located, and a
secondary sector, which has “bad” (low-paying, short-term) jobs. Suppose that the primary
sector has a high marginal product of labour and firms pay efficiency wage. Real wage in the
secondary sector adjusts so that the quantities of labour demanded and labour supplied are
always equal. However, workers who cannot find jobs in the primary sector can work in the
secondary sector.
With the aid of 2 labour market diagrams (one for the primary sector and one for the secondary
sector), illustrate and explain the effects of a productivity improvement in the primary sector on
the real wages, employment, and output in both sectors? (Assume an upward-sloping labour
supply curve)
Question 5 (25 points)
Suppose there are only two countries in the world, Foreign and Home. Foreign is a large country
while Home is small country. Currently, Home runs a huge trade deficit. Concerning about the
country’s trade balance, the government of Home begins to look for policy that can correct its
trade deficit. The Home government asks you for recommendation. In addition, the Home
government wants you to use the long-run classical model of a small open economy to evaluate
the long-run effects of your recommended policy on the Home’s key macroeconomics variables
(output, national saving, investment, real interest rate, net foreign investment, net exports, real
exchange rate, nominal exchange rate, price level, and unemployment rate).
What policy would you recommend? What happens to the key macroeconomic variables in the
long run? Explain and support your answer by a set of appropriate diagrams.
Note: You must provide explanation on how your recommended policy affects the key variables
(explain why the variables change or remain unchanged).
Question 6 (10 points)
“To minimize fluctuations in output in a closed economy, the central bank should target the
money supply not the (real) interest rate if shocks originated from the goods market”.
True/False, explain and use ONE IS-LM diagram to support your argument (Only the first
diagram will be graded)
MGEB05 Sample Final Questions
© Iris Au
2
Question 7 (10 points)
Answer the following questions using the IS-LM model and support your explanation by ONE
diagram for all parts. Compare your answer to initial equilibrium. Each part is worth 5 points.
Suppose a closed economy experiences a fall in money demand.
a) What happens to the economy’s output, price, real money balance and unemployment rate in
the short run? Explain.
b) In the absence of intervention from policy makers, what happens to the economy’s output,
price, the real money balance and unemployment rate in the long run? Explain.
c) Suppose the government finds the change in output in part (a) undesirable and wants to keep
output from changing, what kind of policy should the government pursue? What happens to
the real money balance?
d) Suppose the central bank finds the change in output in part (a) undesirable and wants to keep
output constant, what kind of policy should the central bank pursue? What happens to the
real money balance?
Question 8 (15 points)
Use the AS-AD model and ONE AS-AD diagram to answer the following questions. You
should compare your answer to the initial equilibrium.
Suppose a closed economy experiences a favorable shock in the demand for goods and services.
a) What happens to the economy’s output, price, real money balance, and unemployment rate in
the short run? In the long run? Explain. (10 points)
b) Suppose the government finds the short-run change in output undesirable and wants to keep
it from changing, what kind of policy should the government adopt? What is the effect of
this change in policy on the real money balance? Explain. (5 points)
Question 9 (20 points)
Consider the following closed economy:
Consumption: C = 325 + 0.5(Y – T) – 500r
Investment: I = 200 – 500r
Real money demand: L(i, Y) = 0.5Y – 1000i
Expected inflation: e = 0
Money supply: MS = 6000
Full-employment level of output = 1000
Note: Interest rates, i and r, are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
a) Derive the IS and LM equations as functions of exogenous variables. (4 points)
b) The government runs a balanced budget; government purchases (G) and taxes (T) are both
equal to 150. Calculate the full-employment values of the real interest rate, price level,
consumption, and investment. (6 points)
c) Now suppose that government purchases increase to 250 and there is no change in taxes.
Assuming that the economy was initially at full employment, what are the new values of
output, the real interest rate, price level, consumption, and investment in the short run? In the
long run? (10 points)
MGEB05 Sample Final Questions
© Iris Au
3
Question 10 (20 points)
Consider the following closed economy:
Consumption: C = 300 + 0.5(Y – T) – 50r
Investment: I = 250 – 200r
Government spending: G = 300
Taxes: T = 300
Real money demand: L(i, Y) = 0.5Y – 250i
Expected inflation: e = 0
Money supply: MS = 5000
Production function: Y = 6K0.5L0.5
Note: Interest rates, i and r, are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
a) Derive the AD equation for this economy. (6 points)
b) The supply of capital and labour in this economy are 400 and 100 respectively. Calculate the
full-employment values of the output, real interest rate, price level, and real money balance.
(4 points)
c) Now suppose that there is an increase in autonomous investment such that the investment
function become:
I = 350 – 200r
Assuming that the economy was initially at full employment, what are the new values of
output, real interest rate, price level, and real money balance in the short run and the long
run? (10 points)
Question 11 (10 points)
A principal method used by the Bank of Canada to change money supply is open-market
operations. Use the AS-AD model to illustrate graphically and state in words the impacts, in
both short run and long run, of a Bank of Canada’s decision to increase open-market purchases
on output and price.
Question 12 (30 points)
Macroland is a closed economy and is characterized by the following equations:
Consumption: C = 200 + 0.8(Y – T) – 500r
Investment: I = 200 – 500r
Government spending: G = 196
Taxes: T = 20 + 0.25Y
Real money demand: L = 0.5Y – 250i
Expected inflation: e = 0.1
Production function: Y = K1/3L2/3
Note: Interest rates, i and r, are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
Suppose the IS-LM model can used be to describe Macro-land, and answer the following
questions. Keep your answers to a minimum of TWO decimal points (for fractions).
a) Derive the IS and LM equations for this economy. (4 marks)
b) The supply of capital and labour in this economy are both equal to 1000; and the level of
money supply is 9890. Calculate the long-run or full-employment values of the output,
MGEB05 Sample Final Questions
© Iris Au
4
consumption, investment, real interest rate, public saving, private saving, national saving,
and price level. (5 marks)
c) Now suppose the central bank of Macro-land undertakes open market sales (of assets). As a
result, the level of money supply falls to 9200. Assuming that the economy was initially at
full employment, what are the new values of output, consumption, investment, real interest
rate, public saving, private saving, national saving, and price level in the short run and the
long run? (5 marks)
Now, instead of using the IS-LM model, the AS-AD model is used to describe Macro-land.
Note: DO NOT convert aggressively round your decimal places when you are solving for the
answers, please keep them in fractions with a reasonable number (two or three) of decimal
places. You can report your final answer in decimal form and with a minimum of TWO
decimal places.
d) Derive the AD equation. (5 marks)
e) Redo part (b) using the AS-AD model. (3 marks)
f) Redo part (c) using the AS-AD model. (3 marks)
Now compare your answers in the previous parts (part A to part F).
g) Do you get the same answer by using IS-LM model and AS-AD model to solve for the
equilibriums? Explain (in words and support by ONE IS-LM and ONE AS-AD diagram)
your findings on output, consumption, investment, real interest rate, public saving, private
saving, national saving, and price level in the short run and the long run when the central
bank of Macro-land carries open market sales. (5 marks)
Question 13 (10 points)
Consider a small open economy that has a flexible exchange rate regime, and it can be described
by the following set of equations:
Consumption: C = 1000 + 0.75(Y – T)
Investment: I = 800 – 10r
G = 200
T = 200
NX = 750 – 100e
Real money demand: L(i, Y) = Y – 50i
Expected inflation: e = 0
Note: Both nominal and real interest rates are expressed in percentage points. For example, if r =
10, then r = 10%.
a) Derive the IS* and LM* equations in terms of exogenous variables if the world interest rate
is 10%. (4 points)
b) Suppose the level of money supply is 7000, the domestic price level is 2 and the foreign price
level is 6. Find the equilibrium values of output, net exports, nominal exchange rate, and real
exchange rate. (6 points)
MGEB05 Sample Final Questions
© Iris Au
5
Question 14 (15 points)
Consider a small open economy and it can be described by the following set of equations:
Consumption: C = 2500 + 0.75(Y – T) – 2500r
Investment: I = 3500 – 2500r
G = 1500
T = G + 500
NX = 2000 – 75e
Real money demand: L = 0.4Y – 500r
Note: Real interest rates are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
a) Derive the IS* and LM* equations in terms of exogenous variables if the world interest rate
is 20%. (4 points)
b) Suppose the level of money supply is 22500 and the domestic price level is 5. Use the IS*
and LM* equations from part (a), find the short-run equilibrium levels of output, nominal
exchange rate, private saving, and net foreign investment if the economy has a flexible
exchange rate regime. (6 points)
c) Now, suppose the economy fixes the nominal exchange rate to 40 and the price level is 5.
Use the IS* and LM* equations from part (a), find the short-run equilibrium levels of output
and money supply that are consistent with the fixed exchange rate. (5 points)
Question 15 (15 points)
“According to the Mundell-Fleming model (Y-e diagram), fiscal policy is effective under a
flexible exchange rate regime but is ineffective under a fixed exchange rate system”. Discuss
and support your answer with ONE diagram (only the first diagram will be graded).
Question 16 (20 points)
The economy in question is a small open economy with perfect capital mobility. Due to the
collapse of the real estate market, households find their wealth drop by 20%. In attempt to make
up of this loss of wealth, households save more and consume less.
(Hint: Compare your answers in both parts to the initial equilibrium)
a) Use the Mundell-Fleming/IS-LM model (Y-r diagram) model to show (both in graph and
words) the effects of this change on the country’s output, real interest rate, nominal exchange
rate, real exchange rate, and net exports in the short run if the economy has a flexible
exchange rate. (10 points)
b) Redo part (a) if the economy has a fixed exchange rate. (10 points)
Question 17 (15 points)
“A fall in the real money demand will lead to changes in output and unemployment rate in a
closed economy but no changes in these variables in a small open economy that has a fixed
exchange rate in the short run.” True/False/Uncertain, explain with the aid of ONE Y-r diagram
(only the first diagram will be graded).
MGEB05 Sample Final Questions
© Iris Au
6
Question 18 (20 points)
Home is a small open economy while Foreign is a large open economy, and Home has a flexible
exchange rate. Besides, both countries are in their long-run equilibrium. Now, to lower its
budget deficit, the Foreign government lowers its spending.
Note: For both parts, you must provide explanations why the variables of interest change or
remain unchanged in order to receive any credit.
a) Use the Mundell-Fleming model (Y-r graph) to illustrate graphically and explain in words
the short-run effects of this change on Home’s output, net exports, real exchange rate,
nominal exchange rate, and real money balance. Only the first diagram will be graded. (10
points)
b) Use the long-run classical model of a small open economy to show, in graphs and words, the
long-run effects this change on Home’s output, net exports, real exchange rate, nominal
exchange rate, and real money balance. (10 points)
Question 19 (20 points)
Consider a small open economy with perfect capital mobility that adopts a flexible exchange rate
system. Also, the economy is initially in its long-run equilibrium. Suppose a computer virus has
destroyed most of the country’s payment system and, as a result, money becomes the primary
method to facilitate transactions.
a) Use the Mundell-Fleming to show the effect of this change on the country’s output, real
interest rate, nominal exchange rate, real exchange rate, price level, and net exports in the
short run. Support your answer in words and TWO diagrams (Y-e diagram and Y-r diagram)
(12 points)
b) Now use the long-run model of a small open economy (with appropriate diagrams) to show
the long-run effect of this change on the country’s output, real interest rate, nominal
exchange rate, real exchange rate, price level, and net exports. (8 points)
Question 20 (20 points)
Home is a small open economy that has a fixed exchange rate and perfect capital mobility. It is
also producing at its long-run production capacity. Recently, a trade dispute between Home and
Foreign has been resolved, and the government of Foreign removed its 27.5% tariff on Home
products.
Note: For both parts of the question, you must provide explanations why the variables of interest
change or remain unchanged in order to receive full credit.
a) Use the Mundell-Fleming model (Y-e graph) to illustrate graphically and explain in words
the short-run effects of this change on Home’s net exports, real exchange rate, nominal
exchange rate, national saving, and real money balance. Only the first diagram will be
graded. (10 points)
b) Use the long-run classical model of a small open economy to show, in graphs and words, the
long-run effects of this change on Home’s net exports, real exchange rate, nominal exchange
rate, national saving, and real money balance. (10 points)
MGEB05 Sample Final Questions
© Iris Au
7
Question 21 (10 points)
The economy in question is a closed economy and can be described by the IS-LM model.
Different proposals have been submitted to the government on how fiscal policy should be
conducted and these proposals are:
Proposal 1: Use fiscal policy to target real interest rate
Proposal 2: Use fiscal policy to target real output
Which of the above proposal(s) would minimize short-run fluctuations in investment if there
were a reduction in autonomous consumption? Explain and support your answer by ONE ISLM diagram (only the first diagram will be graded).
MGEB05 Sample Final Questions
© Iris Au
8