Intermediate Macroeconomics 311 (Professor Gordon)
First Mid-Term Examination Fall, 2007
YOUR NAME:
Circle the TA session you are attending:
Costel Friday 9AM
Costel Friday 3PM
Jerry Friday 9AM
Jerry Friday 3PM
INSTRUCTIONS:
1. The exam lasts 1 hour.
2. The exam is worth 60 points in total: 30 points for the three analytical questions, and
30 points for the multiple choice questions.
3. Write your answers to Part A (the multiple choice section) in the blanks on page 1.
You won’t get credit for circled answers in the multiple choice section.
4. Place all of your answers for part B in the space provided.
5. You must show your work for part B questions. There is no need to explain your
answers for the multiple choice questions.
6. Good Luck!
PART A
Answer multiple choice questions in the space provided below.
USE CAPITAL LETTERS.
1. __B__
6. __D__
11. __B__
16. __A__
21. __D__
26. __B__
2. __D__
7. __A__
12. __B_
17. __B__
22. __E_
27. _ D _
3. __B__
8. __A__
13. __D__
18. __B__
23. __E__
28. __E _
4. __A__
9. __E__
14. _ D__
19. __B__
24. __C__
29. __D__
5. __E__
10. __E__
15. __C__
20. __A__
25. __D__
30. __C _
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1) The output gap is zero when
(a)
Actual real GDP > Natural real GDP
(b)
Actual real GDP  Natural real GDP
(c)
Actual real GDP < Natural real GDP
(d)
Natural real GDP  0.
2) Total expenditures on final product are
(a)
C  I  G  IM.
(b)
C  S  T  EX.
(c)
C  I  S  EX.
(d)
C  I  G  EX – IM.
3) The leakage and injections approach implies that the government surplus is equal to
(a)
private saving less private investment plus net exports.
(b)
private investment less private saving plus net exports.
(c)
private investment plus private saving plus net exports.
(d)
None of the above
4) In national income accounting, (S  T) is
(a)
the portion of total income not consumed.
(b)
net national product.
(c)
the government deficit.
(d)
the final output firms absorb as investment.
5) Suppose that in our economy: G  1100, T  900, S  140, and NX  –90. How much
of our final product is used for investment?
(a)
110
(b)
200
(c)
230
(d)
50
(e)
30
6) A change in nominal GDP sums up changes in
(a)
prices alone.
(b)
physical production alone.
(c)
physical production and hours of production time.
(d)
physical production and prices.
7) In the consumption function, when disposable income is zero, consumption is
(a)
Ca.
(b)
–cT.
(c)
+cT.
(d)
–Ca.
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8) Which element of total planned expenditure is not included in “autonomous planned
spending?”
(a)
cY
(b)
–cT
(c)
NX
(d)
Ip
(e)
Ca
9) The multiplier is defined as the ratio of a change in income to the
(a)
marginal propensity to save.
(b)
marginal propensity to consume.
(c)
change in the marginal propensity to consume causing it.
(d)
change in the marginal propensity to save causing it.
(e)
change in planned autonomous spending causing it.
10) Should autonomous consumption rise by one dollar, the effect of this on equilibrium
income can be offset if autonomous taxes are
(a)
raised by one dollar.
(b)
lowered by one dollar.
(c)
raised by c dollars.
(d)
lowered by c dollars.
(e)
raised by (1/c) dollars.
11) According to the first reading item (1-1) in contrast to the unconditional advocacy of
full employment in the first two decades of the postwar era, after 1970 the goal changed
to
(a)
zero inflation
(b)
full employment until the inflation rate goes up
(c)
full employment until the inflation rate goes down
(d)
steady inflation neither going up nor going down
12) Which of the following statements is true about Irish politicians?
(a)
When they brag about their policies they refer to GNP
(b)
When they brag about their policies they refer to GDP
(c)
When they want regional subsidies from the EU they refer to GDP
(d)
None of the above
13) In the consumption function C  Ca  c(Y – T), induced consumption is
(a)
Ca  c(Y – T)
(b)
Ca  cY
(c)
cY
(d)
c(Y – T)
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14) In equilibrium,
(a)
income  planned expenditures.
(b)
unintended inventory investment is zero.
(c)
Ep (planned expenditures) crosses the 45-degree income line.
(d)
all of the above.
15) If the interest rate were to fall, we expect that
(a)
the supply of money will fall.
(b)
the supply of money will rise.
(c)
autonomous planned spending will rise.
(d)
the demand for money will fall.
16) The “velocity” of money is
(a)
the ratio of real GDP to the real money supply.
(b)
the real money supply divided by the real GDP.
(c)
the money supply divided by the price level.
(d)
the money supply multiplied by the price level.
17) Along a downward-sloping money demand schedule, as the interest rate falls
(a)
the quantity of money demanded falls.
(b)
the quantity of money demanded rises.
(c)
real income rises.
(d)
real income falls.
18) When the demand for money becomes less responsive to changes in income, the LM
curve becomes ________ and it also shifts to the _______.
(a)
flatter, left
(b)
flatter, right
(c)
steeper, left
(d)
steeper, right
19) If a given fiscal policy is fully accommodated by monetary policy, then
(a)
GDP will remain constant.
(b)
the interest rate will remain constant.
(c)
GDP and the interest rate will move in the same direction.
(d)
GDP and the interest rate will move in the opposite direction.
20) An increase in the real money supply will have its maximum effect on the
equilibrium level of GDP when the
(a)
LM curve is vertical.
(b)
LM curve is horizontal.
(c)
IS curve is vertical.
(d)
IS curve is negatively sloped.
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21) The article advocating “Green NNP” argues that
(a)
GDP must be adjusted downwards for the depletion of natural resources
(b)
GDP must be adjusted downwards for the depreciation of physical assets
(c)
NNP must be adjusted downwards for the depreciation of physical assets
(d)
A and B
(e)
A and C
22) An article reports that two million men have dropped out of the labor force since
1995. As a counterpart of this:
(a)
More men are receiving disability payments
(b)
More men are in prison
(c)
More men are discouraged workers
(d)
A and B
(e)
A, B and C
23) The U.S. saving rate was almost zero in 2005-07. At the same time
(a)
Household net worth fell
(b)
Household net worth rose
(c)
Saving fell as owners of stock paid capital gains taxes
(d)
Consumption fell as owners of stock paid capital gains taxes
(e)
B and C
(f)
B and D
24) Complete “crowding-out” describes the situation in the economy when
(a)
fiscal policy is effective in changing output.
(b)
the shift in the LM curve by monetary policy is “impotent.”
(c)
the shift in the IS curve by fiscal policy is “impotent.”
(d)
fiscal policy crowds out monetary policy.
25) The three ways of reducing a government budget deficit are to
(a)
decrease government spending, reduce consumption, increase the tax rate.
(b)
increase government spending, decrease real income, reduce the tax rate.
(c)
decrease government spending, increase real income, reduce the tax rate.
(d)
decrease government spending, increase real income, increase the tax rate.
26) Domestic Income is equal to
(a)
GDP-Indirect Business Taxes
(b)
GDP-Indirect Business Taxes-depreciation
(c)
GDP-Indirect Business Taxes-depreciation-Social security contributions –
corporate taxes
(d)
none of the above
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27) In the IS-LM Model, a reduction in government purchases of goods and services (G)
tends to
(a)
raise equilibrium investment
(b)
crowd out investment
(c)
reduce equilibrium output
(d)
A and C
28) Which of the following concerns may limit the amount by which the Fed reduces
interest rates to deal with the sub-prime mortgage crisis
(a)
Fear of higher inflation
(b)
Fear of higher unemployment
(c)
Moral hazard
(d)
Fear of falling household wealth
(e)
A and C
(f)
B and D
29) When the Economist argues that it’s “a good time for a squeeze”, how does it
support its position?
(a)
Profits have been high for years so companies have lots of cash
(b)
American consumers are debt-laden and are being battered by falling house prices
(c)
Emerging markets (less developed countries) have large foreign exchange
reserves
(d)
A and C
(e)
B and C
30) According to the Business Week article “Our Hidden Savings” which of the following
is not true?
(a)
Over the past decade U. S. stock prices went up far more than in Europe or Japan
(b)
Low U. S. saving requires borrowing from foreigners
(c)
The U. S. spends less on higher education than in Europe or Japan
(d)
The U. S. has a lower national saving rate than Europe or Japan
(e)
R&D spending is not counted as part of GDP
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PART B
Question 1. (10 pts)
China is very fast growing economy today. The GDP/person for China is $3,000, it is
growing at 8% per year, on the other side, U.S GDP/ person is 30,000, and it’s growing at
4% per year. So how many years does it take for China to surpass U.S? What if U.S
GDP/person is growing at 5% per year?
Suppose it takes (x) years and GDP at that time is G, so
0.08 = LN(G/3000)/x
0.04 = LN(G/30000)/x
(1)
(2)
Solves these two equations, we get:
X= 57.6 yrs
If U.S GDP grows at 5% per year,
X=76.8 yrs
Note 1: This is supposed to be a very easy question, especially after Professor has
recommended that you look at the growth rate formula. But I don’t understand why so
many people have failed in this question. In my impression, about 2/3 of the students
have problem in this question.
Note 2: Some students hate the natural log way of solving question. They resorted to
common sense, such as:
3000 * ( 1+0.08) n = 30000 * ( 1 + 0.04 ) n ,
By this way you will get slightly different answer like 61 yrs and 82 yrs, although I
prefer the standard solution, I don’t want to be considered too stiff, so I gave this solution
80% of the score.
Note 3: if you do any attempt which I think is serious, no matter how wrong you are, I
will give you 1-3 points,
If you write down the correct equation and fail to solve it, I give you 4-7 points
depending on how close you are.
If you are almost correct but only wrong at the last number, I will give 7.5 – 8
points.
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Note 4: Some students write down the correct equation but fail in go through the process
such as put “log” on both sides of the equation, I think it is a very very pity thing. I
suggest them go back to their math manual and seriously practice some basic math.
Question 2. (10 pts) Consider an economy described by the following equations:
C = CA + c(Y – T)
c = .4
CA = 3000 – 20r
T=500+.2Y
Ip = 1000 – 10r
G = 1500
NX = 100 – .12Y
(M/P)d = .2Y – 40r
Ms/P = 10
A) Derive the IS and LM curves. (2 points)
k=1/(.6*(1-.2)+.2+.12)=1.25=5/4
Ap=3000-20r -.4*(500)+1000-10r+1500+100=5400 -30r
IS: Y=1.25*(5400-(20+10)r) so:
IS Curve
Y = 6750 – 37.5r
or
r = 180 – (1/37.5)Y = 180 - .02667Y
LM: 10 = .2Y – 40r so:
LM Curve
Y = 50 + 200r
or
r = -(1/25) + (1/200)Y = -.25 + .005Y
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Note 1 : LM curve is very easy to solve. IS curve is not hard either, many people mainly
fail to get correct Ap or k. Mostly if you just make numerical error , I only deduct 0.5
points, but since this directly affect your answer in question (b) , so in fact people who
make numerical question suffer 1.5 points of loss.
Note 2 : some people include Y in Ap, this is very serious crime, so I deduct 1 point from
that error.
Note 3 : some people write Ap = 5400 ( excluding 30r), which is fine because it is only
process of calculating IS curve.
B) Find the equilibrium real output and interest rate, respectively Y1 and r1. (2 points)
Y = 6750 – 37.5r
-(Y = 50 + 200r)
0 = 1750 – 237.5r
So,
r1 = 28.2105
Y1 = 5692.11
Note 1: As long as you write down the equation, you normally get 1 pt, but as I have said,
if you make a numerical mistake, I can only give 1pt.
C) Suppose that consumer confidence plummets and causes CA to drop by 60, ceteris
paribus. Now suppose the government is considering taking action to restore output in the
economy to the level you computed in part b, (i.e. before the negative shock to consumer
confidence). Determine the magnitude and direction of change in the following policy
variables needed to restore output to its desired level. Also compute the ending interest
rate (r2), that is, the prevailing interest rate after the government has taken action.
(i) Autonomous Taxes (TA) (3 points)
Need to make Ap = 5400 again. So:
5400 = (3000-60) –.4*(500+ΔTA)+1000+1500+100
So,
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ΔTA = -150
r is unchanged because we are just shifting the IS curve back to its original position,
so:
r2=28.2105
Magnitude of Change in Taxes (TA) = 150
Direction of Change = drop
Ending Interest rate (r2) = 28.2105
Note1: grading policy is :
if you get right magnitude, 1 pt
If you get right direction, 1pt
If you get right interest rate 1pt, ( even you get a wrong
number, if you can point out that r is the same as in b, you get full points in this part)
(ii) Real Money Supply (Ms/P) (3 points)
New IS Curve: Y = 1.25*(5400-60 – 30r), Y = 6675 – 37.5r
Desired Output must lie on this new curve:
5692.11 = 6675 – 37.5r, so new r must be:
r2=26.2105
So New LM curve must be defined by:
10 + Δ(Ms/P) = .2*(5692.11) – 40*(26.2105)
So,
Δ(Ms/P) = +80
Magnitude of Change in Taxes (Ms/P) = 80
Direction of Change = increase
Ending Interest rate (r2) = 26.2105
Note1: grading policy is the same as the above one.
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Question 3: (10 pts)
The liquidity trap
Japan was once the economic star of Asia, but during 1990s and early year this century it
suffers the longest economic stagnation in history. (see Table 1) One possible explanation
is the liquidity trap.
Table 1 GDP growth and annual nominal interest rate in Japan from 1991 to 2003
Real GDP growth
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Annual nominal interest rate
( in percentage)
5.63
3.69
2.31
1.75
1.02
0.50
0.50
0.50
0.50
0.50
0.23
0.10
0.10
3.8
1.0
0.3
0.6
1.5
3.9
2.0
-2.5
0.2
2.8
0.4
-0.3
2.1
(a) Looking at the interest rate shown in Table 1, is there a natural lower limit R0 of
nominal interest rate? Explain. (2pts)
Yes, ( 0.5 pt) nominal R cannot be negative, R0 = 0, ( 1 pt) People cannot pays to
buy a zero interest bond, they would rather spend it today. (0.5 pt)
Note1: people mostly are confused by the number table, however, think about this, if you
are governor of Band of Japan and I bring a piece of the table in front of you, do you
really believe you cannot lower interest rate than 0.1? If you try to persuade me, you at
least should persuade yourself.
Note 2: I admit that in real life, it is possible that 0.10 or 0.05 or any small number could
be the limit of a specific central bank can achieve at a certain time, but it is not natural
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one. If we live under a military dictatorship, it might even be possible that we are forced
pay national bank to deposit. But it is not natural.
Note3: the point of putting GDP there is to show that lower interest really fail to generate
sustained GDP growth, I didn’t mean to confuse you guys.
(b) Suppose (M/P)d = 1/R, what would happen for money demand function when R is
approaching R0? (1pt)
If vertical axis is R , and horizontal axis is M/P, then the function will become
flat when R approach 0, M/P will approach +infinity.
Note 1: If you correct recognize that (M/P)d will increase, you get 0.5 pts.
(c) What happens to the LM curve if interest rate is very close to R0? (2pts)
When R is close to zero, LM curve will be very flat. Consider this, for R
approaching R0, Y/R=(M/P)s is very large, so R = (1/ (M/P) ) * Y is a linear curve
with slope approaching zero. So LM curve is flat.
Note: if you read Professor’s book, this question is very easy. (although detailed
reasoning needs more work). Someone said: “LM curve is shifting right”, but this is an
unwarranted answer, because 1) we asking a static thing when equilibrium R is small
instead of moving R . 2) even we are moving R, we are not necessarily moving LM.
People who answer something like this but correctly mention LM is flat somewhere else
in the exam, I will count that you actually know what the answer is, and I give you 1pt.
For someone who never shows that he/she knows the answer, I am sorry about that.
(d) Take your LM curve obtained in (c), suppose that interest rate is very close to R 0, and
the central bank increases the supply of money. What happens to the interest rate at a
given level of income?
Interest rate will hold almost the same. ( it actually drops very little bit in
theory)
(e) Suppose IS curve is linear function with negative slope, can an expansionary
monetary policy alone increase output when the interest rate is already very close to
R0? Briefly explain.
No! If LM curve is nearly flat, then moving LM curve rightward won’t increase
Y much, in extreme case, if LM is perfectly horizontal, moving LM rightward won’t
make difference at all.
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(f) Now can you propose any policy that might save the country out of trap? ( Hint:
consider IS curve now)
Use expansionary fiscal policy to move IS curve rightward to increase output,
and induce inflation.
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