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Econ 100B
Macroeconomic Analysis
Professor Steven Wood
Spring 2013
Exam #1 ANSWERS
Please sign the following oath:
The answers on this exam are entirely my own work. I neither gave nor received any aid while taking this exam. I
will not discuss the questions on this test until after 3:30 p.m. on February 26, 2013.
_______________________________________
Signature
Any exam turned in without a signature will be assigned a grade of zero.
Exam Instructions
1.
When drawing diagrams, clearly and accurately label all axes, lines, curves, and equilibrium points.
2.
Explanations should be written in pencil or black. Legibility is a virtue; practice good penmanship.
3.
Explanations should be succinct and to the point; make use of bullet points and common mnemonics.
4.
If you have a question, ask one of the GSIs. The GSIs have not seen the exam beforehand and can only
provide general guidance. You are totally responsible for your answers regardless of what a GSI has said to you.
5.
If you need to re-draw a diagram and/or need more room to write your answers, use pages 2, 11, 12, 13
and/or 14.
6.
If you finish your exam before 3:25 p.m. you may turn in your exam and quietly exit the room.
7.
If you finish your exam after 3:25 p.m., close your exam packet but remain seated until time is called.
8.
When time is called, STOP writing, immediately CLOSE your exam packet and TURN IN your exam. You
WILL BE PENALIZED if you continue to write past the official end of the exam.
Do NOT open this test until instructed to do so.
Exam #1 (Spring 2013)
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A.
Multiple Choice Questions (30 points). Highlight the best answer (3 points each).
1.
A major advantage of macroeconomic policy based on pre-specified rules might be that:
a. It is more flexible than discretionary policy.
b. It is easier to adapt to short-run economic fluctuations and, therefore, avoid unfavorable short-run
economic outcomes.
c. It is easier to maintain long-run economic considerations and, therefore, avoid unfavorable longrun economic outcomes.
d. All of the above.
e. None of the above.
2.
Which of the following would be counted as an expenditure in the measurement of GDP? (Assume that
none of the transactions is concealed from the government).
a.
b.
c.
d.
e.
3.
The Fisher equation implies:
a.
b.
c.
d.
e.
4.
Expected inflation equals current inflation.
The real interest rate equals expected inflation.
The growth rate of inflation equals the real minus the nominal rates of interest.
The nominal interest rate equals the real rate of inflation minus expected inflation.
None of the above.
As an investor, negative supply shocks are not beneficial because:
a.
b.
c.
d.
e.
5.
Purchase of flour by a bakery.
Purchase of a loaf of bread using food stamps.
Purchase of a lamp at a neighborhood garage sale.
Payment by a mother to her child for doing household chores.
The value of a used automobile that remains unsold on the dealer’s lot.
They tend to reduce total factor productivity.
The real rental cost of capital tends to decline, reducing capital income.
Declines in expected capital income lead to declines in the stock market.
All of the above.
None of the above.
If we observe an economy in which desired saving has changed but there has been no change in actual
investment, then we may infer that:
a.
b.
c.
d.
e.
This is a large open economy.
The trade balance has changed in the same direction as the change in desired saving.
The trade balance has changed in the opposite direction as the change in desired saving.
All of the above.
None of the above.
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6.
There is empirical evidence of a strong negative correlation between income-per-capita and labor force
growth rates.
a.
b.
c.
d.
e.
7.
Government policies to raise the rate of productivity growth include all of the following except:
a.
b.
c.
d.
e.
8.
Reducing the government budget deficit.
Increased spending on public health and education.
Increased spending to build new and repair old infrastructure.
Encouraging both public and private research and development efforts.
None of the above.
The result that the growth rate of output-per-worker is equal to 1.43 * gA is true for:
a.
b.
c.
d.
e.
9.
This is consistent with the Solow growth model.
This is consistent with the Romer growth model.
This is consistent with both the Solow and Romer growth models.
This is consistent with neither the Solow nor the Romer growth model.
This suggests that labor force growth stimulated technological progress.
Only the Solow growth model.
Only the Domar growth model.
Only the Romer growth model.
Both the Solow and Romer growth models.
Neither the Solow nor the Romer growth model.
The quantity theory of money:
a. Validates the classical assumption that wages and prices are completely flexible in the long-run.
b. Provides a better description of fluctuations in inflation and money growth in the short-run than in
the long-run.
c. Suggests that inflation is always and everywhere (in both the short-run and the long-run) a
monetary phenomenon.
d. All of the above.
e. None of the above.
10. Suppose an economy described by the Solow growth model is at its steady-state with its labor force
growing by 2% per year. The central bank then firmly commits to a policy of growing the money supply by
5% per year. Afterwards, there is a sudden, one-time surge in immigration of new workers. According to
the quantity theory of money, as the economy adjusts to a larger workforce:
a.
b.
c.
d.
e.
Inflation remains steady at its original, pre-immigration rate.
Inflation initially increases and then continues at a faster rate.
Inflation initially decreases and then continues at a slower rate.
Inflation initially increases but then gradually returns to its original, pre-immigration rate.
Inflation initially decreases but then gradually returns to its original, pre-immigration rate.
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B. Analytical Questions (70 points). Answer BOTH of the following questions based on the standard models of analysis developed in class. The information in the
various parts of the questions is sequential and cumulative.
1.
Desired Saving – Desired Investment Model (35 points). Suppose that the world economy is composed of only two “large” open economies—Country A
and Country B—and is characterized by perfect capital mobility. Country A experiences persistent net capital outflows throughout the analysis.
a.
Based only on this information, use an open economy Desired Saving – Desired Investment Model diagram for each economy (Country A on the
left, Country B on the right) to clearly and accurately show each economy’s initial equilibrium (1) real interest rate, (2) actual saving, (3) actual
investment, and (4) net export balance. These diagrams should be drawn in BLACK.
Country B
Country A
Sd1
r
Id0
Id0
Sd0
Sd2
Id2
Sd0
NX2 > 0
w
r
2
NX1 > 0
rw1
rw0
NX2 < 0
NX1 < 0
NX0 < 0
NX0 > 0
I1 I0
I2
Exam #1 (Spring 2013)
S1
S0
S2
Sd, Id
S0 S1
S2
Sd, Id
I1 I0
I2
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b. Now suppose that a political impasse in Country A makes it impossible for the country to reduce its
substantial budget deficit. Despite—or maybe because of—this political stalemate, consumers become
much more optimistic about the economy’s future prospects. Incorporating only this new information,
clearly and accurately show in your diagrams above what effects, if any, this would have on each
economy’s equilibrium (1) real interest rate, (2) actual saving, (3) actual investment, and (4) net export
balance. These effects should be drawn in RED.
c.
Provide an economic explanation of what you have shown in your diagrams above. Discuss what, if
anything, happens to each economy’s equilibrium (1) real interest rate, (2) actual saving, (3) actual
investment, and (4) net export balance. Be sure to explain why these effects take place and what causes
them.
The increase in consumer optimism in Country A would increase Country A’s autonomous
consumption at every real income level and reduce Country A’s desired saving at every real
interest rate level. This would be represented by a leftward shift of Country A’s desired saving
function from Sd0 to Sd1. This would also be a decline in the global supply of loanable funds.
At the initial equilibrium world real interest rate of rw0, the decline in Country A’s desired saving
reduces the global supply of loanable funds so that, at rw0, there is now a global excess demand for
loanable funds. As a result of this excess demand, the equilibrium real world interest rate would
increase from rw0 to rw1.
As the equilibrium world real interest rate increases from rw0 to rw1, there would be effects in both
countries.
In Country A, actual saving would increase endogenously along the new desired saving
function Sd1, but combined with the initial exogenous decline in desired saving from the
increase in consumer optimism, actual saving would have declined from S0 to S1. In addition,
actual investment would decline endogenously from I0 to I1 along the desired investment
function Id0. Both actual saving and actual investment have declined. However, because the
decline in actual saving was larger, the net export balance would decrease endogenously from
NX0 to NX1 (i.e., the net export surplus has become smaller). This is also a decline in net capital
outflows or net foreign investment.
In the Country B, actual saving would increase endogenously from S0 to S1 along the desired
saving function Sd0 and actual investment would decline endogenously from I0 to I1 along the
desired investment function Id0. Because actual saving has increased while actual investment
has declined, the net export balance would increase endogenously from NX0 to NX1 (i.e., the net
export deficit has become smaller). This is also a decline in net capital inflows or net foreign
borrowing.
After these adjustments in both countries are complete, Country A’s net export surplus (which is
now smaller) is still equal in magnitude to the Country B’s net export deficit (which is now also
smaller).
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d. Subsequently, in Country B, home prices surge while business executives anticipate positive
developments that will cause the real rental cost of capital to increase substantially over the foreseeable
future. Incorporating only this new information, clearly and accurately show in your diagrams above
what effects, if any, this would have on each economy’s equilibrium (1) real interest rate, (2) actual
saving, (3) actual investment, and (4) net export balance. These effects should be drawn in BLUE.
e.
Provide an economic explanation of what you have shown in your diagrams above. Discuss what, if
anything, happens to each economy’s equilibrium (1) real interest rate, (2) actual saving, (3) actual
investment, and (4) net export balance. Be sure to explain why these effects take place and what causes
them.
The surge in home prices would increase (household) wealth in Country B. This would increase
autonomous consumption at every real income level and reduce saving at every real interest rate
level. This would be represented by a leftward shift of the desired saving function in Country B
from Sd0 to Sd2. This is also a decrease in the global supply of loanable funds.
The substantial increase in the real rental cost of capital (from anticipated positive developments)
in Country B would increase the expected future marginal product of capital. This would lead to an
increase in desired investment at every real interest rate level. This would be represented by a
rightward shift of the desired investment function in Country B from Id0 to Id1. This is also an
increase in the global demand for loanable funds.
At the equilibrium world real interest rate of rw1, the decline in the global supply of loanable funds
combined with the increase in the global demand for loanable funds creates a global excess demand
for loanable funds. As a result of this excess demand, the equilibrium real world interest rate would
increase from rw1 to rw2.
As the equilibrium world real interest rate increases from rw1 to rw2, there would be effects in both
countries.
In Country B, actual saving would increase endogenously along the new desired saving
function Sd2 but, combined with the initial exogenous decline in desired saving from the
increase in home prices, actual saving has declined from S1 to S2. In addition, actual
investment would decline endogenously along the new desired investment function Id2 but,
combined with the exogenous increase in desired investment from the increase in the expected
future marginal product of capital, actual investment has increased from I1 to I2. Because
actual saving has declined while actual investment has increased, the net export balance would
decrease endogenously from NX1 to NX2 (i.e., the current account deficit has become larger).
This is also an increase in net capital inflows or net foreign borrowing.
In Country A, actual saving would increase endogenously from S1 to S2 along the desired
saving function Sd1 and actual investment would decline endogenously from I1 to I2 along the
desired investment function Id0. Because actual saving has increased while actual investment
has declined, the net export balance would increase endogenously from NX1 to NX2 (i.e., the net
export surplus has become larger). This is also an increase in net capital outflows or net foreign
investment.
After these adjustments in both countries are complete, Country A’s net export surplus (which is
now larger) is still equal in magnitude to Country B’s net export deficit (which is now also larger).
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[To be in equilibrium requires that the net export surplus in Country A to be identically
equal in magnitude to the net export deficit in Country B. However, exactly what happens
to the net export balances in each country depends on the slopes of the desired saving and
desired investment functions in both countries and the relative magnitudes of the shifts in
the desired saving functions in both countries and the shift of the desired investment
function in Country B. I have shown a net increase (from beginning to end) in the net
export surplus in Country A and a net increase (from beginning to end) in the net export
deficit in Country B.]
Exam #1 (Spring 2013)
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2.
The Solow Growth Model (35 points). Suppose that Country X is currently in long-run equilibrium.
a.
Based only on this information, use a Solow Growth Model diagram to clearly and accurately show the
economy’s initial (1) capital-to-labor ratio, (2) economic-output-per-worker, (3) investment-per-worker,
(4) balanced investment-per-worker, and (5) steady state. This diagram should be drawn in BLACK.
Y/L, I/L, IB/L
Y/L = A1*f(K/L)
(Y/L)A
Y/L = A0*f(K/L)
(Y/L)S
(Y/L)2
(Y/L)1
IB/L = (δ0 + gL0)*(K/L)
“A”
(I/L)A = (IB/L)A
I/L = s0*A1*f(K/L) – NX0/L
I/L = s0*A0*f(K/L) – NX0/L
(I/L)2
(I/L)S = (IB/L)S
“S”
(I/L)1
(IB/L)1
(K/L)1
Exam #1 (Spring 2013)
(K/L)S
(K/L)A
K/L
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b. Now suppose that Country X experiences a sudden, one-time surge in the immigration of new workers.
Incorporating only this new information, clearly and accurately show in your diagram above what
effects, if any, this sudden, one-time surge in immigration of new workers would have initially on
Country X’s (1) capital-to-labor ratio, (2) economic output-per-worker, (2) investment-per-worker, and
(3) balanced investment-per-worker. These effects should be drawn in RED.
c.
Provide an economic explanation of what you have shown in your diagram above. Discuss what, if
anything, happens to Country X’s (1) capital-to-labor ratio, (2) economic-output-per-worker, (3)
investment-per-worker, and (4) balanced investment-per-worker. Be sure to explain why these effects
take place and what causes them.
A sudden, one-time surge in the immigration of new workers into Country X has four effects.
First, it immediately increases the size of the labor force in Country X. This causes the capitalto-labor ratio to immediately decline from (K/L)S to (K/L)1.
Second, because each worker in Country X now has less capital to work with, economic outputper-worker (and income-per-worker) would also immediately decline from (Y/L)S to (Y/L)1
along the initial per-worker production function, Y/L = A0*f(K/L).
Third, because income-per-worker has declined from (Y/L)S to (Y/L)1 and the national saving
rate has not changed, investment-per-worker (and saving-per-worker) has declined from (I/L)S
to (I/L)1 along the initial per-worker investment function, I/L = s0*A0*f(K/L)-NX0/L.
Finally, because the capital-to-labor ratio has declined from (K/L)S to (K/L)1, balanced
investment-per-worker has declined from (IB/L)S to (IB/L)1 along the original per-worker
balanced investment function, IB/L = (δ0 + gL0)*(K/L). The lower capital-to-labor ratio requires
less investment-per-worker in order to maintain that lower capital-to-labor ratio.
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d. Now suppose that the workers who immigrated into Country X had much more education and training
than the workers who were originally in Country X. Incorporating only this new information, clearly and
accurately show in your diagram above what effects, if any, this would have on Country X’s (1) capitalto-labor ratio, (2) economic-output-per-worker, (3) investment-per-worker, (4) balanced investment-perworker, and (5) steady state. These effects should be drawn in BLUE.
e.
Provide an economic explanation of what you have shown in your diagram above. Discuss the
adjustment process that occurs during the transition period from Country X’s immediate postimmigration situation (parts b and c) to its final steady state. This discussion should include what happens
to Country X’s (1) capital-to-labor ratio, (2) economic-output-per-worker, (3) rate of economic growth
both during the transition period and once the final steady state is achieved, and (4) a comparison of the
rate of economic growth at the economy’s initial and final steady states. Be sure to explain why these
effects take place and what causes them.
Because the workers who immigrated to Country X had more education and training than the
workers who were originally in Country X, the level of human capital in Country X would increase.
A higher level of human capital would increase total factor productivity in Country X from A0 to
A1. This can be represented by an upward rotation of Country X’s per-worker production function
from Y/L = A0*f(K/L) to Y/L = A1*f(K/L); economic-output-per-worker has immediately increased
from (Y/L)1 to (Y/L)2.
In addition, the increase in total factor productivity in Country X from A0 to A1 would cause an
upward rotation of Country X’s per-worker investment function from I/L = s0*A0*f(K/L) to I/L =
s0*A1*f(K/L); actual investment-per-worker has immediately increased from (I/L)1 to (I/L)2.
During the adjustment process:
First, at the capital-to-labor ratio of (K/L)1, actual investment-per-worker, (I/L)2 is greater
than balanced investment-per-worker (IB/L)1, i.e., (I/L)2 > (IB/L)1. As a result of this
imbalance, the capital-to-labor ratio will increase. This process will continue as long as
actual investment-per-worker is greater than balanced investment-per-worker. Once the
capital-to-labor ratio has increased to (K/L)A, a new steady-state has been reached where
actual investment-per-worker, (I/L)A exactly equals balanced investment-per-worker,
(IB/L)A. The capital-to-labor ratio stops changing.
Second, as the capital-to-labor ratio is increasing from (K/L)1 to (K/L)A, economic-outputper-worker is also increasing from (Y/L)2 to (Y/L)A along the new, higher per-worker
production function, Y/L = A1*f(K/L). This process also continues until the economy
reaches a new higher steady state at “A” with a steady-state capital-to-labor ratio of (K/L)A
and steady-state economic-output-per-worker of (Y/L)A.
Third, because economic-output-per-worker is increasing from (Y/L)1 to (Y/L)A, Country
X’s rate of economic growth is greater than its rate of labor force growth, i.e., gY > gL0.
Once the new steady-state economic-output-per-worker is achieved at (Y/L)A, economicoutput-per-worker stops increasing and Country X’s rate of economic growth is now equal
to its rate of labor force growth, i.e., gY(“A”) = gL0.
Fourth, at the economy’s final steady-state at “A”, the rate of economic growth is equal to
the economy’s labor force growth rate, i.e., gY(“A”) = gL0. At the economy’s initial steadystate at “S”, the rate of economic growth was equal to the economy’s labor force growth
rate, i.e., gY(“S”) = gL0. Because the labor force growth rate did not change, the economy is
growing just as fast in its new steady state “A” as it did in its initial steady state “S”, i.e.,
gY(“A”) = gY(“S”).
Exam #1 (Spring 2013)
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