Agricultural Economics 430
Macroeconomics of Agriculture
Fall 2009
Penson
Second Hour Examination
NAME: _____ANSWER KEY___________________________
SID NUMBER: ______________________________
This examination consists of six questions. Please read each question carefully. The
term “describe fully” asks that you answer all aspects of the question. Avoid giving
extraneous information (i.e., “filler”). Use graphs/formulas whenever possible to help
tell your story. Use the back of the page if necessary. Good luck!
Question 1 _____ of 20 points
Question 2 _____ of 20 points
Question 3 _____ of 15 points
Question 4 _____ of 15 points
Question 5 _____ of 10 points
Question 6 _____ of 20 points
TOTAL
_____ of 100 points
2
1. Please complete the following table describing the short-run effects of specific
macroeconomic policy actions with a “+” denoting an increase in the variable in each
column heading and a “–” denoting a decrease. (20 points; 1 point each)
Macroeconomic
policy action
Federal Reserve
raises the discount
rate
Congress and White
House increases the
income tax rate
Federal Reserve
buys government
bonds
Congress and White
House increase the
level of government
spending
Exchange
rate
Inflation
rate
Unemployment rate
Market
interest
rate
GDP
growth
rate
+
-
+
+
-
-
-
+
-
-
-
+
-
-
+
+
+
-
+
+
3
2. We have used IS/LM analysis to capture the equilibrium in the nation’s product and
money markets. We also related this equilibrium to the individual markets and the
actions of individual producers. Current macroeconomic policy consists of
expansionary fiscal policy and expansionary monetary policy. (20 points)
a. Please graph the effects of these policy actions on the general equilibrium in the
nation’s money and product markets.
LM1
IS2
IS1
LM2
i1=i2
Y1
Y2
b. Given the effects of the monetary and fiscal policy effects drawn in your answer
to part a above, please illustrate the effects this would have on the U.S. wheat
market in an open economy and the impact on an individual producer’s economic
profit.
Average profit would increase from spread between yellow dots to the green dots and
total profit will increase since the quantity produced increased.
4
3. Please define or graphically illustrate (make sure you label graphs) each of the
following terms: (15 points; 3 points each)
General equilibrium
Draw an IS-LM graph indicating that general equilibrium occurs where these
two curves cross or intersect. Levels of interest rate and national income where
the money and product markets are in equilibrium.
Inflationary gap
Draw an aggregate product market graph showing that aggregate demand
equals aggregate supply where planned levels of spending exceed full
employment output.
Total reserves
Element in the money supply equation reflecting the amount of hard money in
the economy. When multiplied by the money multiplier, the level of total
reserves determines the level of the money supply.
Cost push inflation
Draw the aggregate product market showing aggregate supply curve shifting to
the left, pushing up the general price level. Can also show the labor market
graph where a shift in the labor supply curve to the left or higher demand for
labor pushes up wage rates in the economy.
Exchange rate
The rate of exchange in one currency for another. Influenced by US market
interest rate relative to interest rate in the rest of the world.
5
4. Given the following demand and supply equation for a market, please answer the
questions below
MS = 1/rrm(TR)
MD = 45 –125(i) + 1.0(Y)
MS ≡ MD
where i represents the rate of interest, Y represents national income, rrm
represents the fractional reserve requirment ratio, and TR represents total
reserves.
Assume national income in 2008 was $1,200 and is projected to be 5 percent
higher in 2009. Also assume the reserve requirement ratio is 0.25 and total
reserves are equal to 140. (15 points)
(SHOW ALL WORK FOR FULL CREDIT)
a.
What market clearing interest rate would you project for 2009?
MS = (1/.25)(140) = 4(140) = 560
MD = 45 – 125(i) + 1.0(1.05(1200))
560 = 45 – 125(i) + 1260
125(i) = 45 + 1260 – 560
i = 745/125 = 5.96%
b.
What level of the money supply would be needed to achieve a market interest
rate in 2009 of 8 percent? (Hint: using percentage rather than decimal
equivalent; e.g., using12 rather than .12)
MS = 45 – 125(8) + 1260
= 1305 – 125(8)
= 305
c.
Illustrate the curve that represents a series of equilibrium interest rates for a
given set of national income levels?
i
LM curve
Y
6
5. We discussed the “Big 5” macroeconomic variables and their effects on
agriculture. Some of these variables have a bigger impact than others. Please
identify each of these variables and the nature of their effect. Which variables do
you expect have the biggest impact and which have a relatively minor impact? (10
points)
Interest rate – an increase in the interest rate will increase farm interest
expenses, lower net farm income and depress farm land values.
Exchange rate – an increase in the value of the dollar relative to other
currencies will dampen export demand for farm products, depress farm
commodity prices and lower net farm income and farm land values.
Rate of growth in GDP – a decrease in this growth rate will lower disposable
incomes, which shifts the demand curve for farm products to the left. The low
income elasticity of demand for farm products will minimize this effect relative
to other sectors in the economy. Lower commodity prices will reduce net farm
income and affect farm land values as well.
Unemployment rate – an increase in the unemployment rate will affect the
availability and wage rates for jobs off the farm sought by farm operator
families. The level of off-farm income earned by farm operator families is
generally higher than net farm income.
Inflation rate – an increase in inflation will be passed along to farmers in the
form of high farm input prices. Remember farmers are price takers in these
markets.
Interest rates, exchange rates and inflation rates have the biggest effect on
agriculture while the unemployment rate (not all farmers also work off the
farm) and rate of growth in GDP (low income elasticity) have the least effect.
7
6. Given the following set of graphs, please briefly describe in the box below how
you characterize the product market in this economy. Please graphically illustrate
how you would change fiscal policy in the first graph below, indicating in the box
which specific policy you chose and the impact on the federal budget. Then
illustrate its effects on the remaining four graphs. (Hint: draw shifts in curves with
directional arrows) (20 points)
G
Problem in product market:
Recessionary gap in the aggregate product
market, where planned spending is less than
full employment output.
T
T1
Specific choice of policy tool and why:
Can use either tax cut (drawn) or increase in
government spending to eliminate this gap.
Impact on federal budget:
Both policies will lead to an increase in the
budget deficit in the current period.
h
Yt-1
AD1
AD
AS
P1
P
C1
C
AC
Y–T Y1-T1
YPOT
Y
YFE
LD1
LD
LS
WR1
U
WR
U1
L L1
%P %∆P1