SAMPLE FINAL EXAMINATION
Economics 122a.
Mr. Nordhaus
[Note to students for the Fall of 2010. This exam covers slightly different
material than this year’s course. So the questions may not all be relevant. But
the general style will help you get an idea of the type of test.]
This is a 3½ hour test. There are four parts. Points are proportional to minutes. Put
your name, college, TA, and class on each blue book.
Please write each part in a separate blue book.
Your examination will be judged on the soundness of your macroeconomic analysis
and the quality of your writing. Long and rambling answers will be penalized. No electronic
equipment of any kind is allowed.
Part I. Shorties (45 minutes)
A. The Fed at Work (15 minutes)
On December 11, 2007, the FOMC stated, (a) “Incoming information suggests that
economic growth is slowing, reflecting the intensification of the housing correction and
some softening in business and consumer spending.” Further, it stated, (b) “The Federal
Open Market Committee decided today to lower its target for the federal funds rate 25 basis
points to 4¼ percent.” Explain the mechanism by which the step announced in (b) would
help alleviate the concern expressed in (a).
B. Myths of Macroeconomics (15 minutes)
The following are two common myths about macroeconomics. Do each. (a) In your
answer, explain the error in the myth. (b) Restate the proposition correctly. (One-half
page each is sufficient.)
1.
“Eliminating the federal budget deficit will automatically eliminate the current
account deficit.”
2. “Budget deficits cause recessions.”
C. The Economic History Channel (15 minutes)
Each of the following was a major macroeconomic event. Describe each briefly and explain
its significance in economic history. Do two. (No more than one-half bluebook page each.)
1. The crash of 1929
-1-
2. The Fed-Treasury Accord of 1951
3. Kennedy-Johnson tax cuts
4. Britain leaves gold
Part II. (45 minutes) Macro problems. Do both parts
A.
Income and consumption for Jean Eli (20 minutes)
Jean Eli, a Yale student, is assumed to have the following profile of income in thousands of
constant 2007 prices over Jean’s lifetime (the periods are decades starting with age 20-29):
Year
1
2
3
4
5
Income
1250
1750
3500
2500
0
For this example, assume that the real interest rate is zero and that the discount rate on
utility is zero, and that Jean has the same utility function in each period.
(1)
Derive the optimal consumption and savings path for Jean assuming that Jean
can borrow against future earnings.
(2)
Do (1) assuming that Jean cannot borrow against future earnings (but they can
save).
(3)
What are the MPC from a one-time windfall income splash in period 2
according to assumptions in (1) and (2)?
(4)
Assume that the government enacts a social security program that taxes people
10 percent of earnings in their working years and pays benefits (transfer
payments) equal to the present value of their taxes in the 5th period. Calculate the
impact of this program on Jean’s consumption and savings under (1) and (2).
-2-
B.
Some macroeconomic modeling (25 minutes)
Consider the closed economy of Eliland, which has excess capacity and has the
following behavior.
Consumption: C = 200 + 0.75 (Y – T)
Investment: I = 200 – 25 r
The real interest rate is r, while the nominal interest rate is i (in percent per year)
Government purchases (G) are 100 and taxes (T) are 100.
Money demand: (M/P) = Y – 100 i.
The price level is 2.
The money supply is 1000.
(1)
(2)
(3)
Derive the IS curve and graph it.
Derive the LM curve and graph it.
Find the equilibrium nominal interest rate, real interest rate, and output both
numerically and using the IS-LM diagram
(4)
Suppose that a war starts and government purchases rise by 50. Graph the
change in the IS-LM curves and find the new equilibrium.
(5)
What is the multiplier of real output with respect to government purchases?
(6)
Is money neutral in this economy? Explain your answer.
-3-
III. (45 minutes total)
A.
Depressionomics (15 minutes)
Friedman and Schwartz argued that the Depression could have been made less
severe if the Federal Reserve had increased the money supply more rapidly. Tobin argued
that an increase in the money supply would have had no effect on output. Explain each and
provide a brief evaluation.
B.
“To grow or not to grow, those are the questions” (30 minutes)
Assume (in the spirit of the 1994 Economic Report of the President) that the economy can be
represented by the following Cobb-Douglas production function:
Yt  A t K 0.5
L0.5
t
t
where Yt  potential output in year t, A t  total factor productivity in year t,
K t  capital in year t, and L t  labor inputs  population in year t.
(i)
Assume that this is a closed economy, that the national savings rate is 40 percent
of GDP, that the depreciation rate is 17 percent per year, that population
growth is 3 percent per year, that total factor productivity is constant, and that
At = 1. Derive the steady-state levels of per capita GDP and per capita
consumption. What are the steady state growth rates of GDP and
consumption?
Starting in a steady state, assume that the savings rate increases to 80 percent of output.
What are the new steady-state levels of per capita GDP and per capita consumption? Draw a
diagram which shows the change between (i) and (ii) with Y/K and K/L on the axes.
(ii)
What is the “golden rule of capital accumulation”? Is the economy
accumulating more or less than the golden rule rate in part (ii)? What is the
consequence of this for consumption?
-4-
Part IV. Inflation and the dollar (45 minutes)
A.
The Chinese Conundrum (25 minutes)
The following appeared in an article in the Washington Post:
John B. Taylor, Treasury undersecretary for international affairs [eminent Stanford
macroeconomist and inventor of the Taylor rule], urged China to let its currency, the
yuan, rise according to market forces without further delay. "We have very much
stressed that they can begin to have a flexible exchange rate right now," Taylor said.
Assume that China follows Taylor’s advice, and as a consequence the Chinese yuan
appreciates substantially. Using the appropriate model, analyze the effect of this move on
the United States economy. Assume that the U.S. has a floating exchange rate and that the
Fed adjusts the interest rate to maintain full employment. Make sure you analyze the effect
on output, inflation, the current account (or net exports), the real exchange rate, and the real
interest rate.
B.
Inflation targeting? (20 minutes)
There are two basic approaches to the objectives of monetary policy among major central
banks today. The U.S. approach is to include both inflation and real output as targets or
objectives of monetary policy. Many foreign central banks target only inflation.
On December 14, 2007, the U.S. government reported that inflation last month was much
higher than expected. Some analysts believe that the increase was due to (a) a strengthening
of aggregate demand, while others believe that it was due to (b) cost shocks such as rising
energy prices and a falling dollar. Using the Phillips curve theory of the relationship
between inflation and unemployment, analyze the following:
1.
How, if at all, would the central bank respond differently under the two
targeting systems to a shock to aggregate demand (such as (a))?
2. How, if at all, would the central bank respond differently under the two
targeting systems to a cost or aggregate-supply shock (such as (b))?
-5-