PRINCIPLES OF MACROECONOMICS
MIDTERM #3, SAMPLE #1: ANSWERS
Duration – 50 minutes
Aids Allowed: Non-programmable calculators only
The total marks in this test are 50. The test is divided into two parts:
Part I - problem format - is worth 40 marks (40 of the total mark of 50)
Part II - multiple choice- is worth 10 marks (10 of the total mark of 50)
(5 multiple choice questions worth 2 marks each)
Show your work where applicable.
Please use pen instead of pencil.
Print your name and student number clearly on the front of the exam and on any loose
pages.
Name:
(Family Name)
Student #:
.
(Given Name)
.
There are 6 pages to the exam.
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Principles of Macroeconomics: Midterm Exam #3, Sample #1: Answers
Part I: Place your answers (and work where necessary) in the space provided.
Clearly label all axes, curves, and points.
1.
Monetary Policy (10 marks)
The Bank of Canada has recently acted to alter the Canadian interest rate. In the
space below, demonstrate the relationship between their policy and changes in
equilibrium investment and output relative to an orginal equilibrium. Ignore
‘Crowding Out’. Label your axes carefully. Use the subscript ‘o’ to represent the
original equilibrium and ‘s’ to represent subsequent changes. In particular,
a) Draw AE/Y, Money D/S, and MEI diagrams showing an initial equilibrium before the
monetary policy. Use the subscript ‘o’ for initial curves and equilibria. (5 marks)
b) Now show the effect of the Bank of Canada’s monetary policy on the interest rate,
investment, and equilibrium GDP using the subscript ‘1’. (5 marks)
r
SM1
r
SM0
r1
r0
r1
r0
MEI
DM
Mo
real AE
I1 Io
AE0
AE1
M (or M/P)
real I
real Y (or GDP)
Y1 Yo
S M)
MDo
1 mark: vertical M (or
and negatively sloped
with r on the vertical and M on the
horizontal
1 mark: ro at intersection of M (or SM) and negatively sloped MDo
1 mark: downward sloping MEI in diagram with r on vertical and I on horizontal axis
1 mark: Io from negatively sloped MEI at ro
1 mark: Yo from intersection of AEo and 45 degree line
1 mark: Decrease in Money Supply (SM1) Take off 2 marks if they get this wrong(i.e., don’t
give the next mark) and then see if they are consistent with this change
1 mark: increase in interest rate (r1) from intersection of new SM and MDo (no mark for
decrease in interest rate even if it is consistent with an increase in money supply)
1 mark: Decrease in I (I1) (or increase if they increased money supply)
1 mark: shift down of AE to AE1 (or shift up if they increased money supply)
1 mark: Fall of Y (Y1) (or s hift up if they increased money supply)
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Principles of Macroeconomics: Midterm Exam #3, Sample #1: Answers
2.
Monetary Demand and Supply Equations (15 marks)
Suppose that the following equations describe an economy.
Money Demand: Md = 0.09Y – 500r Aggregate Expenditure: AE = 529 + I + 0.6Y
Marginal Efficiency of Investment:
I = 55 – 400r
a) If GDP (Y) = $1,400 billion and Money Supply (MS) = $96 billion, what is the
equilibrium interest rate (in decimal form)? (2 marks)
1 mark: setup: 96 = 0.09(1400) – 500r [or r = (0.09*1400 – 96)/500
1 mark: answer: r = 0.06 (6%)
b) What is equilibrium Investment? (1 mark)
1 mark: I = 31 from 55 – 400(0.06)
c) What is equilibrium Y given your calculation of Investment? (2 marks)
1 mark: Y = 529 + 31 + 0.6Y (or Y = (529 + 31)/(1 – 0.6)
1 mark: Y = 1400 [billion]
d) In the space below, graph the money supply/money demand diagram, the Marginal
Efficiency of Investment diagram, and AE/Y diagram. Carefully label your diagrams,
including the values for equilibrium interest, investment, and income and the
intercepts for the Money, Investment, and Aggregate Spending axes. (3 marks)
1 mark: correct axes (somehow indicated): r and M(or M/P),
r and I (or real I); real AE and real Y (or GDP)(must be
real for AE and Y
1 mark: Money Supply = 96 and I and Y consistent with
their answers above (hopefully 31 and 1400)
1 mark: MD intercept = 126, MEI intercept = 55, and AE
intercept = 560
r
SM1
r
SM0
r1
r0
r1
r0
MEI
DM
Mo
real AE
M (or M/P)
Y1 Yo
I1 Io
AE 0
AE 1
real I
real Y (or GDP)
e) Suppose that the economy is presently at Y = $1400 billion as above and that the
required (or target) reserve ratio is 0.10 (10%).
i) What is the equilibrium interest rate if the Central Bank (e.g. the Bank of Canada)
buys $0.15 billion worth of government bonds? (Ignore Crowding Out) (2 marks)
1 mark: new Money Supply = $97.5 b (from 96 +0.15/0.1)
1 mark: new interest rate = 0.057 (or 5.7%) from (r = (0.09*1400 – 97.5)/500)
ii) What is equilibrium investment and income (ignoring crowding out) if the Central
Bank buys $0.15 billion worth of government bonds? (2 marks)
1 mark: I = 32.2 from 55 – 400(0.057)
1 mark: Y = 1403 (from Y = (529 + 32.2)/(1-0.06))
f) Assume that we have the original equations but Y = 1425, and MS = 110.75, and I = 41.
What is equilibrium Y, r, and I if autonomous government spending increases by 10
($billion)? Be exact and ignore crowding out. (3 marks)
1 mark: Y = 1,450 from 529 + 41 + 10 + 0.6Y or Y = (529 + 41 + 10)/(1 – 0.6)
1 mark: r = 0.0395 (3.95%) from r = (0.09(1450) – 110.75)/500
1 mark: I = 55 – 400(0.0395) = 39.2
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Principles of Macroeconomics: Midterm Exam #3, Sample #1: Answers
3.
Aggregate Demand and Aggregate Supply (7 marks)
Suppose that the Canadian economy is at short-run price and income equilibrium.
Show the effect of an increase in government spending on Aggregate Expenditure,
equilibrium real GDP, and the equilibrium Price level in the short-run by using
AE/GDP and Aggregate Demand/Supply diagrams. You do not need a Money
Demand/Supply diagram. The following subsections will help you through this.
a)
Draw an AE/Y diagram showing an initial equilibrium Yo. (1 mark)
b)
Draw an AD/SRAS diagram below the AE/Y diagram at initial short-run
equilbrium. Use the subscipt ‘o’ for all curves and equilibria. (2 marks)
b)
Show in your AE/Y diagram and AD/AS diagram the short-run equilibrium Ps and
Ys that results from an increase in Government Spending. (4 marks)
AE1
AE0
real AE
P level
Yo
Y1
SRAS
Ps
Po
ADs
ADo
real Y (or GDP)
1 mark: equilibrium Yo from intersection of positively sloped AEo and 45 degree line
1 mark: downward sloping AD in diagram below AE/Y
1 mark: Po and Yo (must line up with Yo from AE/Y) from intersection of ADo and positive
sloped SRAS (Could be linear or increasing slope)
1 mark: shift up of AE
1 mark: AD shifts to the right
1 mark: AD shifts to the right to pass through Po and and the intersection of fallen AE & 45o
1 mark: equilibrium Ps > Po and Ys > Yo from intersection of ADs and SRAS
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Principles of Macroeconomics: Midterm Exam #3, Sample #1: Answers
4.
Aggregate Demand Equation (8 marks)
The following equations describe an economy. There are no taxes in the economy
Consumption:
C = 650 + 0.85Yd – 4P
Investment:
I = 350 – 2P
Government Spending: G = 440
Exports: X = 550 – 3P
Imports: IM = 80 + 0.1Y + P
a) What is the Aggregate Expenditure Equation with a price variable? (2 marks)
1 mark: two of three parts of AE correct (i.e., two of 1910, 0.75Y, and –10P)
(with work, e.g., AE = 650 + 0.85Y – 8P + 350 – 2P + 440 + 550 – 2P – (80 + 0.1Y + 3P)
1 mark: AE = 1910+ 0.75Y – 10P
b) What is the equation for Aggregate Demand? (2 marks)
1 mark: recognition that Y = AE (whatever their AE is in a)
1 mark: Y = 7640 – 40P from Y = 1910 + 0.75Y –10P (must be at least consistent with a)
c) What is the intercept of AE if P = 75? (1 mark)
1 mark: = 1160 (from 1910 – 10(75)) (or consistent with b)
d) What is equilibrium Y if P = 75? (1 mark)
1 mark: = 4,640 (from Y = 1160 – 0.75Y or Y = 1160/(1 – 0.75) (or consistent with b)
e) What is Consumption if P = 75? (1 mark)
1 mark: = 4,294 from 650 + 0.85(4,640) – 4(75)
(e and f) below must be correct, not merely consistent, since I’m trying to show that the
sum of C + I + G + X –IM is the way to double-check the original answer for equilibrium)
f) What are Imports if P = 75? (1 mark)
1 mark: = 619 from 80 + 0.1(4,640) + 75
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Principles of Macroeconomics: Midterm Exam #3, Sample #1: Answers
Part II: Multiple Choice: Circle the best answer.
Each question is worth 2 marks. No marks deducted for wrong answers.
1. What is the present value (to the nearest $) of a return of $7,000 at the end of two years
and $8,000 at the end of 3 years if the interest rate is 8%?
a) $11,907
b) $12,352
c) $12,415
d) $12,860
e) $13,340
f) $13,360
g) $13,420
h) $15,000
i) none of the above
2. Suppose that the money market is presently in equilibrium with the interest rate (r)
determined by a given Ms and a given Md. What is the effect of an increase in the
transactions demand for money, i.e., an increase in k (Md/Y)?
a) an increase in the Money intercept of Md and increase in equilibrium r
b) an increase in the Money intercept of Md and decrease in equilibrium r
c) a decrease in the Money intercept of Md and increase in equilibrium r
d) a decrease in the Money intercept of Md and decrease in equilibrium r
e) no change in the Money intercept of Md and increase in equilibrium r
f) no change in the Money intercept of Md and decrease in equilibrium r
f) none of the above
3.
Suppose that the Government wishes to expand the economy without raising the
interest rate. Which of the following will best accomplish this?
a) increase government spending and increase fixed taxes by the same amount
b) increase transfer payments and increase fixed taxes by the same amount
c) finance an increase in government spending by borrowing from the banks
d) finance an increase in transfer payments by borrowing from the public
e) increase government spending and have the Bank of Canada sell bonds
f) decrease fixed taxes and have the Bank of Canada buy bonds
g) none of the above
4.
Suppose that the unemployment rate falls in Canada in the present month due to a
significant increase in employment. Which of the following is most likely to follow?
a) decrease in the price of bonds due to a likely decrease in the Bank of Canada rate
b) decrease in the price of bonds due to a likely increase in the Bank of Canada rate
c) increase in the price of bonds due to a likely decrease in the Bank of Canada rate
d) increase in the price of bonds due to a likely increase in the Bank of Canada rate
e) none of the above
5.
Suppose that C = 2,500 + 0.8Yd and AE = 3,600 + 0.75Y for an economy. What is the
change in equilibrium income of an increase of 80 (+80) in transfer payments?
a) –400
b) –360
c) –256
d) –80
e) 0
f) +80
g) +256
h) +360
i) +500
j) none of the above
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