YORK UNIVERSITY
Department of Economics
ECON1010A: Principles of Macroeconomics
Midterm #3: June 7, 2011
Duration – 1 Hour
Aids Allowed: Non-programmable calculators only
Time Allowed: 1 Hour
The total marks in this test are 50. The test is divided into two parts:
Part I - Problem format - is worth 42 marks (42 of the total mark of 50)
Part II – Explanations (5 marks) and Multiple choice (3 marks) (8 of the total mark of 50)
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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ECON1010A : Midterm Test #3, June 7, 2011
Name: ______________________
Part I: Place your answers (and work where necessary) in the space provided.
Clearly label all axes, curves, and points.
1.
Monetary Policy: Diagrams (10 marks)
Suppose that the Bank of Canada decreases the money supply to slow down the Canadian
economy to prevent inflation. In the space below, use Money Demand/Supply, Marginal
Efficiency of Investment (MEI), and AE/Y diagrams to demonstrate the impact of a
decrease in money supply on the Interest rate, Investment, and GDP equilibrium. Ignore
‘Crowding Out’. Label your axes carefully. Use the subscript ‘o’ to represent the original
equilibrium and ‘1’ 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. (4 marks)
c) How could the Bank of Canada decrease the money supply? Explain briefly (1 mark)
1 mark: sell bonds (or switch government deposits from private banks to Bof C)
b) Now show the effect of the Bank of Canada’s monetary policy on the equilibrium Interest
rate, Investment, and GDP using the subscript ‘1’. (5 marks)
r
SM1
r
SM0
r1
r0
r1
r0
MEI
DM
Mo
real AE
M (or M/P)
Y1 Yo
I1 Io
AE0
AE1
real I
real Y (or GDP)
1 mark: ro at intersection of or vertical SM (or Ms) and negatively sloped DMo (or MDo) vertical
with M (or M/P) on the horizontal (and r on the horizontal axis)
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 because they
increased Money Supply or changed Demand for Money (i.e., don’t give the next mark)
and then see if there subsequent answers are consistent with their mistake
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: Fall in I (I1) (or rise if they increased money supply but nothing for change Dm)
1 mark: shift down of AE to AE1 (or shift up if they increased money supply but nothing for
change Dm)
1 mark: Fall of Y (Y1) (or hift up if they increased money supply)
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ECON1010A : Midterm Test #3, June 7, 2011
2.
Name: ______________________
Monetary Demand and Supply:Equations (10 marks)
Suppose that the following equations describe an economy (r is in decimal form).
Money Demand: MD = 0.125Y – 900r Aggregate Expenditure: AE = 920 + I + 0.6Y
Marginal Efficiency of Investment:
I = 136 – 1200r
a) What is the equilibrium interest rate is if GDP (Y) = 2400 and Money Supply (MS) = 228?
(2 marks)
1 mark: setup: something like 228 = 0.125*2400 – 900 r
1 mark: correct answer, r = 0.08 (8%)
b) What is equilibrium Investment given your calculation of the interest rate? (1 mark)
1 mark: I =40 from 136 – 1200*0.08
c) Is this economy in equilibrium? Explain (2 marks; all for the explanation)
1 mark: Y = 2400 from Y = 920 + 40 + 0.6Y
1 mark: something like the initial Y (or Y determining demand for money and hence interest
rate) is the Y determined by the interest rate
d) Suppose that Government Spending increases by 14.4 but that Money Supply is unchanged
and I is the same as in b) What is ‘equilibrium’ Y? (1 mark)
1 mark: Y = 2436 from Y = (920 + 40 + 14.4)/(1 - 0.6) (or consistent with their b)
e) What is the equilibrium interest rate if Government Spending rises by 14.4 ceteris paribus?
1 mark: 0.085 (8.5%) from r = (0.125*2436 – 228)/900
f) What is ‘equilibrium’ Investment if Government Spending rises by 14.4 ceteris paribus?
1 mark: I = 34 from 136 – 1200*0.085
g) What is crowding out if Government Spending increased by 14.4 ceteris paribus? (1 mark)
1 mark: = 6 from 40 - 34
h) What government policy (fiscal or monetary) would result in a decrease in equilibrium GDP
and an increase in the equilibrium interest rate? Briefly explain (no diagram) the steps that
bring about this combination. (3 marks)
1 mark: monetary
1 mark: decrease in money supply increases interest rate
1 mark: increase in interest rate decreases Investment and GDP
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ECON1010A : Midterm Test #3, June 7, 2011
3.
Name: ______________________
Aggregate Demand: Diagrams (12 marks)
Suppose that the Canadian economy is presently at full employment income Y*.
Demonstrate the short-run and long-run equilibrium effects of a decrease in Exports in
Aggregate Expenditure/Income and Aggregate Demand/Supply diagrams in the space
below. In particular:
a) Draw an Aggregate Expenditure/Income diagram in an upper diagram to show equilibrium
Yo. Label your axes clearly (1 mark).
b) Draw Aggregate Demand/Supply diagrams in a lower diagram to show Aggregate Demand
(AD), Long-run Aggregate Supply (LRAS) and Short-run Aggregate Supply (SRAS) at full
employment. Indicate equilibrium Yo and Po at use the subscript ‘o’ to indicate all curves
and equilibria. (5 marks)
c) Now show the short-run impact of a decrease in Exports in both your diagrams. Label all new
curves and equilibria with the subscript ‘s’. (4 marks)
d) Finally, show the new long-run equilibrium Y1 and P1 with any changes in curves. (2 marks)
AEo (Po) and AE 1(P1)
real AE
AE1 (Po)
Yo
P
real Y
LRAS
SRASo
SRAS1
Po
Ps
P1
AD1
Ys Y*
Yo
Y1
ADo
real Y
1 mark: Yo at intersection of positively sloped AE with 450 line (or something like it
1 mark: vertical LRAS in lower diagram at Yo from upper diagram
1 mark: positively sloped SRAS
1 mark: SRAS has increasing slope particularly after LRAS
1 mark: downward sloping Aggregate Demand
1 mark: downward sloping Aggregate Demand intersecting SRAS and LRAS at Yo (and Po)
1 mark: Shift down of AE in upper diagram
1 mark: Aggregate Demand shifts to the left
1 mark: Aggegate Demand shifts left through Po and the Y (not designated) formed by
intersection of AE1 and 45 degree line.
1 mark: Ps < Po and Ys < Y* (Yo) from intersection of AD1 and SRASo
1 mark: equilibrium Y1 at LRAS
1 mark: SRAS shifts down to intersect AD1 at LRAS (giving P1)
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ECON1010A : Midterm Test #3, June 7, 2011
4.
Name: ______________________
Aggregate Demand/Supply Equations. (10 marks)
a) Suppose an economy has the following equations (Net Taxes are zero)
Consumption = 1,260 + 0.65Y – 5P
Investment = 300 + 0.2Y - 2P
Government Spending = 900
Exports = 800 - P
Imports = 100 + 0.1Y + 2P
What is the Aggregate Demand function? (2 marks)
1 mark: AE = 3,160 + 0.75Y - 10P
1 mark: AD: Y = 12,640 – 40P
Ignore part a). The following are an economy’s Aggregate Expenditure (AE), Short-run
Aggregate Supply (SRAS), and Long-run Aggregatge Supply (LRAS) equations.
AE = 2,400 + 0.8Y – 6P
SRAS = 5,000 + 20P
LRAS = 8,150
.
b) What is short-run equilibrium price level and GDP? (3 marks)
1 mark: AD = 12,000 – 30P
1 mark: equil P = from 12,000 – 30P = 5,000 + 20P
1 mark: equil Y = 7,800 from 12,000 – 30*140 or 5,000 + 20*140
c) Suppose that Government Spending increases by 40? What is the new Short-run equilibrium
Price level and GDP? (3 marks)
1 mark: AD = 12,200 – 30P from some derivation
1 mark: equil P = 144 from 12,200 – 30P = 5,000 + 20P
1 mark: equil Y = 7,880 from 12,200 – 30*144 = 5,000 + 20*144
d) What is the long-run equilibrium Price level and GDP given the increase of 40 in
Government Spending? (2 marks)
1 mark: GDP = 8,150 or set up of AD = LRAS
1 mark: P = 135 from 12,200 – 30P = 8,150
IIa: Explanations (5 marks)
Give a brief explanation of each of the following.
a) How is Marginal Efficiency of Investment calculated? (1 mark)
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ECON1010A : Midterm Test #3, June 7, 2011
Name: ______________________
b) What is the classical/neo-classical explanation of the Demand for Money? Briefly explain.
(1 mark)
c) Why is the quantity demanded of money inversely related to the interest rate? (1 mark)
d) What is ‘crowding out’? (1 mark)
e) What effect does an increase in a country’s price level have on its imports? Briefly explain.
(1 mark)
Part IIb: Multiple Choice (3 marks): Circle the best answer
Each question is worth 1 mark. No marks deducted for wrong answers.
1.
What is the present value (to the nearest whole number) of a return of $1200 payable at the
end of 2 years if the interest rate is 6%?
a) $1050 b) $1068 c) $1071 d) $1088 e) $1344 f) $1348 g) None of the above
2.
What is the effect of a decline in Government Spending ceteris paribus on equilibrium
GDP, interest rate (r), and Investment (I)? ( = decrease and  = increase)
a)  in GDP, in r, and in Investment
b)  in GDP, in r, and in Investment
c)  in GDP, in r, and in Investment
d)  in GDP, in r, and in Investment
e)  in GDP, in r, and in Investment
f)  in GDP, in r, and in Investment
g)  in GDP, in r, and in Investment
h)  in GDP, in r, and in Investment
i) None of the above
3.
What is the effect of a decrease in the Reserve Ratio on equilibrium reserves, money supply
(Ms) and the interest rate (r)?
a)  in Reserves,  in Ms,  in r
b)  in Reserves,  in Ms,  in r
c)  in Reserves,  in Ms,  in r
d)  in Reserves,  in Ms,  in r
e)  in Reserves,  in Ms,  in r
f)  in Reserves,  in Ms,  in r
g)  in Reserves,  in Ms,  in r
h)  in Reserves,  in Ms,  in r
i) None of the above
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