First Exam. Economics 311
Spring 2010
Name: _________________________________
Score: ________
Question 1 (25 points). Consider how expectations about the future can affect current
behavior.
1. Use the graph on the next page and draw a person’s inter-temporal budget constraint
if he earns $100,000 today and expects to earn $100,000 in the future. Draw
indifference curves if the person prefers to even out his consumption so that he
consumes the same amount today and in the future.
2. Suppose the person receives a layoff notice and expects to lose his job in the future.
Modify your inter-temporal budget constraint and use indifference curves to show
how this will affect current and future consumption and savings and borrowing if the
interest rate is 10% and when he gets laid off he will receive unemployment benefits
equal to 25% of his pay.
3. Suppose the person doesn’t receive a layoff notice but the economy in general enters
a recession and he realizes that there is a reasonable chance he will get laid off in the
future. Depict the inter-temporal budget constraint for this situation and compare and
contrast the effect on current consumption with your answer to (2).
4. Suppose the government passes a “jobs” bill which will increase or extend
unemployment benefits. Depict the effect of such a “jobs” bill on your graph. Will
this type of jobs bill increase or decrease the unemployment rate? Explain.
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First Exam. Economics 311
Spring 2010
Future
Today
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First Exam. Economics 311
Spring 2010
Question 2. (25 points). Consider the two economic models used to explain interest rates
from the textbook- the Liquidity Preference Framework and the Theory of Asset
Demand. Explain and label all changes on your graph.
1. Use the graphs below and compare and contrast predictions about the change in
interest rates from both models if the government increased the money supply.
2. Consider Part (3) from question 1. Use the graphs below and analyze the effects
on interest rates from the change in expectations about future employment
prospects on current interest rates.
3. In your opinion, which framework offers more insight into the determination of
future interest rates. Explain.
Interest Rate
Price of Bonds
Quantity of Money
Quantity of Bond
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First Exam. Economics 311
Spring 2010
Question 3. (25 points). Consider the Asymmetric information explored in the in-class experiment.
1. What is an asymmetric information problem? Give an example.
2. Can the free market solve the asymmetric information problem or is government regulation and
interference necessary?
3. How might this apply to the efficient operation of financial markets? Explain and discuss.
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First Exam. Economics 311
Spring 2010
Question 4 (20 points). Consider the following article about oil prices.
1. What is the article saying about the relationship between the optimal forecast and the expected return on
buying and holding oil?
2. Suppose you invested in such a way that you would make money if the price of oil fell below $75 a
barrel. Is this a wise investment given the information in the article?
3. Discuss in light of the Theory of Rational Expectations and the Efficient Market Hypothesis.
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First Exam. Economics 311
Spring 2010
NEW ORLEANS (Dow Jones)--Energy companies and oil service firms are becoming confident that oil prices will remain above
$75 a barrel driven by demand in emerging markets, but they say that prices for natural gas could remain depressed amid a
production glut.
Sustained higher oil prices, which settled at $81.25 a barrel in New York on Monday, are encouraging exploration and production
companies to increase spending. The trend is evident even in capital-intensive projects such as the deepwater of the Gulf of
Mexico and Canadian oil sands, which saw cuts the last two years as the economic crisis roared.
"2010 will be a year of transition from the sharp down cycle of 2009 to a slow resumption of growth," Schlumberger Ltd. (SLB)
Chief Executive Andrew Gould told analysts and investors at the Howard Weil Energy Conference in New Orleans. "Oil prices
above $75 will give customers confidence to increase spending, and even increase exploration budgets, though we see this more
as a 2011 effect." Schlumberger is the world's largest oil service company.
This positive view for oil prices was also shared by large exploration and production companies such as Houston-based Apache
Corp. (APA). The company's Chief Executive G. Steven Farris said at the Howard Weil conference the world is going to see $100
a barrel soon, driven by aggressive energy demand in developing countries, especially in Asia.
"I'm very bullish on oil prices," he said. The company is planning to invest $6 billion in 2010, or about 50% more than last year,
with an emphasis in projects that have the potential to increase its oil production.
BP PLC's (BP, BP.LN) Chief Executive for Exploration and Production Andy Inglis said the company counts on a $60 a barrel to
increase its production 1% to 2% a year through 2015.
But some uncertainty lingers about the short-term future of natural gas prices. Unlike oil prices, which have been trading around
$80 a barrel since October after falling to less than $40 in February 2009, natural gas prices remained low as producers unlocked
vast new supplies of the fuel from dense rock formations known as shale and the economic downturn undermined demand for the
fuel. While cold winter weather recently spurred additional demand and gave prices a boost, prices have begun to sag as spring
approaches.
Natural gas for April delivery on the New York Mercantile Exchange settled down 9 cents, or 2.16%, at $4.079 a million British
thermal units.
"For natural gas, the picture is very different with short-term supply growing dramatically," Schlumberger's Gould said. "While
we are encouraged by the resilience of the North American natural gas drilling rig count, and recognize that severe winter weather
has reduced gas storage to a level that seemed difficult to achieve four months ago, we remain cautious on the future direction."
Apache's Farris said the company uses an estimate of about $4.50 a million British thermal units as the economic hurdle to
approve its projects, and although it is an internal estimate, he doesn't believe natural gas prices will improve much more than that
in the short term.
-By Isabel Ordonez; at Dow Jones Newswires; 713.547.9207; isabel.ordonez@dowjones.com
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