ECO 302b
Intermediate Macro
Spring 2012
Midterm 3
Part I: Answer completely in the spaces provided, or use the back of the page. (30 points total). Show your work. Answers that appear like miracles out of nowhere may not be given credit.
1. An economy is described by the following equations:
Desired Consumption Cd = 40 + 0.6 (Y – T) - 200 r
Desired Investment Id = 60 – 800 r
Government Purchases G = 35
Taxes T = 30
Desired Imports IMP = 0.1∙Y +10∙e
Desired Exports EXP = 40 – 10∙e +0.2∙(Y#)
Exchange Rate: e = 2 + 40∙(r – r#)
Real Money Demand L = 0.5 Y - 200 r
Real Money Supply M/P = 300/P
Full-employment output YFE = 200
Foreign Income Y# = 100
Foreign real interest rate r# = .05
Assume that expected inflation is zero so that money demand depends directly on the real interest rate.
a. Write the equation that describes the desired national savings line as a function of the real interest rate r. (Assume that Y = 200.)
b. Write the equation that describes the desired Foreign Lending line as a function of the real interest rate r. (Assume that Y = 200).
c. Write the equation that describes the desired net exports line as a function of the real interest rate r. (Assume that Y = 200 and that Y# = 100.)
d. Plot (with reasonable accuracy) on a graph the desired foreign lending and desired net export lines. What (approximately) will be the interest rate and current account balance if the product market is in equilibrium when Y = 200?
e. What is the equation for the open economy IS curve at given levels of Government Purchases, Investment, etc? (Hint: the equation will give combinations of Y and r where the open economy product market could be in equilibrium, so the equation should look like: Y = (some constant) +/-- (some coefficient) x r
2. Keynesian economic theory states that in the short run, prices in product markets and wages in labor markets do not adjust fast enough to guarantee general equilibrium at full-employment. The quantity of output produced and labor employed varies instead.
Give 2 examples of theories which help explain why prices in these markets might not adjust quickly, and explain briefly how these theories result in slow-to-adjust prices and wages.
Part II: Select the best answer for each of the following questions and mark it clearly on the page. (3 points each)
1. A shift to the left of desired domestic investment causes the desired national savings and desired investment curves to intersect at a lower real interest rate. If this is an open economy, this would also cause:
a. the desired foreign lending (savings minus investment) curve to shift to the right.
b. the desired foreign lending (savings minus investment) curve to shift to the left.
c. the desired net exports line to shift to the right.
d. the desired net exports line to shift the left.
e. the short-run aggregate supply curve to shift to the right.
2. Compared to effect it would have in a floating exchange rate economy, the use of expansionary fiscal policy in an open economy with fixed exchange rates would produce a ____ shift in the AD curve because ______.
a. bigger depreciation of the domestic currency will increase net exports
b. smaller the appreciation of the domestic currency will increase net exports
c. smaller the depreciation of the domestic currency will increase net exports
d. bigger the appreciation of the domestic currency will increase net exports
e. bigger there will be no appreciation of the domestic currency
3. The desired net exports line in a floating exchange rate economy is ______because a rise in domestic real interest rates causes:
a. vertical no change in net exports
b. upward-sloping higher foreign incomes increases demand for domestic products
c. horizontal any change in the real interest rate would trigger an infinite change in net exports.
d. upward-sloping higher domestic income will stimulate exports.
e. downward-sloping higher domestic interest rates stimulate appreciation of the domestic currency and lower net exports.
4. If country A has an open economy and floating exchange rates, it’s use of expansionary fiscal policy will (for a given level of country A’s income) cause in country B:
a. a shift to the right of the LM curve and a shift to the right of the AD curve.
b. a shift to the left of the IS curve and a shift to the left of the AD curve.
c. a shift to the right of the IS curve and a shift to the right of the AD curve.
d. a shift to the left of the FL line and a shift to the left of the AD curve.
e. a shift to the left of the NX line and a shift to the right of the AD curve.
5. Above is the degree of effort (or productivity) a typical employee might offer according to the wage paid. The employer would try to select the wage level where:
a. the employee’s effort is maximized.
b. the employee’s effort begins to rise above zero.
c. the slope of the effort curve is maximized.
d. the employer gets the maximum amount of productivity per dollar spent on wages.
e. the chance that the employee will quit is minimized.
6. At lunch hour, all McDonald’s employees are busy cooking and selling hamburgers. Before and after lunch, the employees are cleaning the dining area, re-stocking the storeroom, filling out accounting reports, etc. These other activities are a necessary part of the process of serving hamburgers to customers, but do not need to be done at exactly the same moment the customer is in the restaurant. An economist measuring labor productivity of McDonald’s employees would measure hamburgers-served-per-hour of labor. The economist thinks the lunch hour rush of customers is like a business cycle boom. According to this analysis, labor productivity in McDonald’s will be:
a. pro-cyclical.
b. leading.
c. counter-cyclical.
d. lagging.
e. the cause of lunch hour.
7. American auto assembly workers are represented by a labor union, which also represents workers at companies that supply parts used by the auto industry. When an auto company purchases parts from a non-union company that offers lower prices (because it pays lower wages), these parts are often lost, damaged, misplaced, installed incorrectly, etc. when the autos are assembled. This phenomenon is an example of ____ theory.
a. implicit contract
b. insider-outsider
c. reverse causation
d. misperceptions
e. menu cost
8. The graph above shows how a firm’s profits respond to a change in the firm’s price. Suppose the firm’s “perfect” price is P*. The firm chooses not to change prices as long as its current price is between P1 and P2. This suggests that the firm’s menu cost is:
a. the distance from P1 to P2.
b. the distance from P1 to P*.
c. the distance from π* to 0.
d. the slope of the profit curve at P*.
e. the difference between π* and π1.
9. Keynesians believe that the ____ market can remain in disequilibrium for a prolonged period of time, so business cycle movements can be caused by shifts in _____.
a. labor AS
b. product AD
c. labor AD
d. product AS
e. asset AD
10. If country A has an open economy and floating exchange rates, it’s use of expansionary monetary policy will (for a given level of country A’s income) cause in country B:
a. a shift to the right of the LM curve and a shift to the right of the AD curve.
b. a shift to the left of the IS curve and a shift to the left of the AD curve.
c. a shift to the right of the IS curve and a shift to the right of the AD curve.
d. a shift to the left of the FL line and a shift to the left of the AD curve.
e. a shift to the left of the NX line and a shift to the right of the AD curve.
11. The unemployment rate falls when increases to AD occur that are a surprise to everyone in the economy. Increases in AD created by the government in order to manage the economy create inflation but not lower unemployment. This outcome is best explained if wages are set according to:
a. Misperceptions Theory (with rational expectations)
b. Insider – Outsider Theory.
c. Menu-Cost Theory.
d. Keynesian Business Cycle Theory
e. Reverse Causation Theory
12. The Phillips Curve relationship between inflation and unemployment is what would result if the SRAS were _____ and the AD curve was _____.
a. upward-sloping and stable unstable
b. upward-sloping and unstable stable
c. vertical and unstable stable
d. vertical and stable unstable
e. horizontal and stable unstable
13. “Stagflation” is the name given to the phenomenon of the 1970’s when unemployment was rising even as inflation was rising. Using SRAS – AD analysis, stagflation occurs if:
a. the SRAS shifts to the left faster than AD shifts to the right.
b. the SRAS shifts to the left at the same as AD shifts to the left.
c. the SRAS shifts to right at the same time AD shifts to the left.
d. the SRAS is constant while the AD shifts to the left.
e. the SRAS shifts to right at the same time AD shifts to the right.
14. The _____ theory explains why there might still be involuntary unemployment even when the labor market is in “equilibrium” (no tendency for wages to either rise or fall).
a. implicit contract
b. efficiency wage
c. menu cost
d. quantity
e. reverse causation
15. Increases in the money supply occur:
(i) before the Christmas shopping season
(ii) in the USA before presidential elections
(iii) during the gold standard era, following big gold discoveries.
Which theory states that the increase in the money supply will cause an increase in economic activity only in case (iii)?
a. Keynesian theory.
b. Standard market-clearing (classical) model.
c. Reverse causation theory.
d. menu-cost theory.
e. Misperceptions theory with rational expectations.
16. The “reverse causation” argument is useful to ____ economists because it helps explain why ______.
a. Keynesian average labor productivity is counter-cyclical
b. classical money supply growth is leading and pro-cyclical
c. classical stock prices are leading variables
d. Keynesian real wages are pro-cyclical
e. Keynesian unemployment is a lagging variable
17. Both classical and Keynesian economists agree that the long-run Phillips Curve is:
a. unstable.
b. dependant on expected inflation
c. downward-sloping
d. vertical over the natural rate of unemployment
e. upward-sloping
18. The fact that _____ is a leading and pro-cyclical variable is not explained by the Keynesian theory. The fact that _____ is a leading and pro-cyclical variable is not explained by the real business cycle (market-clearing model) theory.
a. unemployment rate inflation
b. money supply growth average labor productivity
c. residential investment stock prices
d. business fixed investment employment
e. none of the above.
19. Above is a production function diagram showing how much labor is used and how much output is produced when the economy both before and after a shift of the economy’s aggregate production function. If the real wage paid to workers is the marginal product of labor, then the diagram above shows that a business cycle expansion caused by the shift of the aggregate production function should have _____ employment, _____ average labor productivity, and _____ real wage.
a. pro-cyclical pro-cyclical pro-cyclical
b. pro-cyclical counter-cyclical counter-cyclical
c. pro-cyclical pro-cyclical counter-cyclical
d. counter-cyclical counter-cyclical pro-cyclical
e. counter-cyclical pro-cyclical counter-cyclical
20. For a big country, most domestic output is consumed domestically, and most domestic employment is related to production of goods for the home market. For a small country, a large share of output is exported, and a lot of the country’s consumption is of imported goods. Variations in the exchange rate are ____ disruptive to a small country’s economy, so it is likely to choose to use a ____ exchange rate.
a. more fixed
b. more floating
c. less fixed
d. less floating
e. none of the above.
Part III. Extra Credit (1 point each). Do not waste time on these until you are finished with the rest of the exam!
1. Show how the shape below can be divided into 2 identical shapes with one cut.
2. Who are these guys?
Match the photo with the name:
Dominque Strauss Kahn
Andrew Abel
Dean Croushore
Bernie Madoff
Ben Bernanke
.
3. Mark with a check the names of the guys who are the authors of your textbook for this semester.