document.docx

Econ 1120 - INTRODUCTORY MACROECONOMICSMakeup PRELIM #2 – Wissink – Fall 2016 – November 4

________________________________________ ____________________________________Your LAST (FAMILY) NAME Your First (given) name

Your NetId:_________________ Your Student Number:________________________________

Instructions and Exam Taking Policy:

There are two sections in this exam. Answer all questions.

Part I: 14 multiple choice/fill in the blank questions @ 3.5 points eachPart II: 2 problems @ 20 points and 31 pointsTotal Points = 100, Total Time = 90 minutes.

NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.

NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”.NO GRAPHING CALCULATORS.NO BOOKS. NO NOTES. NO HELP SHEETS.NO TALKING TO EACH OTHER.

Check the TA’s name for the section you regularly attend (that is, where you will pick up your prelim):

One more time, please…

_____________________________________ _________________________________Your LAST (FAMILY) NAME Your First (given) name

Your NetId:_________________ Your Student Number:________________________________

GRADING

MC/FIB (out 49 points) =___________________

Q1 (out of 20 points) =__________________

Q2 (out of 31 points) =__________________

TOTAL SCORE: =_____________________

document.docx

1. Which one of the following is always TRUE? Note: the notation refers to marginal and average propensity to consume (MPC and APC) and marginal and average propensity to save (MPS and APS) and aggregate output (Y).

A. MPC + APC = 1B. MPC + MPS = 1C. APC < MPCD. MPC + MPS = YE. APC < APS

2. Refer to the table for all the information you need on a simple frugal economy with no government or international sector. At an aggregate output level of $200 billion, which one of the following statements is true?

A. Desired leakages equal desired injections.B. Planned investment is greater than actual investment.C. Actual saving does not equal actual investment.D. There are unplanned accumulations of inventory.E. Saving is zero.

3. Consider a simple frugal governed economy with no international sector and only one marginal propensity, the marginal propensity to consume, which equals 0.9. If equilibrium output Y* rises by $100 billion due to an increase in government spending, the increase in government spending must have been

A. $100 billion.B. $90 billion.C. $50 billion.D. $10 billion.E. $1 billion.

Aggregate Output (Y) Aggregate Consumption Desired Investment

Part I: Multiple Choice and Fill-In-The-Blank Questions. Do them ALL.Circle the letter for your answer or fill in the answer in the blank provided.

$3,000 $2,000 $1,600$4,000 $2,800 $1,600$5,000 $3,600 $1,600$6,000 $4,400 $1,600$7,000 $5,200 $1,600$8,000 $6,000 $1,600

4. Consider the economy referred to in the table above and assume there is no government and no foreign trade in the model. Ignore the money market. If the economy is in equilibrium, and planned investment increases by $200, then Y* will

A. increase by $200.B. decrease by $200.C. increase by $1,000.D. decrease by $1,000.E. increase by $250.

5 Consider an economy completely described by the following two equations: S = -400 + 0.2Y and Id = 3,000.The “paradox of thrift” applied to this economy suggests that

A. an exogenous increase in subsistence consumption will make it so that, in equilibrium, people actually consume less.

B. an exogenous decrease in subsistence consumption will make it so that, in equilibrium, people actually save less.

C. an exogenous decrease in subsistence consumption will make it so that, in equilibrium, people save the same amount.

D. an exogenous increase in desired investment leads to less saving in equilibrium.

E. an exogenous increase in desired investment leads to less consumption in equilibrium.

6. Banks hold no excess reserves and the required reserve ratio is 10%. If the FED buys up $10 million in bonds from the public, but the public deposits only $8 million of the money received into commercial banks (and keeps the other $2 million as cash), then the maximum resulting increase in the money supply from this open market purchase will be:

A. $8 millionB. $80 million.C. $10 million.D. $100 million.E. $82 million.

7. The economy of Greenspan is in equilibrium and can be completely described by the table. If its full employment output, YFE, is equal to $3,000 then

Greenspan’s Economy (note that YFE = $3,000)$Y $C $T $Id G0 1,050 100 50 900

1,000 1,550 100 50 9002,000 2,050 100 50 9003,000 2,550 100 50 9004,000 3,050 100 50 9005,000 3,550 100 50 9006,000 4,050 100 50 900

A. the economy of Greenspan must always equilibrate at Y=$3,000.B. the economy of Greenspan is currently experiencing higher

unemployment than is consistent with full employment.C. the economy of Greenspan will have inflationary pressures.D. the economy of Greenspan is running a budget surplus.E. the economy of Greenspan must be experiencing unplanned

accumulation of inventories.

8. Referring back to the information about Greenspan, if Greenspan were to increase taxes so that T=$1,100 and simultaneously increase government expenditures so that G=$1,100

A. the economy would be unchanged.B. the economy would experience a severe jump in inflationary

pressure.C. the value of Y* would decrease by $600.D. the economy would get to full employment Y.E. the value of Y* would increase by $1100.

9. Assume there is no leakage from the banking system and that all commercial banks are fully loaned up. The required reserve ratio is 16%. If the Fed sells $5 million worth of government securities to the public, the change in the money supply will be

A. +31.25 million.B. -$16 million.C. -$31.25 million.D. -$80 million.E. +$80 million.

10. Jamee Diamond offers you the following risk free promissory note today: “I Jamee Diamond promise to give you $2,000 two years from today.” Suppose the current annual market interest rate is 2%. Suppose there is no inflation.

A. Jamee’s promise is worth less than $2,000 today.B. Jamee’s promise is worth exactly $2,000 today.C. Jamee’s promise would be worth more today if the market interest

rate were 6% rather than 2%.D. Jamee’s promise would be worth more today if you received the

$2,000 three years from today rather than two years from today.E. Jamee’s promise is worth $1,961 today.

11. Consider our model of an economy where there is a “goods and services market” and a “money market” where money demand depends on the interest rate and aggregate output. Suppose the desired investment curve is very sensitive (that means flat) with respect to the interest rate. In such an economy

A. the fiscal policy crowding-out effect is small.B. the fiscal policy crowding-out effect is large.C. monetary policy is extremely ineffective.D. reducing the money supply will have a big impact on Y*, whereas

increasing the money supply has very little impact on Y*.E. there is no feedback effect with either monetary or fiscal policy.

12. Assuming money demand depends on all three variables we introduced, what is the chain of events that results from a Federal Reserve Bank open market sale of securities to the public?

A. Aggregate output decreases, demand for money decreases, the interest rate decreases, planned investment increases, and aggregate output increases.

B. Money supply decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.

C. Money demand decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.

D. Money supply decreases, the interest rate decreases, planned investment decreases, aggregate output decreases, and money demand decreases.

E. Money supply decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and the money demand remains unchanged.

13. Consider the money market in the graph. Firms and households will attempt to reduce their holdings of money by buying bonds

A. at any interest rates less than 3%.B. at an interest rate equal to 3%.

C. at an interest rate equal to 5%.D. at any interest rate greater than 5%.E. only at interest rates greater than 8%.

14. Which one of the following pairs of events will definitely lead to a decrease in the equilibrium interest rate in the money market?

A. The sale of government securities by the Federal Reserve to the public and an increase in the price level.

B. A decrease in the Federal Reserve’s discount rate and an increase in the level of aggregate output.

C. The purchase of government securities from the public by the Federal Reserve and a decrease in the price level.

D. A decrease in the Federal Reserve’s required reserve ratio and an increase in the level of aggregate output.

E. All of the above.

document.docx

1. Illustrated below is everything you need to know about the T-accounts for the Fed, the consolidated Commercial Banks, and one citizen (of many) named Leroy J. Gibbs in a very small economy which uses the dollar($) as its currency. Assume the following: the required reserve ratio is 5%, all loan activity in the economy is handled via demand deposits, all demand deposits stay in the banking system, and banks operate with zero excess reserves.

Initial PositionThe Federal Reserve Bank(Fed) Commercial Banks Gibbs

Assets Liabilities+Net Worth

Assets Liabilities+Net Worth

Assets Liabilities+Net Worth

Securities=$1,000

$45=Reserves Reserves=$45 $900=DDp DDGibbs=$15 $0=Debts

$300=Currency Loans=$855 $0=Net Worth

Securities=$50 $105=Net Worth

$655=Net Worth

CashGibbs=$40

Final PositionFederal Reserve Bank(Fed) Commercial Banks Gibbs

Assets Liabilities+Net Worth

Assets Liabilities+Net Worth

Assets Liabilities+Net Worth

Securities= =Reserves Reserves= =DDp DDGibbs= $0=Debts

=Currency Loans= $0=Net Worth

Securities= $105=Net Worth

$655=Net Worth CashGibbs=

Part II: Make sure you read and do ALL parts of each question. Show as much work as possible. TRY to get started on every question. Show us something. Write legibly and remember to label all graphs and axes in diagrams.

a. What is the initial value of the money supply, M1?b. Suppose the Fed decides to buy all of Gibbs’ securities. Assume that Gibbs gets paid for his securities

with a demand deposit that he leaves in the banking system. In the end, after all loans are made and loans are spent and monies deposited back into the commercial banking system, by how much will the money supply have changed, and in what direction, as a consequence of the Fed’s open market operation with Gibbs?

c. Fill in all the missing values in the T-accounts.d. Identify two realistic changes to the assumptions made in this question that would reduce the impact

of the Fed’s open market operation with Gibbs.

ANSWERS

2. Suppose that the following set of equations describe ALL the relevant information about the island nation, Isle d'Trump. Assume the fiat currency is called the dollar and its symbol is $.

Consumption function: C = 100 + 0.75Yd (where Yd = disposable income) Desired Investment function: Id = 75 Government expenditures function: G = 500 Tax function: T = 100 + 0.5Y Export function: EX = 500 Import function: IM = 200 The full employment level of national income is YFull employment = $2,240 The money market can be safely ignored for now. Inflation is assumed to be non-existent.

a. Determine the equilibrium level of national output(income), Y*. Show your work.b. Sketch the equilibrium position in a “Keynesian Cross” diagram.c. How could the government use fiscal policy via “G” to achieve full employment national

output(income)? Be specific with your answer – that is state by how much and in what direction G changes. Show your work.

d. Sketch this in the diagram you already constructed.

Suppose you now recognize there is a money market. Money supply is completely determined by the Fed. Money demand depends only on the interest rate and desired investment depends only on the interest rate in the typical ways. Assume all banks operate at zero excess reserves and that all money stays in the banking system. Assume there is no currency in circulation.

Assume the following money market equations:

Money demand = MD = 10,000 - 9,000r Money supply = MS = 8,200 Required reserve ratio for the banking system = rrr = 5%.

e. Given the money supply, what is the current equilibrium interest rate? (Assume Id=75 at this interest rate.)

f. If the monetary authorities want to get the economy to YFull employment, by how much and in what direction would investment need to change via monetary policy?

g. Suppose this new desired amount of investment occurs at an interest rate = 15%. If the government (i.e., the Fed) wanted to use monetary policy instead of fiscal policy to attain the full employment level of national income, what would the money supply need to be?

h. Should the Fed buy or sell government securities to the public?i. Exactly how many dollars in securities?

Answers

Answers

Econ 1120 Fall 2016 Makeup PRELIM 2 Answers

1. B. MPC + MPS = 1 and APC + APS = 1 are always true.

2. B. Consumption + Desired investment = $260, but only $200 worth of stuff was currently made, so there is $60 of unplanned depletion of inventory. Actual investment (-40) always equals actual saving (-40). Actual investment is SMALLER than planned investment (-40<20). Leakages do not equal injections.

3. D. If MPC=0.9 then the government multiplier is 1/(1-.9)=10. So ∆Y*=Kg∆G 100=10∆G ∆G=10.

4. C. The marginal propensity to consume can be calculated as follows: when output increases from 3000 to 4000, consumption increases from 2000 to 2800. Therefore, the MPC is (2800-2000)/(4000-3000)=0.8. In turn, the multiplier is 1/(1-0.8)=5. Therefore, Y* increases by 200*5=1000.

5. C. Suppose the economy is closed and there is no government. Then S = Y – C. Exogenous decrease in subsistence consumption implies upward shift of the saving curve. However, since I d=$3000 is fixed, in equilibrium people save the same amount but have less income and less consumption. (A) makes the saving curve shift downward and people consume more. (D) and (E) Exogenous increase in desired investment leads people to save and consume more.

6. E. So there is only +2mil for the cash part and then the +8mil that goes into the banking system becomes +80mil since the money multiplier is 10. So added together you get +82 million.

7. C. Note that Y* is currently at Y*=4000. So Greenspan is producing more than YFE, so it is in an inflationary gap.

8. C. The government multiplier is 2. The tax multiplier is -1. Current Y*=$4000. The change in G is +200. This increases Y* by +400. The change in taxes is +1000 and this changes Y* by -1000. So the net is -600.

9. C. Selling securities will decrease the money supply. The amount is equal to -5/.16=-31.25.

10. A. A classic example of the time value of money. The promise will worth less than $2000. So B and E are incorrect. If the interest rate is higher, or the time to maturity is longer, the promise will worth even less. Therefore, C and D are incorrect.

11 B. The crowding-out effect is bigger when investment is sensitive to interest rate. Therefore, B is correct but A is incorrect. Monetary policy influences the economy through the interest rate. Therefore, the fact that investment curve is sensitive to interest rate is good news for monetary policy.

12 B. Suppose money demand depends on interest rate, price level, and income level. If the Fed sells government securities to the public, money supply decreases and interest rate rises. Consequently, cost of investment becomes higher so that planned investment declines. Since Y = C + I + G (if the economy is closed) Y will also decrease and at the end money demand will decrease because income level falls.

13. D. Above r*=5% these is excess supply of money, so people will attempt to get rid of money by buying bonds, driving the price of bonds up and the interest rate down.

14. C. (A) Money supply increases but money demand rises as well so that direction of the equilibrium interest rate change is uncertain. (B) Again, money supply increases but money demand increases as well due to the rise in income. (C) Money supply increases while money demand falls so that the equilibrium interest rate clearly declines. (D) Money supply shifts to the right but money demand shifts to the left the equilibrium interest rate can either rise or fall.