Download Document

Selva Demiralp/ Erhan Artuc
Econ 202, Midterm 1
March 19, 2007
 DO NOT open the cover page until you are told to do
so.
 You have 90 minutes.
 DO NOT cheat. If I or one of the proctors suspect that
you are cheating or trying to cheat we will mark your
exam right away and if you get two marks, your test
will be sent to the Dean’s Office.
 You are NOT allowed to ask any questions during the
exam. The questions are clear. If you cannot
understand the question it means you don’t know the
material well enough. You can only ask a question
regarding the dictionary meaning of a word (but we
will not explain technical terms which are the subject
material of this course).
 You are NOT allowed to leave the room during the
exam. If you need to use the restroom, do it before the
test starts.
Name: _________________________________________
1
1)
a) Suppose a government education program succeeds in getting households to
save more (you may interpret it as a downward shift in the consumption
function). Using the long-run model of the economy developed in Chapter 3,
graphically illustrate the impact of the higher saving rate by households. Be
sure to label i) the axes, ii) the curves, iii) the initial equilibrium values, iv) the
direction curves shift, and v) final equilibrium values. (4 points)
r
S2
S1
r1
r2
I (r )
I1
I2
S, I
b) State in words what happens to:
i)
real interest rate (1 point): decreases
ii)
national saving (1 point): increases
iii)
investment (1 point): increases
iv)
consumption (2 points) (Note: Consider both versions of the consumption
function discussed in class)
C=C(Y-T): Consumption decreases due to policy
C=C(Y-T, r): Part of the decline in consumption may be offset due to an increase in C
when interest rates decrease
v)
output (1 point): no change
2
c) What is the impact of the government education program on nominal interest
rates? Explain briefly. ( 4 points)
According to the Fisher equation i  r   e . Hence a decrease in real interest rates
will reduce nominal interest rates
d) What is the impact of the government education program on money demand?
Explain briefly. (5 points)
Given that L(i,Y), a decrease in nominal interest rates will increase money demand.
e) What is the impact of the government education program on the price level?
Explain briefly. (6 points)
Money market equilibrium implies that Ms/P=L(i,Y). If the right hand side
increases (due to part (d)), then Price level has to decline to achieve money market
equilibrium.
f) What type of a policy could the central bank consider to offset the impact of
the government education program on the price level? Explain briefly. (10
points)
Increase the money supply (expansionary MP)
2) Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent,
while nominal interest rates in the same three periods are 5 percent, 5 percent,
and 6 percent respectively.
a) What are the ex-post real interest rates in the same three periods?
r=i- 
Period 1: (2 points) r=5-1=4
Period 2: (2 points) r=5-2=3
Period 3: (2 points) r=6-4=2
3
b) If the expected inflation rate in each period is the realized inflation rate in the
previous period, what are the ex ante interest rates in periods two and three?
Period 2: (2 points) r=5-1=4
Period 3 (2 points) r=6-2=4
c) If someone makes a loan (i.e. a lender) in period two, based on the ex ante
inflation expectation in part b, will he or she be pleasantly or unpleasantly
surprised? (5 points)
Ex ante r=4 > Ex post r=3. The lender would be unpleasantly surprised. She
thought that she would earn 4% in real terms but she only made 3%
3)
Base Year
Later Year
Price of good A
100
200
Quantity of good A
100
200
Price of good B
100
100
Quantity of good B
100
100
In the table, citizens of country Sydonia come to desire more of good A. As a
result the quantity and price of the good both rise.
a) Compute nominal GDP in the base year and later year. (7 points)
NGDP (base)=Pa.Qa+Pb.Qb=100.100+100.100=20000
NGDP (later)=200.200+100.100=50000
b) Compute real GDP in the base year and later years. (8 points)
RGDP (base)=20000
RGDP (later)=100.200+100.100=30000
4
c) Compute the GDP deflator in the later year. (5 points)
Deflator=(NGDP/RGDP)=(50000/30000)=1.66 (66% increase in prices)
d) Compute a fixed-weight price index for the later year, using the base year
quantities as weights. (5 points)
CPI=(100.200+100.100)/(100.100+100.100)=(30000/20000)=1.5
e) Which price index rises faster, GDP deflator of the fixed weight index? (5 points)
GDP deflator rises faster
4) Assume that the demand for real money balance (M/P) is M/P=0.6Y-100i,
where Y is national income and i is the nominal interest rate. The real interest
rate r is fixed at 3 percent by the investment and saving functions. The
expected inflation rate equals the rate of nominal money growth.
a) If Y is 1000, M is 100, and the growth rate of nominal money is 1 percent,
what must i and P be? (10 points)
5
i  r   e =3+1=4 percent
100/P=0.6(1000)-100(4/100)
100/P=596P=100/596=0.167
b) If Y is 1000, M is 100, and the growth rate of nominal money is 2 percent,
what must i and P be? (10 points)
i  r   e =3+2=5 percent
100/P=0.6(1000)-100(5/100)
100/P=595P=100/595=0.168
6