Download Midterm Exam – Potential questions

Macroeconomic Theory
Spring 2005
M. Finkler
Midterm Exam #1
Answer both questions in Part I, one question in Part II, and two questions in Part III. Be
sure to show your work. Exams will be collected at 9:00 P.M. You may use any
inanimate objects you choose. Please reaffirm the Honor Code. Use your time wisely.
“I don’t know of any country that has managed to consumer and invest 6 percent more
than it produces for long. The United States is absorbing 80 percent of the net flow of
international capital. And, at some point, both central banks and private institutions will
have their fill of dollars.” – Paul Volcker, April 10, 2005, washingtonpost.com
Part I. Do both questions. Be sure to show all of your work.
1. (28 points) Consider the following Neo-Classical model of a country called
Angelinos.
 Labor Demand
W/P = n0 – n1*Ld + n2*K
 Labor Supply
Ls = s1 + s2*(W/P) – s3*IB
where IB = immigration barriers (higher values imply more restrictive entry)
 Labor Market Equilibrium Ls = Ld
 Production
Y = y0 + y1*Ld + y2*K
 Aggregate Demand AD = M/(P*k)
 Goods Market Equilibrium Y = AD
n0, n1, n2, s1, s2, s3, y0, and y1 are positive constants.
Endogenous Variables
W, P, Ld, Ls,Y,AD
Exogenous Variables
K, IB, M, k
a.
Derive the reduced form statements for output(GDP), employment, and real
wages.
b.
Derive the Aggregate Supply curve. Indicate the slope.
Use either the mathematical or graphical versions of the above model for parts c-e.
c.
If Angelinos were struck by an earthquake that destroyed a portion of its capital
stock (K), what would the model predict would happen to output, employment, wages,
and prices?
d.
If Angelinos chose to loosen (make less restrictive) its immigration barriers, what
would be the effects on output, employment, wages, and prices?
e.
How would an increase in the velocity of money affect output, employment,
wages, and prices?
2. (24 points) Consider any economy as described in the table below.
Item
Food
Food
Clothing
Clothing
Housing
Housing
Year
Price
Quantity
Price
Quantity
Price
Quantity
1
$30
100
$20
50
$300
10
2
$45
200
$25
70
$400
8
a.
Compute the rise in prices for this economy using the CPI approach (Laspeyres)
b.
Use a variable weight (Paasche) index approach to determine the change in output
between the two years.
c.
Use a chain weighted approach to determine how much prices have increased.
d.
Explain why a unique measure of how much prices have increased from one year
to another is impossible to find.
Part II. Answer either question 3 or question 4. (18 points) Show your work.
3.
Use the following data to determine the trade-weighted exchange rate for Japan
based on the following data.
Country
1995
2000
2005
China
10 Yen/RMB 12.6 Yen/RMB 12.9 Yen/RMB
Europe
60 Yen/Euro* 100 Yen/Euro 140 Yen/Euro
United States 84 Yen/$
106 Yen/$
107 Yen/$
*Actually, this rate is based on the Deutsche Mark.
a.
Assuming that Japan has one third of its trade with each of the three countries and
that the index is 100 for 1995, calculated the trade weighted exchange rate for
2000 and 2005. Did the trade-weighted yen appreciate or depreciate for Japan
between 1995 and 2000? 2000 and 2005?
b.
Assume that presently one can buy a new Toyota Camry for $20,000 in the U.S.,
2,500,000 Yen in Japan, 250,000 RMB in China, or 15,000 Euros in Europe.
Assuming no transactions costs, if you were an agent for a world trading group, in
which country would you buy Camrys? Which would you sell Camry’s in?
c.
Based on the information in b., what does purchasing power parity suggest about
which currencies are overvalued and which undervalued relative to the Yen?
4.
a.
b.
c.
d.
Analyze an economy with the following characteristics:
 A Cobb-Douglas production function
 The technology parameter equals 70
 Labor force growth equals 3%
 The depreciation rate equals 5%
 The rate of growth of technology equals 2.5%
 The savings rate is 16%.
 Capital’s share of income is 50%.
What is the steady state level of income per capita for this country?
In steady state, what is the growth rate for income? Income per capita?
What is the steady state level of consumption per capita?
Is the value determined in c optimal? Explain why or why not?
Part III. Answer any two of the following questions (all parts.) Each question counts 15
points. Be sure to provide appropriate graphical or mathematical support for your
answers.
5.
a.
b.
c.
Consider income and substitution effects in a competitive loanable funds market.
Illustrate and explain how the relationship between real interest rates and the
supply of loanable funds depends out which effect dominates.
Assume that substitution effects dominate income effects in credit supply. How
would an income tax on interest income affect real interest rates, the total amount
of loans, and private investment?
How would the results in b. change if income effects were dominant?
6.
This question relates to the study of trade and capital flows in a small open
economy.
a.
How would a rise in world (real) interest rates affect investment, net exports, and
the domestic real interest rate in this economy?
b.
How would an increase in governmental expenditures affect investment, net
exports, and the domestic real interest rate?
c.
How would a lowering of trade barriers affect investment, net exports, and the
real exchange rate?
7.
The U.S. Congress is considering a 27.5% tariff on Chinese imports as a way to
reduce the loss of jobs.
a.
b.
Use a graph with the real exchange rate on one axis and net exports on the other
to evaluate the effects for the U.S. economy.
Use the “sources” equal “uses” national income identity to evaluate the effects of
the aforementioned tariffs.
8.
Use the Neo-Classical Model (Model 1) to answer the following questions:
a.
How would a rise in the availability of raw materials affect the levels of
employment, output, real wages, and prices?
How would an increase in governmental expenditures affect the levels of
employment, output, real wages, and prices?
How would a decrease in the stock of money affect the levels of employment,
output, real wages, and prices?
b.
c.