Download QUIZ 2: Macro – Winter 2002 - The University of Chicago Booth

QUIZ 4: Macro – Fall 2014
Name: _ANSWERS________
Section Registered:
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Tue a.m.
Campus
Tue p.m.
Gleacher
Wed a.m.
Exchange Student None
For the entire quiz, make the following assumptions. (1) All consumers are non-liquidity
constrained, non-ricardian PIH, (2) Prices are held fixed unless told otherwise, (3)
expected inflation does not affect money demand (MD), (4) the capital stock (K) is fixed, (5)
all exogenous variables (A, tax rates, government spending, Fed policy, etc.) are fixed unless
told otherwise, (7) we are considering a closed economy (NX=0), and (8) changes in N do
not independently affect investment demand. Finally, assume all changes to exogenous
are permanent and unexpected.
Note: For questions 1-3, you must circle ALL true answers. Multiple answers could
be true (or not). You should view the answers as a series of True/False questions.
Question 1 (1 points each – 3 points total)
Circle all true answers to the following statement. Assume that the income effect on labor
supply (NS) is the same size as the substitution effect on labor supply. An increase in the
required reserve ratio (m) will:
An increase in the required reserve ratio will cause the money supply (M) to shrink. We
define the LM curve as (M/P). Thus, as M decreases, the LM curve will shift left
causing r to increase, Y to fall below Y* and the interest-rate-sensitive component of
Investment to fall (move up the IS curve).
We define the Aggregate Demand curve as the IS and LM curves drawn in {P,Y} space.
Thus, as M falls, AD shifts left and Y falls below Y*.
We define the LRAS curve as Y*=AK*0.3N*0.7. As the money supply changes, nothing
happens to A, K* or N*. Thus, nothing happens to Y*.
We define the Money Demand curve as a function of Y. As M decreases, the LM and
AD curves shift in causing Y to fall below Y*. As Y falls, the Money demand curve
shifts left.
As m increases, the Money Supply curve shifts to the left (that’s the change that sets
this whole thing in motion).
All the answers are FALSE.
a. Shift both the LM curve to the right and the Aggregate Demand (AD) curve to the
right.
b. Shift the Long Run Aggregate Supply (LRAS) curve to the right.
c. Shift both the Money Demand (MD) and Money Supply (MS) curves to the right.
Question 2 (1 point each – 5 points total)
Circle all true answers to the following statement. Assume that the income effects on labor
supply (NS) are large relative to the substitution effects on labor supply. A fall in labor
income taxes (tn) will:
As tn falls, we know that after tax wages must increase. Why? The government is taking
less out of every pay check. As after tax wages increase, the substitution effect says that
the labor supply curve will shift out as we work more. As after tax wages permanently
increase, the income effect says we will want to work less, shifting the labor supply
curve in. Because the income effect dominates, we know that the labor supply curve
will, on net, shift to the left. This means that before tax wages (which are endogenous)
will increase and N* will decrease. Recall, A did not change and K is fixed. The labor
demand curve (ND) will not shift.
For the LRAS curve, as N* decreases, Y* must also decrease. Thus, the LRAS curve
shifts left.
For the IS-LM market, as after tax wages permanently increases, PVLR increases. This
means that consumption (C) will increase. As C increases, the IS curve will shift to the
right. This will cause r to increase, I to fall (move along the IS curve) and Y to increase.
In the assumptions, we told you that prices are held fixed. Thus, nothing happens to the
LM curve.
Similarly, as C increases the AD curve must shift right.
Nothing happens to the Money Supply (there is no change in Fed policy and P is fixed).
The Money Demand curve will shift right as Y increases (from the increase in C).
All the answers are FALSE.
a. Shift the Labor Demand (ND) curve to the right and the IS curve to the right.
b. Shift the Aggregate Demand (AD) curve to the right and the Labor Supply (NS) curve
to the right.
c. Shift the Long Run Aggregate Supply (LRAS) curve to the right.
d. Shift both the Money Demand (MD) curve and the Money Supply (MS) curve to the
right.
e. Shift the LM curve to the right.
Question 3 (1 point each – 5 points total)
For this question, circle all the answers that are true. Also, use the IS-LM framework
developed in class to answer the questions (like we did in the middle of class last week).
Focus your analysis on the short run (such that nominal wages are fixed and the labor
market is allowed to be in disequilibrium). Again, assume prices are fixed (and all other
quiz assumptions hold).
All answers are FALSE.
a. An increase in the nominal money supply (M), will cause real interest rates (r) to fall
and will shift the IS curve to the right.
As M increases, the LM curve shifts out, r falls and I increases. The increase in I (the
interest rate sensitive part of I) is reflected as a movement along the IS curve. The IS
curve does not shift as C(.), G, and NX do not change and the autonomous part of I (i.e.,
I(.)) does not change.
b. A fall in government spending (G) will cause the IS curve to shift to the left and
investment (I) to fall.
We define the IS curve Y= C+I+G+NX. As G decreases, the IS curve will shift to the left
causing r to decrease and the interest rate sensitive part of I to increase.
c. An increase in consumer confidence will cause real interest rates (r) to fall and the
Aggregate Demand (AD) curve to shift to the right.
An increase in consumer confidence causes C to increase. The IS curve will shift right.
This causes r to increase and I to decrease (move along the new IS curve). As C
increases, the AD curve will shift right.
d. An increase in business confidence will cause real interest rates (r) to rise causing the
effect on total investment (I) to be ambiguous.
An increase in business confidence will cause the autonomous part of I to increase (i.e.,
I(.)). This will shift out the IS curve causing r to increase. As r increases, the interest
rate sensitive part of I will fall. On net, the increase in the autonomous part of I will be
greater than the decline in the interest-rate-sensitive part of I. Thus, on net, I increases.
Y must increase as I, on net, increases. The intuition for this is that the only reason that
r went up was because money demand increased. The only reason that money demand
increased was because Y (via I) increased. The increase in I is necessary to have the
offsetting interest rate increase.
e. An increase in TFP (A) will have no effect on either the Money Supply (Ms) or the
Money Demand (MD) curves.
As A increases, the labor demand curve (ND) will shift right. This causes W/P to
increase permanently. As W/P permanently increases, PVLR increases. As PVLR
increases, consumption (C) must increase. As C increases, the IS curve will shift right
causing Y to increase. Also, the AD curve will shift right causing Y to increase. The
money demand curve is a function of Y. As Y increases, the money demand curve will
shift right. The Money Supply curve is a function of Fed Policy which does not change.
Thus, the Money Supply curve does not move.
Question 4 (4 points total - Graded on 0/4 scale)
Below, I have listed some approximate facts about the U.S. economy during the 2008-2009
recession. Here are the facts:





The unemployment rate increased by 4.1 percentage points during 2008-2009.
Real GDP increased by 0 percent during that time period.
Nominal interest rates (1 year Treasury) fell by 2.1 percentage points during that time period.
The nominal money supply increased by 20.1 percent
The CPI inflation rate was 5.7 percent
What happened to the velocity of money during this time period?
box below.
Put your answer in the
This was so easy for anyone who knew the quantity theory of money definition. Given
the definition, you just had to plug in numbers.
%∆M +%∆V =%∆P + %∆Y
.201 +%∆V = .057 + 0
%∆V = -14.4%
Question 5 (3 points total. No partial credit.)
The Planet Money article "The Birth of the Dollar Bill" spoke about the evolution of a single
currency within the United States. The article spoke about how one war was instrumental in
moving the U.S. towards a single U.S. backed currency (as opposed to the existence of
various local bank notes). According to the article, what war was that? Your answer should
only be the name of one U.S. war.
Civil War