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ECO 302b
Intermediate Macro
Spring 2009
Midterm 3
Part I: Answer completely in the spaces provided, or use the back of the page. (40
points total)
1.
An economy is described by the following equations:
Desired Consumption
Desired Investment
Government Purchases
Taxes
Real Money Demand
Real Money Supply
Full-employment output
Cd = 26 + 0.5(Y – T) - 100r
Id = 20 - 100r
G = 20
T = 20
L = 0.5Y - 200r
M/P = 264/P
YFE = 100
Assume that expected inflation is zero so that money demand depends directly on the
real interest rate.
a.
Write the equation that describes the IS curve.
b.
Write the equation that describes the LM curve.
c.
Calculate the real interest rate, price level, consumption, and investment if all
markets are in equilibrium at the full-employment level of output.
d.
Suppose that consumers feel more secure about their future wealth, and the
consumption function shifts to become:
Desired Consumption
Cd = 46 + 0.5(Y – T) - 100r
Assuming that the price level is fixed in the short run, what will be the new short-run
equilibrium output and real interest rate?
e.
Under the new consumption function in part d, what will be the long run level
of output and the new price level?
2.
The discovery of a new technology raises the expected future marginal product
of capital (MPK).
a.
Use the classical IS-LM-FE model to determine the effect of the change in
MPK on current output, the real interest rate, employment, real wages, consumption,
investment, and the price level. Assume that expected future real wages and future
incomes are unaffected by the new technology. Assume that current productivity is
unaffected.
b.
Fine the effects of the increase in expected future MPK on current output and
prices using the AD – AS diagram based on the misperceptions theory. What accounts
for the difference in your answer here compared to part a?
Part II:
Select the best answer for each of the following questions and mark it
clearly on the page. (3 points each)
1.
Examples of “aggregate demand shocks” include:
(i)
change in desired investment arising from changes in expected future marginal
product of capital
(ii)
changes in government expenditures or taxes
(iii) changes to consumer confidence that affect the position of the desired national
savings curve.
a.
b.
c.
d.
e.
only (i) is true.
only (ii) is true.
only (iii) is true.
only (i) and (ii) are true.
(i), (ii), and (iii) are all true.
2.
Both classical and Keynesian economists agree that the long-run Phillips
Curve is:
a.
b.
c.
d.
e.
vertical over the natural rate of unemployment
upward-sloping
unstable.
dependant on expected inflation
downward-sloping
3.
People who believe that the natural rate of unemployment can be reduced
suggest that ____ might work to lower the natural rate.
(i)
(ii)
(iii)
government support for job training and worker relocation
increased labor market flexibility
more generous unemployment compensation
a.
b.
c.
d.
e.
only (i) is true.
only (ii) is true.
only (iii) is true.
both (ii) and (iii) are true.
both (i) and (ii) are true.
4.
A government that wants to implement a policy to lower inflation will be more
successful if the government ____ credibility and tries to make sure the new policy is
_____.
a.
b.
c.
d.
e.
has
has
does not have
does not have
none of the above.
anticipated
unanticipated
anticipated.
unanticipated
5.
The “sacrifice ratio” is the ratio of:
a.
b.
c.
d.
1%.
e.
the percentage of output lost in order to reduce the inflation rate by 1%.
the percentage of investment lost when real interest rates rise by 1%.
the percentage of GDP lost when tax rates rise by 1%.
the percentage of investment lost when the government budget deficit rises by
the percentage of real wage decrease when the labor force increases by 1%.
6.
Above is the degree of effort (or productivity) a typical employee might offer
according to the wage paid. If the prospect of unemployment becomes less frightening
to the employee (because unemployment compensation is made more generous), then
the effort curve will shift to the _________ and the wage the firm will want to pay
will _____.
a.
b.
c.
d.
e.
right
rise
right
fall
left
fall
left
rise
none of the above.
7.
If a firm’s current price for its product is pretty close to the “perfect” (profitmaximizing) price, profits should be pretty close to the maximum level of profit. It
might not be worth the bother or cost of adjusting the price to the perfect level. This is
the idea behind the ______ theory.
a.
b.
c.
d.
e.
implicit contract
insider-outsider
menu cost
reverse causation
misperceptions
8.
If existing employees regard a newcomer who is paid less than them as a threat
to their jobs, the existing employees will withhold cooperation and undermine the
work of the new employee. This makes the employer reluctant to hire new employees
at lower wages. This is the idea behind the _____ theory.
a.
b.
c.
d.
e.
misperceptions
menu cost
implicit contract
insider-outsider
reverse causation
9.
If money demand increases suddenly, then the _______ ; which will cause the
_____.
a.
b.
c.
d.
e.
IS curve to shift to the left
IS curve to shift to the right
LM curve to shift to the left
LM curve to shift to the right
none of the above.
AS curve to shift to the right
AS curve to shift to the left
AD curve to shift to the left
AD curve to shift to the right
10.
Keynesians believe that the ____ market can remain in disequilibrium, so
business cycle movements can be caused by shifts in _____.
a.
b.
c.
d.
e.
product
asset
labor
product
labor
AS
AD
AS
AD
AD
11.
The Phillips Curve relationship between inflation and unemployment appears
to be stable when governments do not attempt to manage the economy – but unstable
when governments do try to manage the economy. This outcome is best explained by:
a.
b.
c.
d.
e.
Implicit Contract Theory
Real Business Cycle Theory
Lucas Misperceptions Theory
Keynesian Business Cycle Theory
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.
b.
c.
d.
e.
horizontal and stable
upward-sloping and stable
upward-sloping and unstable
vertical and unstable
vertical and stable
unstable
unstable
stable
stable
unstable
13.
A government wants to lower inflation by lowering the growth rate of the
money supply. If it believes inflation expectations will adjust quickly to a dramatic
change in policy, it will prefer the ____ approach to lowering inflation.
a.
b.
c.
d.
e.
gradual
Lucas
Phillips
Bernanke
cold turkey
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.
b.
c.
d.
e.
efficiency wage
menu cost
quantity
reverse causation
implicit contract
15.
When an economy experiences a prolonged period of high unemployment,
some members of the population become less employable because of the lack of job
history or experience. Thus the natural rate of unemployment depends on the history
of actual unemployment rates. This is the idea behind _____ .
a.
b.
c.
d.
e.
hysteresis
psoriasis
halitosis
implicit contracts.
political business cycle.
16.
According to the Lucas misperceptions model, a shift to the right of the AD
curve will cause a business cycle expansion if the shift is _____.
a.
b.
c.
d.
e.
unexpected.
perfectly anticipated.
caused by a shift of the IS curve.
caused by a shift of the LM curve.
caused by a shift of the FE line.
17.
The Solow residual is:
a.
the difference between national savings and desired investment.
b.
the difference between the quantity supplied and quantity demanded of nonmonetary assets.
c.
the portion of the change in output that cannot be explained by changes in
measured capital or labor inputs.
d.
the portion of the adult population that is not counted as part of the labor force.
e.
the difference between actual inflation and expected inflation.
18.
The “reverse causation” argument is useful to ____ economists because it
helps explain why _______.
a.
b.
c.
d.
e.
Keynesian
Keynesian
Keynesian
classical
classical
real wages are pro-cyclical
unemployment is a lagging variable
average labor productivity is counter-cyclical
money supply growth is leading and pro-cyclical
stock prices are leading variables
19.
In 1914, Henry Ford tried to reduce worker turnover and absenteeism in his
factory by offering workers $5 per day to work (double the normal wage for factory
workers at the time.) The result was:
a.
b.
c.
d.
e.
even more turnover and absenteeism.
union protests.
his cars became too expensive to sell profitably.
absenteeism and turnover fell, and labor productivity went up.
the union demanded $6 per day.
20.
According to Keynesians, firms keep some workers on the payroll during
recessions even if the firm doesn’t need them at that moment – to avoid losing hardto-replace workers. When demand increases, the firm can increase output without
adding many new workers. This will make _____ appear to be pro-cyclical, even
though there has been no change in the production function.
a.
b.
c.
d.
e.
money supply growth
real wages
average labor productivity
labor force participation
inventory investment