Download Midterm 3

Econ 302
Spring 2008
Midterm 3
Name____________________________
SID # ___________________________
Part I: Answer the following questions in the space provided, or on the back of the
page(s) if necessary.
Cd = 20 + (0.4)·Y –200·r
Id = 50 – 400·r
G = 60
Xd = 0.1·(P#/P)·Y#/enom
IMPd = 0.1·Y·(P/P#)·enom
MS = 200
L(Y, r) = 80 + 0.4·Yc – 400·r
enom = 0.5 + 10·r – 10·r#
In the equations above, P#, Y#, and r# represent the foreign price level, income, and real interest rate,
respectively.
Assume initially that P# =1, Y# = 100, and r# = .04, and that P = 2, and Y = 100
1.
Below is a graph of the MS-MD diagram, at current prices and incomes. For Yc taking on the
values of 80 and 120, sketch out the effects in the MS-MD diagram, and use the information to plot
out the country's LM curve.
MS/P
real interest
rate
.07
.05
.03
L(Y=100, r)
92
100
108 M/P
page 1
2.
Below are the desired national savings – desired investment lines, assuming that Y = 100.
Plot the difference between Snd and Id and use the information to plot the desired foreign lending line.
Snd = 10 + 200r
real interest rate
.125
.067
Id = 50 – 400r
10
23.3
50 S, I
3.
Assuming that Yc = 100, sketch out the desired NX curve, assuming that the country is using a
flexible exchange rate system.
4.
Using this information, sketch out the open economy IS curve, and find the point on the AD
curve corresponding to a price level of 2.
page 2
5.
Suppose the economy is at full-employment, but the government wants to bring the current
account balance closer to zero (keeping output at approximately full-employment.) What should it do?
6.
(Short essay)
In the 1990’s, Argentina had a fixed exchange rate with the US dollar, but found it could
not keep its economy close to full employment, keep its banking system solvent (the
government had forced the banks to purchase government debt), and maintain the fixed
exchange rate all at the same time. Suspecting that the government might abandon the
fixed rate, currency speculators sold Argentine currency in foreign exchange markets,
putting even more pressure on the fixed exchange rate.
Suppose there was no Argentine currency, and Argentina had simply adopted the US
dollar. If Argentina had a large current account deficit (required borrowing), was already
deeply in debt (and default was a real threat), and finding it difficult to convince outsiders
to lend to it, would its problems have been less severe if the ability to devalue its
currency did not exist?
page 3
Part II:
the exam.
Instructions: Select the best answer for each question, and record it on
1.
For an open economy with flexible exchange rates, a fall in the domestic real
interest rate also causes the domestic currency to _______ , which makes the product
market _____ sensitive to changes in interest rates than a closed economy, so the IS curve
is _____.
a.
b.
c.
d.
e.
depreciate
more
depreciate
more
appreciate
less
appreciate
less
none of the above.
flatter
steeper
flatter
steeper
labor
productivity
w0
wage
The graph above applies to the next two questions.
2.
Suppose the graph above shows the relationship between labor productivity in
real wage before a new law takes effect that protects workers’ rights by requiring firms to
justify all employee dismissals with solid, court-admissable evidence that the employee
was negligent or unproductive. (This makes it more difficult for firms to get rid of
unproductive employees.) The effect on the graph would be:
a.
to shift the line representing the relationship between wage and productivity to the
right, which will increase the wage that firms will want to pay.
b.
to shift the line representing the relationship between wage and productivity to the
right, which will decrease the wage that firms will want to pay.
c.
to shift the line representing the relationship between wage and productivity to the
left, which will decrease the wage that firms will want to pay.
d.
to shift the line representing the relationship between wage and productivity to the
left, which will increase the wage that firms will want to pay.
e.
none of the above.
page 4
3.
The efficiency wage model explains why there can be ______ unemployment
when there is ____ pressure on wage levels in the labor market.
a.
b.
c.
d.
e.
frictional
structural
involuntary (not frictional or structural)
voluntary
cyclical
upward
downward
no
downward
no
4.
Country Alpha has the following transactions with the outside world during 2007:
Purchase of foreign assets by Alpha:
Goods exported from Alpha:
Income earned by Alpha’s citizens working in other countries:
Assets in Alpha purchased by foreigners:
Goods imported into Alpha:
In 2007, Alpha’s current account balance was:
$7
$3
$4
$9
$5
_______
Alpha’s capital account balance (including official settlements balance) was _______.
Alpha’s official settlements balance was:
_______
5.
Country A and Country B trade extensively with each other and maintain flexible
exchange rates. When Country A uses contractionary fiscal policy, Country A’s domestic
real interest rate falls. The fall in A’s interest rate also causes in Country B:
a.
b.
c.
d.
e.
a shift to the right of NXd, IS, and AD due to the depreciation of B’s currency.
a shift to the left of NXd, IS, and AD due to the rise in the value of B’s currency.
a shift to the right of the FLd, which will cause the IS and AD to shift to the left.
a shift to the left of the LM and AD curves.
a shift to the left of FLd, and a shift to the right of IS and AD.
6.
Country A and Country B trade extensively with each other and maintain flexible
exchange rates. When Country A uses contractionary monetary policy, Country A’s
domestic real interest rate rises. The rise in A’s interest rate also causes in Country B:
a.
b.
c.
d.
e.
a shift to the right of NXd, IS, and AD due to the depreciation of B’s currency.
a shift to the left of NXd, IS, and AD due to the appreciation in B’s currency.
a shift to the left of the FLd, which will cause the IS and AD to shift to the right.
a shift to the left of the LM and AD curves.
a shift to the left of FLd, and a shift to the right of IS and AD.
page 5
7.
According to the Friedman-Phelps (expectations augmented) version of the
Phillips curve, when the government convinces the public that the government is fully
committed to lowering the inflation rate, there is a:
a.
b.
c.
d.
e.
shift to the left of the labor supply curve.
shift to the left of the Phillips curve.
shift to the left of the SRAS.
shift to the right of the AD curve.
none of the above.
8.
If a central bank is maintaining a fixed exchange rate and finds itself purchasing
international reserve assets to prevent the appreciation of its domestic currency, then the
need to maintain the fixed exchange rate requires:
a.
making fiscal policy more expansionary so that desired foreign lending increases.
b.
making fiscal policy less expansionary in order to raise interest rates.
c.
the central bank to raise interest rates and make monetary policy less
expansionary.
d.
the central bank to lower interest rates and make monetary policy more
expansionary.
e.
making monetary policy more expansionary so that extra money can be used to
buy back international reserves.
9.
A country with a fixed exchange rate has a ________ desired net exports curve
than if it had a flexible exchange rate. Therefore the _______ curve is _________ than it
would be with a flexible exchange rate.
a.
b.
c.
d.
e.
steeper
IS
steeper
LM
flatter
LM
steeper
IS
none of the above.
flatter
flatter
steeper
steeper
10.
If the Purchasing Power Parity condition holds between the Bulgarian lev and the
euro, then the real exchange rate between the lev and euro is equal to:
a.
b.
c.
d.
e.
the fundamental value of the lev.
the official exchange rate of BGN 1.955 = 1 euro.
the ratio of the euro price level to the Bulgarian price level.
one.
none of the above.
page 6
11.
When a country’s currency depreciates on the foreign exchange markets, the
effect of the depreciation on the country’s current account balance is for the current
account balance to _____ in the short run, and _____ over time as importers and
exporters adjust to the new value of the currency.
a.
b.
c.
d.
e.
increase (or become less negative)
decrease (or become more negative)
increase (or become less negative)
decrease (or become more negative)
increase (or become less negative)
decrease to the original level
increase to a higher level
decrease to a lower level.
increase to the original level
decrease but stabilize at a higher level.
12.
The theory of “menu costs” is used to explain why:
a.
firms respond to changes in demand by adjusting output, instead of changing
prices.
b.
changes in employment are less than proportional to changes in output, when
economic theory says that employment should change more.
c.
average labor productivity appears in the data to be procyclical, but Keynesian
economic theory suggests it should be countercyclical.
d.
the Phillips Curve trade-off suggests that countries should choose higher inflation
and lower unemployment, but some countries do the opposite.
e.
labor unions are successful in winning higher wages for their members even when
unemployment is high.
13.
If a worker experiences a period of unemployment, he/she may lose skills and
become less employable later. If a country experiences a period of high unemployment,
its labor force becomes less employable – raising the country’s natural rate of
unemployment. This idea is called:
a.
b.
c.
d.
e.
arbitrage.
hysteresis.
rational expectations.
seigniorage.
gradualism.
14.
An increase in national income would cause the desired foreign lending line to
shift to the _____ . This would also cause a ______ in the open economy IS curve.
a.
b.
c.
d.
e.
right
left
right
left
left
movement along
movement along
shift to the right
shift to the left
shift to the right
page 7
15.
In an open economy, the product market is in equilibrium when:
a.
desired foreign lending equals desired investment.
b.
desired national savings equals desired net exports.
c.
the current account balance equals zero.
d.
the current account balance plus the capital account balance equals zero.
e.
desired foreign lending (desired savings minus desired investment) is equal to
desired net exports.
16.
During lunch hour at McDonald’s®, all workers are busy cooking or selling
hamburgers. At other times, they are busy cleaning, re-stocking, performing maintenance
on equipment, etc. An economist measuring labor productivity as hamburgers per hour
finds that average labor productivity is ____ during lunch hour. Keynesians use this idea
to explain why average labor productivity appears in the data to be procyclical, even
though business cycle fluctuations are actually caused by ______.
a.
b.
c.
d.
e.
higher
higher
lower
lower
higher
technology shocks
changes to labor supply
changes in aggregate demand
changes in labor demand
changes to aggregate demand
17.
Depreciation of the domestic currency makes exports ______ expensive for
foreign buyers and imports _______ expensive for domestic buyers, thus ______ total
demand faced by the country’s domestic producers.
a.
b.
c.
d.
e.
more
less
more
less
less
more
less
more
none of the above.
increasing
decreasing
increasing
decreasing
18.
The costs to society of a small increase in inflation are _______ the costs of a
small increase in unemployment. An activist Keynesian central banker would therefore
be likely to use the Phillips Curve trade-off to choose:
a.
b.
c.
d.
e.
greater than
greater than
smaller than
smaller than
equal to
to reduce the current account deficit
to depreciate the currency to stimulate exports
to lower unemployment by raising inflation a bit
to raise interest rates to reduce inflation
stable prices and the natural rate of unemployment
page 8
19.
Critics of activist management of the economy claim that if people have rational
expectations about the level of inflation, the result of the government’s predictable
attempts to choose an attractive trade-off along the Phillips Curve will be:
a.
b.
c.
d.
e.
higher inflation and lower unemployment.
higher inflation and no effect on unemployment.
higher current account deficits and lower unemployment.
lower inflation and higher unemployment.
higher interest rates and lower unemployment.
20.
In an open economy, the product market equilibrium with a current account
balance equal to zero is attained automatically by:
a.
exchange rate appreciation or depreciation sufficient to bring desired net exports
equal to zero.
b.
domestic real interest rate changes will reverse the capital flow that finances the
current account deficit, forcing the deficit back to zero.
c.
changes in domestic output will induce changes in imports sufficient to bring
desired net exports equal to zero.
d.
changes in the domestic price level will make the country’s export products either
more or less attractive in foreign markets, and set desired net exports equal to zero.
e.
nothing makes the current account balance automatically zero.
21.
Suppose a (Keynesian) country with a flexible exchange rate system has a high
current account surplus. The type of policies that would tend to reduce the current
account surplus would be (ignore effects on domestic output):
(i)
(ii)
(iii)
(iv)
expansionary fiscal policy
expansionary monetary policy
contractionary fiscal policy
contractionary monetary policy
a.
b.
c.
d.
e.
only (i) is true.
only (iii) is true.
both (ii) and (iii) are true.
both (i) and (iv) are true.
both (i) and (ii) are true.
page 9
Extra Credit (1 point)
The shape on the left can be divided into two identical parts by cutting along the dashed
line. Show how the shape on the right can be divided into two identical parts with a single
cut.
page 10