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Exam in Macro B
Short questions and short answers:
1,5 points
1. Assume that GDP(Y) = C + I + GC + GI + NX,
where GC = Government consumption and GI = government investment.
Assume that C=100, I=20, GC=40, GI=20, NX=10, T=70.
T = net taxes = taxes – transfers.
Assume that net foreign income from abroad (NFI)= net transfers from abroad (NFTr)=0.
Calculate National real saving, private real saving, and government real saving.
Answer1:
National real saving= Y-C-GC= I + GI + NX = 20+20+10=50.
Private real saving = Y-T-C.
Y=100+20+40+20+10=190.
Thus, private real saving = 190-70-100=20.
Government real saving = T-GC=70-40=30.
2+1 = 3 points
2A. In the Keynesian model for a closed economy, what is the effect of expansionary fiscal
policy (a higher G or a lower T) on the real interest rate, private investment, output, and
private consumption in the short run (when the price level is assumed to be fixed)?
Assume a simple Keynesian consumption function, which means that private consumption
only depends on private disposable income.
2B. According to the life-cycle model of consumption, what is the effect of lower taxes today
on private consumption today if lower taxes today mean higher taxes in the future?
Answer2:
Output, private consumption, and real interest rate up, and private investment down.
According to the life.cycle model no effect on current consumption.
4 points
3A. Use the classical model for the closed economy = Keynesian model for the closed
economy in the long run (when prices and wages are completely flexible) to analyze the effect
of expansionary fiscal policy (a higher G or a lower T) on output, and private investment.
3B. Use the classical model for the small open economy = Keynesian model for the small
open economy in the long run (when prices and wages are completely flexible) to analyze the
effect of expansionary fiscal policy (a higher G or a lower T) on output, real exchange rate,
and the trade balance.
Answer3A: No effect on output. Private investment decreases equally much that for example
G increases.
Answer3B: No effect on output. Trade balance decreases equally much that for example G
increases. The real exchange rate appreciates.
2 points
4. Assume a country that constantly (for many years) is running huge government budget
deficits and finance these government budget deficits by printing new money. Use the
quantity theory of money to analyse the effects of a higher growth rate of the nominal money
supply. What is the effect on the inflation rate, on the nominal interest rate, and on the real
money demand? If the country has a currency that floats, do you expect the value of this
currency to depreciate or appreciate as consequence of higher growth rate of the nominal
money supply?
Answer:
4.Higher money growth leads to a higher inflation and to a higher nominal interest rate (due to
the Fischer equation), and to a lower real money demand, and to a depreciating currency.
2 points.
5. Suppose that an economy has the Philips curve
   e  0.5(u  0.07)   1  0.5(u  0.07)
a. What is the natural rate of unemployment?
b. How much cyclical unemployment is necessary to reduce inflation by 5 percentage
points in one year?
Answer 5:A. u=0.07, which is the natural rate of unemployment.
5B. To reduce inflation, the Phillips curve tells us that unemployment must be above its
natural rate of 7 percent for one year. We can write the Phillips curve in the form: Actual
inflation – last period’s inflation = 0.5(u-0.07). Since we want inflation to fall by 5 percentage
points, we want (actual inflation – last period’s inflation)=-0.05. Plugging this into the lefthand side of the above equation, we find that -0.05=-0.5(u-0.07). 0.1=u-0.07. Solving for u:
u=0.17. Hence, we need 10 percentage point-increase of cyclical unemployment above the
natural rate of 7 percent.
3 points
6. Assume that the economy’s production function is:
Y  A  K 0,2  L0,8 . Assume that L / L = 0.02, K / K = 0.02 and Y / Y =0.03.
A. Use growth accounting to calculate A / A
B. Calculate the growth rate of labor productivity, Y/L:
Answer6a: 1 procent. Answer6b: 1 procent.
Longer questions:
3+1+1= 5 points
7. Use the Solow-model with the following production function: Y  AK  L1 .
Assume as usual that every person in the economy is a worker.
Assume also that the growth rate in A is zero.
A
4
Saving rate (s)
0.5
0.5

Population growth rate (n)
0.0
0.1
Depreciation rate (  )
L(0)
100
7a. calculate the long-run equilibrium values for capital per worker (K/L), consumption per
worker (C/L), production per worker (Y/L), the real wage (W/P), and the real return on capital
(r =MPK-  ). Also calculate long-run equilibrium of GDP (Y).
7b. What is the effect on the long-run equilibrium values of K/L, Y/L, W/P, and the real
return on capital (r) if n increases? No need to calculate with numbers.
7c. What is the effect on the long-run equilibrium values of K/L, Y/L, W/P, and the real return
on capital (r) if A increases? No need to calculate with numbers.
Answer:
savum
k=(sA/(n+d))^2 400
y=Ak^0.5
80
c=(1-s)*y
40
W/P=0.5*y
40
r=
0.0
A0.5k^-0.5 - d
Y=y*L
8000
7b. k, y, and the real wage decrease, and the real return on capital increases.
7c. k, y, and the real wage increase, and the real return on capital stay constant.
7a.
4.5 points
8. Use the Keynesian model for a small open economy with its own currency.
Some of the assumptions of this model are:
Equilibrium in the goods market: Y = C(Y-T) + I(r=r*) + G + NX (real exchange rate)
Equilibrium in the money market: M/P = L(r=r*,Y)
Assumption 1: r is the real interest rate and r* is the real interest rate in the rest of the world.
Assumption 2: The domestic price level and the price level in the rest of the world are
constant in the short run.
A. Suppose the economy experiences a fall in demand for its export products.
What happens in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, to the nominal and to the
real exchange rate and to the trade balance (NX)?
Compare the old short-run equilibrium with the new short-run equilibrium.
Answer qualitatively: Has Y increased, decreased or is the same, etc.
Answer: Y goes down due to a fall in aggregate demand. Lower income lowers real money
demand which means a lower interest rate (below the world market interest rate) which means
that financial investments in Sweden are relatively unprofitable; hence the demand for the
currency decreases, which leads to a depreciation of the nominal and real exchange rate,
which increases NX.
GDP, private consumption and NX are unchanged but the nominal and real exchange rate are
depreciated.
B. Assume now that the CENTRAL BANK decreases the nominal money supply (M) and
thereby temporarily increases the nominal interest rate (above the world interest rate).
What happens in the short run (when the domestic price level and the price level in the rest of
the world are constant) to GDP (Y), private consumption, to the nominal and to the real
exchange rate and to the trade balance?
Compare the old short-run equilibrium with the new short-run equilibrium.
Answer qualitatively: Has Y increased, decreased or is the same, etc.
Answer: Y, C, and NX decreases and currencecy appreciates.