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Agricultural Economics 430 Macroeconomics of Agriculture Fall 2008 Penson Second Hour Examination NAME: _____ANSWER KEY____________________________ SID NUMBER: ______________________________ This examination consists of six questions. Please read each question carefully. The term “describe fully” asks that you answer all aspects of the question. Avoid giving extraneous information (i.e., “filler”). Use graphs/formulas whenever possible to help tell your story. Use the back of a page if necessary. Good luck! Question 1 _____ of 20 points Question 2 _____ of 15 points Question 3 _____ of 15 points Question 4 _____ of 15 points Question 5 _____ of 15 points Question 6 _____ of 20 points TOTAL _____ of 100 points 2 1. Please complete the following table describing the short-run effects of specific macroeconomic policy actions on the “Big 5” variables with a “+” denoting an increase in the variable in each column heading and a “–” denoting a decrease. (20 points; 1 points each) Macroeconomic policy action Federal Reserve lowers the reserve requirement ratio Increase in the federal marginal income tax rate Reduction in the level of government spending Federal Reserve raises the discount rate GDP growth rate Inflation Unemploy Interest Exchange rate -ment rate rate rate + + _ _ _ _ _ + _ _ _ _ + _ _ _ _ + + + 3 2. We have used IS/LM analysis to capture the equilibrium in the nation’s product and money markets. Please graphically illustrate the effects that the combination of hike in the fractional reserve ratio by the Federal Reserve and a fiscal policy featuring a tax cut will have on the equilibrium interest rate, level of GDP and general price level. Make sure you label all graphs. (15 points) AS1 AS2 LM2 LM1 i2 i1 Y1 = Y2 AD P1 = P2 AS 4 3. Please define or graphically illustrate each of the following terms in the context of this course: (3 points each, 15 points) Recessionary gap Occurs where YE < YFE Potential GDP Occurs in the classical range of the aggregate supply curve, or where it becomes perfectly inelastic. Money multiplier The reciprocal of the fractional reserve requirement ratio or (1/rrm) Demand pull (excess demand) inflation Occurs when the general price level in the aggregate product market is pulled up by an increase in aggregate demand. Discount rate The rate banks pay when borrowing from the discount window at the Federal Reserve. 5 4. Please graphically illustrate the concept of “macro-to-market-tomicro” relationship we have discussed in this class assuming (1) a perfectly competitive firm and then (2) assuming a monopoly. (15 points) Perfectly competitive case: AD D AS S MC PC CPI QPC QC Y Monopoly case: AD AS D MC CPI MR Y QM 6 5. Given the following demand and supply equation for a market, please answer the questions below MS = 1/rrm(TR) MD = 75 –125(i) + 1.0(Y) MS ≡ MD where i represents the rate of interest, Y represents national income, rrm represents the fractional reserve requirment ratio, and TR represents total reserves. Assume national income in 2007 was $1,500 and is projected to be 2 percent higher in 2008. Also assume the reserve requirement ratio is 0.20 and total reserves are equal to 150. (15 points) (SHOW ALL WORK FOR FULL CREDIT) a. What market clearing interest rate would you project for 2008? (1/.20)(150) = 75 – 125(i) + 1,530 750 = 75 – 125(i) + 1,530 125(i) = 1,530 + 75 – 750 125(i) = 866 i = 6.84 b. What level of the total reserves would be needed to achieve a market interest rate in 2008 of 9 percent? (Hint: using percentage rather than decimal equivalent; e.g., using 9 rather than .09) 5(TR) = 75 – 125(9) + 1,530 5(TR) = 480 TR = 96 7 6. Given the following set of graphs, please briefly describe in the box below how you characterize the product market in this economy. Please graphically illustrate how you would eliminate this problem in the product market, indicating in the box which policy you chose and the impact on the business sector’s capital stock. Illustrate its effects on all five four graphs. Clearly label all graphs using arrows to indicate the direction of change. (20 points) Problem in product market: Inflationary gap MS Choice of policy and why: MD Federal Reserve sold government bonds Federal Reserve raised reserve requirements Federal Reserve raised discount rate i Impact on the capital stock: Higher interest rates reduced investment and hence lowered the capital stock from what it would have been. AD AS YFE YPOT P i I AI Y LD LS WR UR L %P