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478184334 Econ 1120-INTRODUCTORY MACROECONOMICS PRELIM #2-Wissink-Fall 2015 – November 5 Clearly Print Your LAST(family) Name: ______________________________________________________ Clearly Print Your First Name: ___________________________________________________ Your Cornell NetId: ___________________ Your Student Number: __________________________ There are two sections in this exam. Answer all questions. Part I: 18 multiple choice questions @ 3 points each Part II: 2 problems @ 26 and 20 points, respectively TOTAL POINTS = 100, TOTAL TIME = 90 minutes. NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom. NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”. NO GRAPHING CALCULATORS. NO BOOKS. NO NOTES. NO HELP SHEETS. NO TALKING TO EACH OTHER. “X” the SECTION you regularly attend (that is to say, check where you will pick up your prelim): "X" DIS # TA Meeting Times Location 252, 253 Luoyi (Roy) Su Mondays 12:20-02:15 Goldwin Smith G22 256, 257 Naveen Sunder Wednesdays 10:10-12:05 Rockefeller Hall 102 250, 251 Sylverie Herbert Fridays 09:05-11:00 Uris Hall 202 254, 255 Tilahun Emiru Fridays 01:25-03:20 Rockefeller Hall 102 One more time, please… Clearly Print Your LAST(family) Name: _______________________________________________________ Clearly Print Your First Name: ___________________________________________________ Your Cornell NetId: ___________________ Your Student Number: __________________________ GRADING MC (3 each, total of 54) =___________________ Q1 (out of 26 points) =_________________ Q2 (out of 20 points) =_________________ TOTAL SCORE: _____________________ 478184334 Part I: Multiple Choice. Do them ALL. CIRCLE the letter for your answer. _____________________________________________ 1. If the consumption function for the economy is: C = 500 + 0.6Yd, then the saving function, S, is: A. B. C. D. E. S = -500 + 0.6Yd. S = -500 - 0.6Yd. S = -500 + 0.4Yd. S = 500 + 0.4Yd. S = 500 + 0.6Yd. 2. Assume a simple linear frugal ungoverned closed economy where the consumption function (in billions) is: C = 500 + 0.6Y and desired investment, Id, is $100 billion. If current aggregate output/income is Y = $1,000 billion, we can conclude that A. B. C. D. E. undesired changes in inventories will be zero. there will be an undesired rise in inventory. there will be an undesired fall in inventory. aggregate output/income will tend to fall. the economy is in equilibrium, so there is no tendency for aggregate output to change. 3. Refer to the table. At an output level of $2,400 billion, there is a tendency for aggregate output(income) A. B. C. D. E. to fall. to increase. to remain constant. to either increase or decrease. to increase at an increasing rate. 4. Assume the “Keynesian” AEd multiplier is 3.0. If desired investment falls by $20 million while exogenous exports rise by $50 million (other things remaining constant), by how much will the equilibrium level of income (Y*) rise? A. B. C. D. E. It doesn’t rise, Y* falls. By $90 million. By $210 million. By $50 million. By $75 million. 5. In a simple frugal economy with no government and no international trade, which one of the following will occur when the economy is at equilibrium Y*? A. B. C. D. E. S = C + Id and at the same time, S = Id Y = S and at the same time, C = Id C = Y and at the same time S = 0 Id = C Y = C + Id and at the same time, S = Id 6. Consider a simple linear frugal governed economy with no international sector and only one non-zero marginal propensity, the marginal propensity to consume (MPC). Assume MPC = 0.9. If Y* rises by $100 billion due to an increase in desired investment spending, the increase in desired investment spending must have been A. B. C. D. E. $100 billion. $90 billion. $50 billion. $10 billion. $1 billion. 7 Consider an economy completely described by the following two equations: S = -120 + 0.30Y and Id = 10 +0.10Y. The “paradox of thrift” applied to this particular economy suggests that A. an exogenous increase in the desire to consume will make it so that in equilibrium people actually consume less. B. an exogenous increase in the desire to save will make it so that in equilibrium people actually save less. C. an exogenous increase in the desire to save will make it so that in equilibrium people save the same amount. D. an exogenous increase in desired investment leads to less saving in equilibrium. E. an exogenous increase in desired investment leads to less consumption in equilibrium. 8. Consider a simple linear frugal governed economy with no international sector. Which one of the following statements below is TRUE? A. Equilibrium will occur where Saving = Actual Investment. B. Equilibrium will occur where Saving = Desired Investment. C. Equilibirum will occur where Saving + Taxes = Actual Investment + Government Expenditures. D. Equilibirum will occur where Saving + Government Expenditures = Taxes + Desired Investment. E. Equilibirum will occur where Saving + Taxes = Desired Investment + Government Expenditures. 9. The current Chair of the Board of Governors of the U.S. Federal Reserve System is A. B. C. D. E. Ben Bernanke. Alan Krueger. Janet Yellen. Janet Mitchell. Alan Greenspan. 10. Which one of the following is NOT included in what the U.S. government defines as M2? A. B. C. D. E. currency in circulation and held by the public checkable deposits savings accounts government bonds held by the public travelers checks 11. Bob lives in a country with a MONOPOLY commercial bank named Big Bank. The required reserve ratio (rrr) is 5%. Big Bank is always fully loaned-up. Bob finds $100 under his sofa and deposits it into his Big Bank checking account. Bob’s deposit of $100 A. will not change demand deposits at all. B. will ultimately increase demand deposits by less than or equal to $100. C. will ultimately increase the money supply by $2,000. D. has the potential to increase total demand deposits by $2,000. E. has the potential to increase Big Bank’s loans by $2,000. 12. The Fed wants to DECREASE the money supply. In which answer do both listed options have the potential to decrease the money supply? A. The Fed sells securities to the public & lowers the required reserve ratio. B. The Fed sells securities to the public & raises the required reserve ratio. C. The Fed buys securities from the public & raises the required reserve ratio. D. The Fed buys securities from the public & lowers the required reserve ratio. E. The Fed buys securities from the public & lowers the discount rate. 13. Assume an economy and banking “world” like the one assumed in lecture. The required reserve ratio (rrr) is 40%. If the Fed wants to increase the money supply by $600 it should A. B. C. D. E. increase the required reserve ratio. sell $240 worth of government securities to the public. buy $240 worth of government securities from the public. buy $600 worth of government securities from the public. buy $359 worth of government securities from the public. 14 If the annual market interest rate is 5% and there is no inflation, a bond with a face value of $10,000 and a maturity date in exactly two years is worth _________________ today. A. B. C. D. E. $9,523.81 $9,070.29 $10,526.63 $10,000 $10,500 15. If the interest rate is high, speculators tend to hold onto A. bonds instead of money because they expect the interest rate to fall, and when it does, they will be in a position to sell bonds to people at a nice high price. B. bonds instead of money because the opportunity cost of money is low. C. money instead of bonds because the brokerage fees and other costs of buying bonds are high when the interest rate is low. D. money instead of bonds because there is a speculation motive for holding a larger amount of money. E. cash instead of bonds because they will want to buy bonds in the future. 16. Contractionary monetary policy combined with expansionary fiscal policy is predicted to A. have uncertain effects on the interest rate and planned investment. B. drive income and consumption up. C. drive income and consumption down. D. drive the interest rate up and planned investment down. E. drive the interest rate down and planned investment up. 17. Refer to the money market figure. At an interest rate of 3%, typical households A. will attempt to increase their holdings of money by selling bonds. B. are satisfied with the amount of money they are holding. C. will attempt to increase both their holdings of money and their holdings of bonds. D. will attempt to reduce their holdings of money by buying bonds. E. will attempt to consume less. 18. This multiple choice question is simply a fill in the blank, instead. Suppose an economy that is completely described by the following equations: C [C c Yd ], I d I , G G, EX EX , IM IM , and T [T t Y ] The investment multiplier for the economy is: 478184334 Part II: Make sure you read and do ALL parts of each question. Show as much work as possible. TRY to get started on every question. Show us something. Write legibly and remember to label all graphs and axes in diagrams. 1. Seppo and Vin (among others) are neighbors who live in Grayville, a country with a fractional reserve banking system with a required reserve ratio (rrr) of 25%. Assume there is only one monopoly commercial bank in Grayville, Blackbank. Blackbank always loans up to where its excess reserves = $0. The symbol for Grayville’s currency is $. The Fed (that is the central bank) in Grayville wants to buy up $500 in government securities from the public. Suppose it buys $200 worth of securities from Seppo and $300 worth of securities from Vin. Suppose the Fed pays both Seppo and Vin by depositing payment into their respective checking accounts at Blackbank, denoted DD-Vin and DD-Seppo. Note DDp refers to ALL of the public’s checking accounts at Blackbank – including Vin’s and Seppo’s. ORIGINAL T-Accounts THE FED Blackbank Assets Liabilities +Net Worth Securities $20,000 Reserves $5,000 Currency $2,500 Net Worth $12,500 Assets Reserves Loans $17,000 Net Worth Seppo Assets Vin Liabilities +Net Worth DD-Seppo Currency $2,000 Debt Net Worth Securities $2,000 Liabilities +Net Worth DDp $20,000 $0 $4,500 Assets DD-Vin Currency Liabilities +Net Worth $4,000 Debt $1,000 Net Worth Securities $0 $5,500 $500 FINAL T-Accounts THE FED Assets Securities Blackbank Liabilities +Net Worth Reserves Assets Reserves Liabilities +Net Worth DDp Currency $2,500 Loans Net Worth Net Worth $12,500 Seppo $2,000 Vin Assets DD-Seppo Liabilities +Net Worth Debt $0 DD-Vin Liabilities +Net Worth Debt $0 Currency Net Worth Currency Net Worth Securities $4,500 Assets Securities $5,500 Questions: a. Fill in any missing cells (see bold) in the ORIGINAL T-Accounts. b. Given the information in the top half of the T-Accounts for Grayville, what is the value of the money supply (M1) PRIOR to the Fed’s purchase of the securities from Seppo and Vin? (Note that Seppo and Vin are just two of many people that live in Grayville.) c. What final impact does the open market operation above have on the money supply (M1) of Grayville assuming Blackbank uses its portfolio of loans to make adjustments to its reserves position? (Note: Assume Seppo and Vin are no longer involved after the initial transaction and that all subsequent transactions are carried out in the commercial banking system.) d. Fill in all the missing blanks (see bold) in the FINAL T-Accounts illustrated on the previous page as they would appear once the money supply has reached its new final position. e. How would your answer to part (c) change if it turns out that Vin immediately withdraws the $300 that was credited to his checking account and puts the cash in a vault behind a picture of Adam Smith that hangs in his living room? Note: If you can’t come up with a number answer, at least tell us the direction in which your answer would change and why. Answer Space: Answer Space: 2. Suppose that the following set of equations describe ALL the relevant information about the island nation, Itsanice. Itsanice’s currency is called the dollar and its symbol is $. The Goods and Services Market (Keynesian Cross) can be described by: Consumption function: C = 20,000 + 0.8Yd (where Yd = disposable income) Planned Investment function: Id = 3,000 – 4,000r. Current Id = 2,000 Government expenditures: G = 1,000 Taxes: T = 400 Exports: EX = 600 Imports: IM = 400 The money market can be described by: Required reserve ratio (rrr) = 10% = 0.10 Money Demand function: MD= 1500 – 1,000r Total Reserves = Required Reserves = 125. Excess Reserves = 0. Other: The full employment level of national income is YFull employment = 114,000. Inflation is assumed to be non-existent. Questions: a. Determine the equilibrium level of national income, Y*. Show your work! b. Illustrate this equilibrium using the 3-panel diagram from class. Make sure you label ALL the values on the horizontal and vertical axes in ALL three panels in your graph. c. Calculate the multipliers for Gbar, Tbar and Ibar. Show some work for how you arrived at your particular values. d. How could the government use its fiscal policy variable Gbar to achieve full employment national income? Be specific with respect to the value and direction of the policy you suggest. e. Instead of using fiscal policy, how might the Fed use monetary policy to achieve full employment national income? DO NOT FIND AN EXACT NUMBER. Just explain what the Fed would do using a verbal narrative with arrows. Indicate how this monetary policy would “look” in your 3panel diagram. PLEASE START ANSWERS ON NEXT PAGE Answer Space: Answer Space: ECON 1120 F2015 PRELIM 2 Answers 1 C By the identity Yd = C + S, we can solve for the saving function: S = Yd – C = Yd – (500 + 0.6Yd) = 500 + 0.4Yd. 2 C Aggregate desired expenditure at Y = $1000 is $1200 (which is C+Id), so not enough was produced to satisfy all of desired expenditure. Thus, there will be unplanned depletions of inventory. 3 C When aggregate output equals $2400, AEd = C + Id + G = $2400. Since Y = AEd, the economy is in equilibrium and aggregate output will have a tendency to remain constant. 4 B The net exogenous change in AEd equals 50 – 20 = $30 million. Using the Keynesian multiplier, we can find the change in income that will result: Y* = 30 * 3 = $90 million. 5 E A simple frugal economy with no government or international sector is defined by AEd = C + Id. In equilibrium, Y = AEd, so Y = C + Id. Since Y = C + S is identically true, it follows that C + S = C + Id S = Id. 6 D Using the marginal propensity to consume, we can calculate the multiplier on investment: KI = 1/(10.9) = 1/0.1 = 10. Since KI = ΔY/ ΔI, we can solve for the change in desired investment: ΔI = 100/10 = $10 billion. 7 B Graphing the saving and investment functions, it can be seen that, when the saving function shifts upwards, equilibrium savings will decrease. 8 E In a simple linear frugal governed economy with no international sector, it must be case that, if the economy is in equilibrium, saving equals desired investment and taxes equal government expenditures. Since we can think of saving and taxes as the sources that fund desired investment and government expenditures, respectively, S and T will be on side of the equation whereas Id and G will be on the other. 9 C Janet Yellen was sworn in as Chair of the Fed Board of Governors on February 3, 2014. 10 D Government bonds are a type of security and do not qualify as money. 11 D Bob’s deposit of $100 increases by the monopoly bank’s reserves by $100. Using the money multiplier (1 / 0.05 = 20), we see that total demand deposits can increase by, at most, 20 * 100 = $2000. 12 B Selling securities to the public will decrease the money supply, as well raising the reserve requirement ratio. 13 C The money multiplier is 1 / 0.4 = 2.5. Therefore, if the Fed wants to increase money supply by $600, it will have to decrease reserves in the commercial banking system by 600 / 2.5 = $240. It can do so by purchasing $240 worth of government securities to the public. 14 B Since PV = FV/(1+r)^T, where FV is the face value of the bond, r is the interest rate, and T is the time until the bond matures, we have: PV = 10000/(1+0.05)^2 = $9070.29. 15 A Choice A corresponds to the speculative motive for holding bonds. Recall that, if the interest rate is high, bond price is low: the investor is betting that the price will eventually go up and that, when it does, he will be able to turn a profit. 16 D Contractionary monetary policy will increase the interest rate and decrease desired investment. Similarly, expansionary fiscal policy will increase the interest rate (increase in aggregate output increase in money demand higher interest rate), which will depress desired investment. 17 A At an interest rate of 3%, there will be upward pressure on the interest rate. As the interest rate increases, bond prices are going down, suggesting that typical households are selling bonds and increasing their money holdings. 18 KI = 1/(1-c+ct)