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Practice Exam Material: Macro – Winter 2011
Name:
______________________
State clearly your assumptions when you derive a result. You must always show your
thinking to get full credit.
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Question 1
The following table includes price and quantity information on the only two goods produced in an
economy. Answer each of the following questions based on that information.
Food
Year
2000
2006
a.
Price
$30
$45
Clothing
Quantity
10
20
Price
$20
$25
Quantity
5
7
Calculate nominal GDP in each year.
Nominal GDP(2000)= 30*10+20*5= 300+100=
Nominal GDP(2006)= 45*20+25*7= 900+175=
$400
$1075
b.
Using 2000 as the base year, calculate real GDP in each year. What was the percent change
in real output?
Real GDP (2000)=30*10+20*5=300+100=
400
Real GDP (2006)=30*20+20*7=600+140=
740
% Change in Real GDP=100*[ Real GDP(2006)-Real GDP(2000)] / Real GDP(2000) =85%
c.
Compute the GDP deflator for each period and its percentage change between 2000
and 2006.
GDP Deflator (2000)=
GDP Deflator (2006)=( 45*20+25*7)/( 30*20+20*7)=1075/740=
% Change in GDP Deflator=
d.
1.00
1.45
45%
Using the GDP deflator computed above as Price Index, what was the average rate of
inflation between 2000 and 2006?
Inflation Rate between 2000 and 2006=
45%
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e.
Assume that over the same periods your income jumped by 60 percent, from $20,000
to $32,000. Using the GDP deflator computed above as Price Index, express those values in
2006 dollars and compute the percentage change in your real income. Is the change in your
real income bigger or smaller than the change in your nominal income (60 percent)?
Real Income 2000=Income 2000 (in $2006)= (20,000/ [1.00]) * [1.45]=
29,000
The % Change in real income between 2000 and 2006 (all in 2006 dollars):
=100*[Income 2006 – Real Income 2000] / Real Income 2000=
=100* [32,000-29,000] /29,000 =
10.3%
Smaller change in real income compared to nominal income:
10.3%<60%
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Question 2
Answer each of the following questions regarding the relation of interest rates and inflation.
a.
Suppose that in 2000 you loaned out $100 at 5 percent interest, to be paid back one
year later. Over the year, inflation was 8 percent. Compute the real value, expressed
in 2000 dollars, of the money paid back in 2001, as well as the percent change in the
real value.
Money paid back in 2001= $100*(1+0.05)=
Real value of money paid back in 2001 expressed in 2000 dollars:
Real value 2001=105/1.08=
% Change in real value (in 2000 dollars):
=100* [97.2-100] /100 =
b.
105
97.2
-2.77%
Using the values in part a. above, compute the real rate of return on the money loaned
out. Does it (approximately) equal the percent change in the money’s real value,
calculated above?
ra = i – πa =5%-8%=
-3%
Yes: -3% is approximately the change in the money’s real value above.
c.
If you require a real rate of return of 4 percent and the inflation rate is expected to be
3 percent, what interest rate would you charge? Compute the real rate of return if the
inflation turns out to be 1 percent and 7 percent.
Interest rate charged would be:
i = re + πe =4%+3%=
7%
If πa =1% the real rate of return is: ra = 7%-1%=
If πa =7% the real rate of return is: ra = 7%-7%=
6%
0%
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Question 3
Fill in the blanks in the following statements about ‘Economic Growth’:
a.
b.
c.
d.
e.
Balanced Growth occurs when the capital stock and real output grow at rate___0___.
Along a Balanced Growth Path, the ratio of capital to output equals __s / (n +d) ___.
Numerically, an extra percentage point of labor growth will add about _0.7____
percentage point to growth in output.
It takes about __3.3__ percent of growth in capital to add 1 percent to output growth.
Suppose that the target rate of long-run equilibrium per capita GDP growth is 1
percent per year. If labor input and population are expected to grow at 1 percent, then
a rate of GDP growth of __2%__ is required to achieve the target of per capita GDP
growth.
Question 4
Determine if the following statements related to ‘Consumption Demand’ are TRUE or FALSE.
1. Consumption expenditures fluctuate more than GDP over short-business cycles. F
2. Most of the business cycle fluctuations in consumption expenditures are due to
consumption of durables. T
3. Over the long-run personal consumption expenditures and GDP grow at different rates. F
4. The Lifecycle/Permanent Income Hypothesis Theory of Consumption predicts that the
marginal propensity to consume out of temporary changes in income will be close to 1. F
5. Over the last few decades in the United States public has spent about 90 percent of its
disposable income to consumption. T
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Question 5
Taking into account the perspective of the Keynesian Theory vs. the Lifecycle/Permanent Income
Hypothesis Theory of Consumption, compare the answers to the following questions in view of
one theory compared to the other.
1. Is the marginal propensity to consume higher in the case of temporary or in the case of
permanent income changes?
The Keynesian Theory of Consumption would predict that the marginal
propensity to consume is the same in case of temporary compared to permanent
income changes. The Lifecycle/Permanent Income Hypothesis Theory would
predict that the marginal propensity to consume in case of transitory changes in
income is much lower compared to permanent changes in income.
2. Would you predict that a liquidity constrained individual changes his expenditures
differently in case of a temporary income change vs. a permanent income change? Which
Models’ prediction is more consistent with empirical evidence?
The Keynesian Theory of Consumption predicts that the liquidity constrained
consumers would increase their expenditures as they receive more income
regardless of whether the change is temporary or permanent.
The Lifecycle/Permanent Income Hypothesis Theory disregards the possibility
of liquidity constraints. It would predict that the liquidity constrained
consumers will change their consumption almost by the full amount of the
income change in the case of permanent but would vary their consumption little
in case of transitory changes in income, contrary with what empirical evidence
suggests.
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Question 6
The Fed is considering two alternative monetary policies:
1)
2)
holding the money supply constant and letting the interest rate adjust;
adjusting the money supply and hold the interest rate constant.
In the IS-LM model which policy would be better at stabilizing output under the following
conditions?
a) All shocks in the economy arise from exogenous changes in the demand for
goods and services. (5 pts.)
ii) All shocks in the economy arise from exogenous changes in the demand for
money. (5 pts.)
Explain.
In case (i), it would be better to employ monetary policy 1) in order to stabilize output.
Shifts in the IS curve [which are the essence of point (i)] would be even more emphasized by
holding real interest rates fixed (for given r try to graph where you would be in terms of Y
on any new IS). Instead by letting interest rates move we allow saving and investment to
counterbalance.
In case (ii), it would be better to employ monetary policy 2) with the purpose of holding the
real interest rate constant. The Ld curve’s could basically move around, but by adjusting
Ms one could maintain the same r and, given the absence of movements in IS in this
instance, we would not have any change in the equilibrium output level. If you hold r fixed
for a given IS curve you always pin down Y.
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Question 7
In our analysis of the labor market we have assumed that employment is determined by labor
demand in the short-run. A more realistic assumption may be that employment at a given real
wage equals the minimum of labor demand and labor supply; this is known as the short-side rule.
a) Draw diagrams showing the situation in the labor market under this assumption when
1) P is at the level that generates the maximum possible output. (4 pts.)
Ns
W0/P0
ND
N*0
2) P is above the level that generates the maximum possible output. (4 pts.)
Ns
W0/P0
P1>P0 → N1<N0*
W0/P1
Negative relationship between P and N
ND
N1
N*0
b) With this assumption, what does the short-run aggregate supply curve look like? (4 pts.)
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P
AS
P0
Y0*
Y
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