Download ECON 3010 Intermediate Macroeconomics Solutions to Exam #2

Aadland – Spring 2013
ECON 3010 Intermediate Macroeconomics
Solutions to Exam #2
Multiple Choice Questions. (25 points; 2.5 pts each)
#1. All of the following are considered major functions of money except as a
a.
b.
c.
d.
medium of exchange.
way to display wealth.
store of value.
unit of account.
#2. Money that has no value other than as money is called ____ money.
a.
b.
c.
d.
fiat
intrinsic
commodity
government
#3. In the U.S., monetary policy is controlled by
a.
b.
c.
d.
the President.
the Congress.
the Federal Reserve.
the Treasury Department.
#4. The Federal Open Market Committee (FOMC)
a.
b.
c.
d.
controls U.S. government spending.
controls U.S. tax rates.
regulates gasoline prices.
schedules eight regular meetings per year and occasional emergency meetings.
#5. The nominal interest rate is equal to the
a.
b.
c.
d.
inflation rate.
real interest rate.
real interest rate minus the inflation rate.
real interest rate plus the inflation rate.
Aadland – Spring 2013
#6. If the velocity of money remains constant while the quantity of money and real GDP doubles, the
a.
b.
c.
d.
price level will double.
price level will remain constant.
price level will fall.
inflation rate will double.
#7. One possible benefit of moderate inflation is
a.
b.
c.
d.
a reduction in boredom attributable to changing prices.
the elimination of menu costs.
the elimination of uncertainty.
better functioning labor markets by allowing real wage rates to fall.
#8. When exports exceed imports, all of the following are true except:
a.
b.
c.
d.
net capital outflows are negative.
net exports are positive.
the country is a net lender on the world capital market.
the country is running a trade surplus.
#9. Net capital outflow is equal to the amount that
a.
b.
c.
d.
foreign investors lend here.
domestic investors lend abroad.
foreign investors lend here minus the amount domestic investors lend abroad.
domestic investors lend abroad minus the amount that foreign investors lend here.
#10. The United States is currently
a.
b.
c.
d.
running a trade deficit.
running a federal budget deficit.
experiencing an unemployment rate over 7%.
all the above.
Aadland – Spring 2013
Problem Solving / Essay Questions. (75 points)
#11. (30 pts) Assume that currency (C) is $20 billion and reserves (R) are $10 billion, the reservedeposit ratio (rr) is 0.1, and the currency-deposit ratio (cr) is 0.2.
(a) (10 pts) What is the monetary base? What is the amount of demand deposits? What is the money
multiplier? What is the money supply?



The monetary base (B) is the sum of currency (C) and reserves (R):
Demand deposits (D) are (1/0.2) = 5 times currency (C):
billion.
The money multiplier (m) is
billion.
.

The money supply (M) is
billion = $120 billion.
(b) (10 pts) If the reserve-deposit ratio (rr) changes to 0.2 and the monetary base remains unchanged,
what is the new money supply?
The new money multiplier is
.
The new money supply is
billion = $90 billion.
(c) (10 pts) Assume that the velocity of money and real GDP are constant. Use the numbers in part (a)
to answer the question below. If the Fed wishes to target a 1% inflation rate, how much do they
need to increase the money supply? [BONUS 5 PTS: How much do reserves need to increase to hit
the money supply target?]
The quantity equation in percentage change is
. If V and Y are
constant, then the Fed needs to increase M by 1% to achieve
. From part (a),
we know that M = $120 billion. The Fed needs to increase the money supply by $1.2 billion.
BONUS: The multiplier is m = 4 so reserves would need to increase by $300 million.
Aadland – Spring 2013
#12. (30 pts) Consider the following Neoclassical model of the economy, where the domestic interest
rate and the world interest rate are in percentage terms. Show all your work.
Supply
Demand
,
(a) (10 pts) Find the equilibrium real interest rate, national saving, and investment in a closed economy.
Show the equilibrium real interest rate on a saving-investment diagram with measured on the
vertical axis.




National saving is
Investment is
The equilibrium real interest rate is
See Figure 3.8 in the textbook.
.
.
(b) (10 pts) Now assume the small economy opens up to trade. Calculate the real exchange rate, trade
balance and net capital outflow. Show the trade balance on a saving-investment diagram with
measured on the vertical axis.






National saving remains
Investment is now
Net capital outflow is
Net exports are
The real exchange rate is
See Figure 6.8 in the textbook.
.
.
.
.
.
(c) (10 pts) Assume that fiscal policymakers enact a government spending “sequester” equal to 100.
Find the new real exchange rate, trade balance and net capital outflows. Redraw the diagram from
part (b) to show the changes.







After the “sequester”, government spending falls to
.
National saving rises to
.
Investment remains
.
Net capital outflows turn positive to
. The country is now a net lender.
Net exports are
.
The real exchange rate depreciates to
.
See Figure 6.10 in the textbook. The vertical
curve shifts to the right.
Aadland – Spring 2013
#13. (15 pts) True or False. If “False”, correct the statement to make it true.
(a) (5 pts) “All else equal, an appreciation of the dollar will decrease imports.”
False. An appreciation of the dollar will make foreign goods cheaper and lead to more imports.
(b) (5 pts) “Unanticipated high inflation redistributes wealth toward debtors.”
True. Unexpected high inflation will decrease the real value of the debt.
(c) (5 pts) “The Federal Reserve increases the money supply by selling government bonds.”
False. When the Federal Reserve sells government bonds, they remove reserves (R) from the
banking system. This reduces the money supply.