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Econ 302
Spring 2007
Midterm 3
Name____________________________
SID # ___________________________
Part I: Answer the following questions in the space provided, or on the back of the
page(s) if necessary.
Cd = 40 + (0.5)·[Yc –T] –100·r
Tc = 20
Id = 40 – 400·r
G = 20
Xd = 0.2·(P#/P)·Y#/enom
IMPd = 0.2·Yc·(P/P#)·enom
MS = 100
L(Y, r) = 25 + 0.5·Yc – 500·r
enom = 0.5 + 8·r – 8·r#
In the equations above, P#, Y#, and r# represent the foreign price level, income, and real interest rate,
respectively.
Assume initially that P# =1, Y# = 100, and r# = .04, and that P = 2, and Yc = 100
1.
Below is a graph of the MS-MD diagram, at current prices and incomes. For Yc taking on the
values of 80 and 120, sketch out the effects in the MS-MD diagram, and use the information to plot
out the country's LM curve.
MS/P
real interest
rate
.09
.05
.01
L(Y=100, r)
30
50
70 M/P
page 1
2.
Below are the desired national savings – desired investment lines, assuming that Yc = 100.
Plot the difference between Snd and Id and use the information to plot the desired foreign lending line.
Snd = 100r
real interest rate
.10
.06
.02
Id = 40 – 400r
2
32
40 S, I
8
3.
Assuming that Yc = 100, sketch out the desired NX curve, assuming that the country is using a
flexible exchange rate system.
4.
Using this information, sketch out the open economy IS curve, and find the point on the AD
curve corresponding to a price level of 2.
5.
Suppose the economy is at full-employment, but the government wants to bring the current
account balance closer to zero (keeping output at approximately full-employment.) What should it do?
page 2
Part II:
the exam.
Instructions: Select the best answer for each question, and record it on
1.
Country A and Country B trade extensively with each other, and B fixes the
exchange rate between its currency and the currency of Country A. When Country A uses
expansionary monetary policy, A’s domestic interest rate falls. Because of the fixed
exchange rate, this is most likely to cause Country B to:
a.
b.
c.
d.
e.
use contractionary monetary policy, shifting its LM and AD curves to the left.
use contractionary fiscal policy, shifting IS and AD curves to the left.
use expansionary fiscal policy, shifting LM and AD to the right.
use expansionary monetary policy, shifting LM and AD to the right.
use expansionary monetary policy, shifting IS and AD to the right.
2.
A firm with a downward-sloping demand curve for its product will choose not to
change its price following a shift in the demand curve for its product when:
a.
b.
c.
d.
e.
the firm is a perfect competitor.
the firm’s marginal revenue is above its marginal cost.
the firm’s gain in profit from re-setting its price is less than the menu cost.
the firm’s average cost per unit of output is equal to the price.
the firm’s marginal cost is greater than its marginal revenue.
3.
With flexible exchange rates, the open economy IS curve is ______ than the
closed-economy IS curve (all else equal), because as domestic real interest rates rise, the
exchange rate ______ causes net exports to __________.
a.
b.
c.
d.
e.
flatter
appreciation
flatter
depreciation
steeper
depreciation
steeper
appreciation
none of the above.
rise
fall
rise
fall
4.
Expansionary fiscal policy would cause the desired foreign lending line to shift to
the _____ . This would also cause a ______ in the open economy IS curve.
a.
b.
c.
d.
e.
right
left
right
left
left
movement along
movement along
shift to the right
shift to the left
shift to the right
page 3
5.
In an open economy, the product market is in equilibrium when:
a.
b.
c.
d.
e.
desired foreign lending equals desired investment.
desired national savings equals desired net exports.
the current account balance equals zero.
the current account balance plus the capital account balance equals zero.
none of the above.
6.
A small country with a ______ exchange rate will find that expansionary _____
policy is more effective in stimulating aggregate demand than expansionary ________
policy.
a.
b.
c.
d.
e.
fixed
fiscal
fixed
monetary
flexible
fiscal
flexible
trade
none of the above.
monetary
fiscal
trade
monetary
7.
Appreciation of the domestic currency makes exports ______ expensive for
foreign buyers and imports _______ expensive for domestic buyers, thus ______ total
demand faced by the country’s domestic producers.
a.
b.
c.
d.
e.
more less
increasing
more less
decreasing
less
more increasing
less
more decreasing
none of the above.
8.
The costs to society of a small increase in unemployment are _______ the costs of
a small increase in inflation. An activist Keynesian central banker would therefore be
likely to use the Phillips Curve trade-off to choose:
a.
b.
c.
d.
e.
greater than
greater than
smaller than
smaller than
equal to
to reduce the current account deficit
to lower unemployment below the natural rate
to depreciate the currency to stimulate exports
to raise interest rates to reduce inflation
stable prices and the natural rate of unemployement
page 4
9.
Critics of activist management of the economy claim that if people have rational
expectations about the level of inflation, the result of the government’s attempts to
choose an attractive trade-off along the Phillips Curve will be:
a.
b.
c.
d.
e.
higher inflation and lower unemployment.
higher inflation and no effect on unemployment.
higher current account deficits and lower unemployment.
lower inflation and higher unemployment.
higher interest rates and lower unemployment.
10.
In an open economy, the product market equilibrium with a current account
balance equal to zero is attained automatically by:
a.
exchange rate appreciation or depreciation sufficient to bring desired net exports
equal to zero.
b.
domestic real interest rate changes will reverse the capital flow that finances the
current account deficit, forcing the deficit back to zero.
c.
changes in domestic output will induce changes in imports sufficient to bring
desired net exports equal to zero.
d.
changes in the domestic price level will make the country’s export products either
more or less attractive in foreign markets, and set desired net exports equal to zero.
e.
nothing makes the current account balance automatically zero.
11.
Suppose a (Keynesian) country with a flexible exchange rate system has a high
current account deficit. The type of policies that would tend to reduce the current account
deficit would be (ignore effects on domestic output):
(i)
(ii)
(iii)
(iv)
expansionary fiscal policy
expansionary monetary policy
contractionary fiscal policy
contractionary monetary policy
a.
b.
c.
d.
e.
only (i) is true.
only (iii) is true.
both (ii) and (iii) are true.
both (iii) and (iv) are true.
both (i) and (ii) are true.
page 5
12.
An open economy with flexible exchange rate and excess supply of goods
requires a ______ fall in real interest rates to achieve a product market equilibrium
(compared to a closed economy) because the fall in domestic interest rates also causes the
domestic currency to _______ , which would stimulate net exports.
a.
b.
c.
d.
e.
larger
appreciate
larger
depreciate
smaller
appreciate
smaller
depreciate
none of the above
labor
productivity
w0
wage
The graph above applies to the next two questions.
13.
In the graph above, a firm will pay a wage of w0 because:
a.
b.
c.
d.
e.
wage w0 gives the firm the highest attainable level of productivity.
the firm will find no workers available at lower wages.
the quantity of labor supplied will equal the quantity of labor demanded at w0.
the firm has social objectives besides trying to minimize the cost of production.
the wage w0 minimizes the cost of production for the firm.
14.
Suppose it becomes more difficult for employers to monitor or observe directly
the effort or productivity of employees. This would be shown in the diagram above as a
shift to the _______ of the effort-wage line. The result would be__________ .
a.
b.
c.
d.
e.
left
higher wages but less unemployment in equilibrium
right
lower wages and less unemployment in equilibrium
right
higher wages and more unemployment in equilibrium
left
higher wages and more unemployment in equilibrium
none of the above.
page 6
15
Country A and Country B trade extensively with each other and maintain flexible
exchange rates. When Country A uses expansionary fiscal policy, Country A’s domestic
real interest rate rises. The rise in A’s interest rate also causes in Country B:
a.
b.
c.
d.
e.
a shift to the right of NXd, IS, and AD due to the depreciation of B’s currency.
a shift to the left of NXd, IS, and AD due to the rise in B’s domestic interest rate.
a shift to the right of the FLd, which will cause the IS and AD to shift to the left.
a shift to the left of the LM and AD curves.
a shift to the left of FLd, and a shift to the right of IS and AD.
16.
Country A and Country B trade extensively with each other and maintain flexible
exchange rates. When Country A uses expansionary monetary policy, Country A’s
domestic real interest rate falls. The fall in A’s interest rate also causes in Country B:
a.
b.
c.
d.
e.
a shift to the right of NXd, IS, and AD due to the appreciation of B’s currency.
a shift to the left of NXd, IS, and AD due to the appreciation in B’s currency.
a shift to the left of the FLd, which will cause the IS and AD to shift to the right.
a shift to the left of the LM and AD curves.
a shift to the left of FLd, and a shift to the right of IS and AD.
17.
According to the Friedman-Phelps (expectations augmented) version of the
Phillips curve, when there is an increase in the amount of inflation expected by workers,
there is a:
a.
b.
c.
d.
e.
shift to the right of the labor supply curve.
shift to the left of the Phillips curve.
shift to the left of the SRAS.
shift to the right of the AD curve.
none of the above.
18.
If a central bank is maintaining a fixed exchange rate and finds itself spending
international reserves to uphold the value of its currency, then the need to maintain the
fixed exchange rate requires:
a.
making fiscal policy more expansionary so that desired foreign lending increases.
b.
making fiscal policy less expansionary in order to raise interest rates.
c.
the central bank to raise interest rates and make monetary policy less
expansionary.
d.
the central bank to lower interest rates and make monetary policy more
expansionary.
e.
making monetary policy more expansionary so that extra money can be used to
buy back international reserves.
page 7
19.
A country with a fixed exchange rate has a ________ desired net exports curve
than if it had a flexible exchange rate. Therefore the _______ curve is _________ than it
would be with a flexible exchange rate.
a.
b.
c.
d.
e.
steeper
IS
steeper
LM
flatter
LM
steeper
IS
none of the above.
flatter
flatter
steeper
steeper
20.
Country A and Country B trade extensively with each other, and B fixes the
exchange rate between its currency and the currency of Country A. When Country A uses
expansionary fiscal policy, A’s domestic interest rate rises. Because of the fixed
exchange rate, this is most likely to cause Country B to:
a.
b.
c.
d.
e.
use contractionary monetary policy, shifting its LM and AD curves to the left.
use contractionary fiscal policy, shifting IS and AD curves to the left.
use expansionary fiscal policy, shifting LM and AD to the right.
use expansionary monetary policy, shifting LM and AD to the right.
use expansionary monetary policy, shifting IS and AD to the right.
Extra Credit (1 point)
Why do cyclones of the southern hemisphere spin in the opposite direction of cyclones
(hurricanes) of the northern hemisphere?
page 8