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,5q
eueens Couege, ECo
101,
2nd
Mid-Term Exam Spring 2014
Last Name @rint)
Phone Number
Language spoken at home
,
First
Year_ Major
Prof. Dohan
Student ID #
College e-mail
Country of birth
Note: for a statement to be true, the entire statement must be true, not just part of it.
I. Matching basic vocabulary with concepts
Select the best answer for the word or term in Column
Put letter
here
2
3
Cause of Multiplier effect
4
Causes demarrd-pull infl ation
5
Induced investment (rnpi x Ya)
Aggregate demand <Yn
6
7
8
9
Real GDP
Marginal propensity to save
Current definition of investment
bv businesses
l0
B.
(Abbreviations/symbols were used frequently in class & are on "hint sheet".)
Column A
The reason why income taxes
reduce the multiplier
Y3 : Ypotelrral outprLt
I
(2pteach)
A fiom the answers given in Column
Cost of unexpectedly high
inflation rates
1l Federal government sutplus
t2 Rule of doubling time
Column B.
A Ir{ominal GDP coruected for price changes by the GDP deflator
B taxes on cigarettes, alcohol, per.fume, tires, phone service
C Taxes such as property tax that don't va.ty with income or sales
D Taxes-(gov't spending + gov't transfer payments >0
E Intports, income toxes, unenxployment payntent :) {value of ruultiplier
F 4ll vvorkers receiving unemployment benefits.
G 4ll non-institutionalized people above age 16 whorn actively seek work
H Adiustment to multiplier because taxes are paid partlyfrom sa:tings.
I Caused by the spending and respending oJ a prirnary shift in Yd from the
hioher incomes earned bv the workers - consunlers
J Noninal interest rates minus inflation rate
K
L
The prirne rate minus the federal funds rate
Sales - cost ofgoods and services boughtilom otherJirms.
M When Y,t > Yr,
N Building of new plant and equipntent,, building of new residences, and
the chdtrse in inventorie.s
1/(1-mpc + mpc*tx)
o
Equal increases in government spending and taxes raise Yn*
llt
of
investment
ng
Crowd
P I{oninal GDP adjusted by GDP price deflator.
CroVd ng out of investment
measured
in
use
as
Unernployment
a 70 divided by growth rate per period
R Hurts creditors and helps debtors if inJlation is higher than expected.
Excise taxes, examples of
S Inve,strnent caused by increased needfor capaci! as output rises
real interest rate
T Firrns dentanding higher prices for their excess inventory
Potential GDP or Yi.
U A saving resultingfroru an A in disposable hrcome
Equilibriurn only if I": Ia:Sa
V An increase in the deJicil increases interesl rates which leads to a
Interest-sensitive parl of
reduction in private investment
investment
\[ Yd:c:d +Id+Gd+xd- Md
The paradox of thrift
x Businesses order/produce more, same or less depending on Io 1, -, or >
Balanced budget multiplier
Ia. Io always : Sd in the short run
Y Taxes based on income reduces the multiplier ffict by reducing
Value-add by a firm
lisposable income earned at every level of outptrt '
Z Rapid increases in prices distorts peoples' and prodtrcers' purchase
The definition of aggregate
lecisions towards gold, hou,sing, etc.
dernand
aa .lggregale demandfor all inputs in the economy
Lump sum taxes
bb Tctxe,s > government spending and transfer paymenls
ct Derntmdfor investment goods increoses cts real interest ratesfall
dd Level of GDP (called
Yr) whichfully enploys the laborforce
ee An increase in produclion leads to an increase in investment as capacity
Automatic stabilizers
t4 Tax multiplier:
13
15
t6
l7
1E
le
20
2t
'r)
23
24
25
26
27
is reached
ff The economy
l4lhen
will experience unemployment
everybody tries to scne more they will probably saye the same or
less becquse of the fallacy of conryosition
II. Inflation (o pt')
price
We have identified three causes of inflation as measured by an increase in the consumer
price
(imporl
index. They are demand pul| (DP), cost puSh (cP), and increased prices of imports
that could be associated
shock : IpS;, no effect NE. There are several scenarios described below
with inflation.
l.
ven below
the
abbreviation for the
which shifted the
a. Price of crude oil rose sharply in 1973 and 1980 causing an oil price shock
aggregate suPPlY curve inward.
firriort lot"" ,p wages, then companies raise prices to cover higher costs, so unions force
up prices again etc.
ftre f'eO gr-atly increases the money supply to fight a deep recession & high
Write i
--b
_c.
unemploYment.
and the
e. Low interest rates in the US weakens the dollar relative to all other cumencies
prices of foreign goods rise and the demand for US goods rises.
goods a
_f ih" d"rnurrd fo-r g-oods a services exceeds the capacity of the economy to produce
services.
rising faster than labor productivity.
Wages
---g.
Eve| thougf,*. ur. at full employment the FED greatly increases the money supply to
--[ finance a major deficit incurred to finance a major upgrading of the infrastructure.
I[[. Investment and Saving(2
_-1*.
*irg.
_2*.
pts per question unless noted otherwise)
level of
In the long run the desired level of investment in the economy determines the equilibrium
(Careful)
But in the short run what determines the actual rate of investment in the economy?
a. The profitability of new investment.
b. The need to replace sold inventories and depreciated capital.
l
c. The interest rate.
d. The desired rate of savings, which also equals the actual rate of saving.
e. The desired rate of investment
one or
Which of the following affect the desired or planned rate of investment in the economy? circle
more answers. (6 pts) (Careful)
a. The desired rate of saving.
b. The profitability of new investment compared to the interest rate.
c. The depreciation of existing capital.
d. The need for new capacity as the economy expands'
by using new technology'
e. The opportunity to lower costs by automating the production process
is
Choose the complete definition of disposable income from the choices below
payments + imports+
transfer
all
a. GDp depreciation "addition to retained earnings" - all taxes
3x.
-
b. GDP c. GDp d. NDP e. GDP 4+
-
depreciation - all taxes r all transfer payments'
depreciation - "addition to retained earnings" - all taxes
all taxes + all transfer payment'
taxes f transfer payment.
t
all transfer payments'
What determines the desired leve1 of savings in an economy?
(X-M)
,. S;;;: Personal Saving * Co.po*t" Su"ing plus Government Saving plus net imports
b. Actual Saving: Actual Investment
Saving minus net imports (X-M)
c. Saving: personal Saving * Corporate Saving plus Government
d. S:Yai-C : Personal saving
e. saving : Personal Saving + corporate Saving plus Government Saving
.
5. 1: ptslt pt each) (For this problem it may
be helpful to consult your "cheat sheet" to look for the formula for the multiplier and
The multiplier is caused by the secondary expansion of demand that results when the
autonomous variables (C, Tx, Tr,I, G, x, M) as seen in the marginal propensity to consumption from
disposable income (yu,) and crowding in of new investment as output rises. The size of the multiplier
shift in
however, is also affected by something called "automatic stabilizers" which reduce the impact of a
impact each of the
aggregate demand. Using up t or down J arrows or zero for no change. Show what
following events has on the size of the multiplier.
to .9 its normal level.
_jJ tt . -rtginal propensity to consume falls from: .99
.|
b. the tax rate "lx" is lower on all income e.g. Tx Tx /rYa'
the marginal propensity to invest, e.g. the mpi ises from 0.01Yuto 0.05Yu'
-". d. the marlinal properrsity to import (*pm) goods fall because American made goods are becoming
exogenous components.)
less expensive.
The government decides to build a smaft electric grid'
(GDPX Put an "X if counted in the Expenditure
(yes), DI if only
approach, E if in Earnings approach, B if appear in both expenditures and earnings approach
*:>Careful (1 pt each : l8 pts)
in disposable income, Not if not included at all.
-e.
6. How are these items counted in gross domestic product
_a.
b. Purchase ofpaint by professional house painters.
c. Purchase ofa new house at a cheap price.
d. Purchase
ofa foreclosed house at a cheap price.
he
-e.
hiring of Transportation Safety Officers by the
government for airPorts
me hiring of a security force by the residents of a
ity.
-f commun
The payment by the govemment to private firms to
-g. build a new smart electricity grid.
Prrchase of a new computer by a homeowner to do
taxes.
-h*.ilurchase
at QC financed by the
governmenl.
--lt state
k. Wases oaid to private university professors
l. Social Securitv Davments paid to professors.
m. The total income from garnbling casinos at Atlant c City.
n. Capiial gains on the sale ofstock and other securities'
W"gd paid to a university professor
Purchase of paint by the rnan around the house
of paper and printer supplies by a student'
1""*s l}om the sale of gold purchased at $ 1,700 that
was ourchased at $2,700.
-"{"p,t"t
College students for which
_ lr--Sclt"t"rships received by Queens
no service is sunendered in exchange.
D"p...t"tton on private sector equipment and machinery
-.t
Interest paid by the government
-r*. government bonds.
IV. Growth
to households on
(z pts)
years?
Which policies would lead to a hisher per capita GDP growth rate over the next 20
Label as TRUE or FALSE.
:
Hint: Output per capita : Q/L : f,(K/L, N/L, HC/L)' {t pt each:7 pts)
A. The rate of population growth has fallen below the growth rate of GDP.
B. Increased investment by the government and private industry in research
and developmel.rt of new
technologies.
rates to stimulate
In our depressed economy with widespread unemployment, the FED lowers interest
investment in new plant and equipment.
D. Granting a dollar for dollar investment tax credit against corporate taxes making in essence the cost of
C.
investment zero.
it to no more than
China,s policy at first of restricting the birth rate to one child per family and now holding
2 children per familY.
and the government
F. In a fult employment economy, the Fed lowers interest rates to encourage investtnent
produce
ilrvestment
to
resources
real
increases taxes on households to discourage consumption to free up
E.
goods.
behavior (crowing in) the
[n an economy with unemployment but has a strong induced investment
government finally lowers household income taxes petmanently.
G.
4
-- A.
V. TRUE = T, FALSE = F. (1 Pt each, 19)
Even though these questions may look familiar, do not be fooled!
a significant impact
Cutting taxes on the poor (incomes under $20,000/yearlhousehold) will probably have
on
consuription because their marginal propensity to consumer is probably around 0.93.
function upward
lncreasing taxes on the rich and cutting taxes on the poor will probably shift the consumpiion
because of the differences in the marginal propensity to consume.
of unemployment to our society is the benefits lost by not having the lost output such as new
_B
_C.
The primary cost
infrastructure,
but some still have an MPS< 0'
_ D. Households which consume more than tlieir disposable income are dissaving,
to stimulate the
E. At a time of high unemployment and stable prices the sale of bonds by the federal governmentsmaller
capital
*itt..o*alut private investment and leave future generations worse off because of the
-;o"orny
stock and the larger national debt.
deficit each
F. We are still in a recession with high unemployment, stable prices and running a large national
; l;;;";;".ease in spending by the Federal government (G) to build infrastructure would actuallybestimulate
-y"u..
actually
ieal private investment ("ciowding in" or induced investment) so that future generations could
economically be better off because of the larger private capital stock.
and the multiplier becomes
_G. If, the MpC falls from .99 to .90 the slope of the consumption function is flatter
smaller.
investment equals desired
Economists still believe that the economy will be in equilibrium when desired
savings (la:Sa) which both depend on the interest rate'
disposable income rather than on
I*. Keynes hypothesized that since consumption and saving depended mostly on We
now believe that the
the interest rate, so that the equilibriurn levei of income was reached when Ia:Sa
of income. Indeed, it is likely
equilibrium level of income willNor automatically go to the ful1employment level
tobe above or below Yn without some government intervention'
l
started to save more'
they
in200l,
prices
of
housing
collapse
the
(net
with
assets)
fell
wealth
J. As people,s
K*. Since interest rates on bonds right now are relatively low compared to historically normal rates, peoplea who
money to earn higher
are a good investment for retirement will have to save enough additional
_ H*.
_
_
-u"ri"r"'irr"tillror
income to compensate
_
_
for the lower return on their initial investment.
L*. Rapid growth in technology and investment, which increases labor productivit-v, makes it more difficult to
reduce unemployment in a slow growth economy'
generations and will depress
M. Republicans state that the size of the federal debt creates a burden for future
people
answer "no"'
most
debt
federal
the
by
consumption. Most people when asked if they are burdened
interest rates to increase
N. The economy is at full employment with price stability. Tlie Federal Reserve lowers
inu"r*ent in reaiplant and equipment. If this ls the only policy followed, this will cause inflation'
_ O.
government finances more spending on
The economy is at less than full employment with price stability. The
holds interest rates steady by
infiastructure such as roads, a smart gria, ana research by issuing bonds. The Fed
leave future generations better off and able
expanding the money supply so that no 'lcrowding out" occurs. This will
bonds.
additiorral
to pay the*slightly higher interest costs for servicing the
induced to
is raised by increased government spending, desired investment is
_ p. Ceteris pari6ers, when GDP (Y")
and
for more productiort capacity
rise by the marginal propensity to invest (mpi* LY ^) because of the need
investment.
inventories. we call this crowding in of private
however, rightly say that as interest rates retum to their normal higher level
_a The Republicans and Democrats,
have to raise tax rates or cut government spending on
as we reach full employment, they are concerned that we will
now larger public debt. Independents
essential services i, o.i". to pay ihe borrd holders the higher interest on the
spending will be more than
deficit
this
by
generated
say that the increased productivity and higher incomes
adequate to pay the slight increase in interest payments'
from 200 to 220 (10%) and the nominal GDP rises from $17 trillion to Sl8
_ R. If the GDp price deflator rises
trillion, then the real GDP has gone down as measured in constant prices'
of domestic producers, we measure the output of every good
_S. To get an accurate measurement of the output
us nominal GDP'
(grain, iour, bread) and service as evaluated aimarket prices which gives
5
T.
Nominal GDP measures the output of all legalfinal goods & serrrices bouglit by households, the government,
sold as expofis, or bought as an investment good by producers that are evaluated at the current market prices.
U. When we are at full employment on the PPF, then a large increase in the Federal deficit, (Tx - G - Tr > 0),
ceteris paribus, is likely to cause inflation and shortages.
_V. An increase in disposable income Yoi resulting from a small long-term reduction in weekly payroll taxes
withheld will probably have a higher irnpact on the consumption function than if we had the same total amount
sent out to us in one lump sum per year.
_W. The primary purpose of savings by households is to redistribute consumption over time and maybe to give to
their children rather than to earn interest and profit at their current levels.
PART
VI. MACRO ECONOMIC POLICY ltlttte algebra is required)
I'lo credit v,ill be givenfor just a number!
:
European economies, still recovering from the world financial crisis, have been suffering higher and liiglier rates
unemployment as they try to follow the policy urged by Germany's leader Merkel. Assume initially that these
economies are described by the following:
of
C:consumption, I:desiredorplannedinvestment,G-plannedgovernmentspending,X:expotls,M-imports,Tx:taxes'
:
:
transfer payments, Ya : actual GDP, Disposable Income Ydi Ya-Tx + Tr
"aggregateerpentliture"
dehnedasYd:C + I +G +X-Mf
(inlecture
orAEintexlandis
or
Yd:aggregate demand
output.
GDP
equals
actual
denrand
aggregate
Yd
where
Ya:
Ya* is where
/
C-C+.75Ydi, I - l, G - G, Tx-Tx, Tr:Tr, X:X, andM: M, C, l, G, X, M, Tx, andTrareassumedconstan{.
so Yd- C +.75Ya+ I + G + X-M.
Tr:
Initial Conditions of the Economv in billions of Euros.
The equilibrium level of GDP output is cur:rently:
Yu* =
11,000
Full employment level of G
Yfe = 15i000
You can draw straight lines on
the graph using your QC ID or
a credit card
Marginal propensity to consume
MPC
l
:
0.8
What is the one basic economic problem in this economy?
a. high rate of inflation b. grorving recession & unemployment c. slow growth.
German Chancellor Merkel believes that the large deficits such as in Greece,
Italy and Spain were the cause of their economic problems, so she has been 45o
urging them to cut government spending bv 400 Euros (austerity approach).
what impact do you predict such a cut will have on equilibrium the GDP (Y".) on
the European economv. Be sure to specili' sign of the change in Yo*'
2 pts
2ph
-2.
$Y,
3. Using post-Keynesian macro theory, what basic fiscal policy strategy would you
recommend to achieve ful1 employment?
a*. raise or lower Yd (aggregate demand) by the amount of the demand gap
b. crt][hg ieIpfl firSI and then see what else needs to be done'
c. lower the full employment level of income
d*. raise or lower Yd (aggregate dernand) by the amount of the income gap
e. simply change the equilibrium level of GDP
? f.S
Watch your signs & show equations and
I
rons
4. Calculate the simple multiplier (show equations)
?nh
*
I 5a. Calculate AYu lthe income or output gap)with the correct tign that gets Yt"
5b.Calculate
+ pts
Aya with the correct sign (aggregate demand gap AYa :
2 pt$
:> Yu* or Yu* :>
Yr"
the amount by which aggregate demand Ya has to be
shifted up or down to achieve economic goals of ,tY,-,
2
ncome Gap
AYo*
:
Yr. -Ya*
Aggregate Demand Gap So that AYa *
M : AY.- :
aY.* =
nu
mbers).
(Use a folded piece of paper as ruler)
on the appropriate place on the Yu axis and draw a verlical line up to 45o Y" line
line
Yu
45o
to
line
up
2..p,ts' 6b. Mark yi", on the ippropriate place on the Yo axis and draw a vertical
2
pts
6lIiT.t
:-2.ph;r.7a.
y",
Draw the "original" Yd curve so that it crosses the Ya line at Ya. from above'
6
Z,ps 7b. Draw the "new" Y6 curve sufficient to close the aggregate demand gap so that it crosses the
pb
2
Yu line flom above at Yfe
8. Now mark the income or output gap AYo- by drawing an arrow in the correct direction and label it "income gap" with the amount
2pis 9. Mark the "demand
gap"aYo by drawing an ar:row in the correct direction of desired change of Yd, and label it "demand gap" with
the amount.
The goal: Get Y"* to move from $11,000 to Yu*: $15,000: Yr".
B. Use Goal Oriented Thinking:
Start from where you want to end up (Yr. of 15,000) and rvork backwards. (same as 1ou calculated up above in 5b)
So Fiscal Policv is easy to figure out but you must show that your recommended change reaches the goal.
10. In this situation, how could the administration reach full ernployment using just government spending so that AG - AYa
I Change in Government Spending: AG (+ : increase in G, - : cut in G) show increase as f, decrease as j
\C:
:>
$AG--xMof
3 pt$
AYu*:$
+AY,.of$-:
-;' \z4x :
Tax and Transfer Poiicy (more difficult)
Let's assume that the administration is forced into rnaking (permanent) changes in taxes.
1 1. What two economic variables does changing taxes affect in order to shift Yd by the desired amount (AY6)
zffi
., 2 pts
ptfl
A I
-l
4
12.
ln taxes
So what amount of change in taxes or transfers do you wo[t, (1for
l3 How
.4
pts:: 14.
A
?
l'r bt'
does this Tax
increase and J for decrease)
to change AYa to make Yax
-
Yfe?
(Tr) policy work?
What change in transfer payments (Tr) would do the same thing?
(+l) AYaiby $_ which*MPC oL:>_ AC by $
:
AYu- of $
pts 15. What would this policy do at first to the deficit in the goverrrment budget?
a. Nothing
b. Lower it
c. Raise it.
d. Not enough information.
16. Changes in investment needed to achieve the same result.
The European central bank decides that it must act now using monetary policy to influerrce private irvestrnent that
responds to the interest rate because it could possibly leave a larger capital stock for the future. They change the
interest rate by changing the money supply (Ms).
The money supply (Ms) is currently 200
Here is how private investment I(i) responds to changes in the interest rate "i" usually.
Ms
100
200
300
400
500
600
800
i
14%
12
10
e
8
7
6
I(i)
500
800
1.000
lg00
2.200
2,800
3.000
2 Pts,:
? pr*
2,,p1$,.]
EI:-----l
2.pi$
Z,pi$'
2pE
2 pls
How much do we want investment to change and in wh/at direction?
o/
lncrease Ms
from
What do we want to do to the interest rate to achieve our goal of Yfe
How rnuch do we have to change the money supply to get the required rate of interest.
to
will go up by$
Yax
:
and Ya*
What
-
Yfb
will
happen to investment and Yd
if we change the interest rate that way?
After the multiplier effect, what will be the change in Ya*?
7
VII Consumption & Savings Functions, S:I equilibrium, Paradox of thrift
In a simple economy, with no I. G. or Tx or Tr.
? pts
_1.
_2.
M. consumption equals C= 500 + .75Y,
Which function is the numerical savings function that is the twin of the consumption function above?
A.
2 pts
or X &
S-Ya-C
B.
S:Ya-500
C.
S
:
-500
+.25Ya D. S-
-500
+
'75 Ya
What is the multiplier? It will help you answer the questions below.
What consumption graph below best plots this C-function.
2 pts
-3.
A
D
C
B
Ya
$
Ya
AE or Yd
Aggregate
Expenditure
500
Ya
4.
Ya
GDP
.75Y
2400
Output
Atwhat output level Ya- will the people be spending exactly as much
A.
5.Show
+.75Y
GDP
Output
R.
s00 c.2000 D.2400
as is being produced at
Y,
E. 2500
lour calculations to the right.
Saving-lnvestment Graphs (Not to scale)
la*+200'
Sa=0
.75Y
$t n
Sa=++6gl- u
Sa=+400
Sa
Sa=-500
l;=+200
Ya
Ya
Sr=-500
2000 1ioo
Sa=0
Sa=-500
Sa=-500
_6
function
Based on your choice above, or a calculation. which saving-investnent g:aph best representsthe savings
graph
corresponding to (or derived liom) the consumption poblem in the above problem \. Think about which
that
Ya.
Remember
C
equals
where
level
repre;efis thi acrual savings.function, such that Sd 0 at the outpfi
that
level
where the consumptionfuiction intersect,c the 15 degree Ya line, colwumption exactly equals output and
of ougtut is called the "hrealreven peiny". The slopes of these gnphs are reaesentational & not realistic-
:
So
:0
and Io =0. Calculate & enter on left. Show your calculation down below.
End ofExam
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