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Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com ECON 202 MACROECONOMIC THEORY Dr. Yetkiner 5 April 2013 Midterm Exam I--KEY 1. (15 Points) Calculate the GDP of KingLand, a fictitious economy whose numbers are listed below. Do so using all three methods (value added approach, income approach, and expenditure approach) and do not forget to indicate your calculations clearly. KingLand, year 2012 Farmer King, (private firm) Corn Sold to Govt Corn Sold to Singapore Corn Sold to KingFoodCo, Inc Payment to workers Tax on profit Pesticides imported for Corn Production Govt Total Tax Income Payment to workers Purchase of Corn Purchase of Corn Flakes Unemployment benefits Paid KingFoodCo, Inc Corn Flakes Sold to Consumers Corn Flakes Sold to Govt Corn bought from Farmer King Salt bought from Egypt for Corn Flakes Payment to workers Tax on Profit Corn Inventory Beginning of Year End of Year $30 $25 $20 $40 $25 $5 Households Taxes on wage income Unemployment benefits Received Corn Flakes purchased $65 $15 $30 $20 $5 VA App: Farmer Jones (30+25+20-5) + FoodCo (100+20-[20+5]-10 Exp App: C I G 100 + (-5) + 65 + (X-M) (25-15) Inc. App.: Wage Income (40+20+15) + Profits (5+35) + 75 120 -70 -85 Govt. 15 $100 $20 $20 $10 $20 $30 $10 $5 $10 $5 $100 = 170 = 170 Grading: 5 points each 1 TA (25+30) = 170 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com 2. (15 Points, 5 points each) The country of Old Jersey produces milk and butter, and it has published the following macroeconomic data, where quantities are in gallons and prices are dollars per gallon. a) Calculate the percentage change in nominal GDP between Year 1 and Year 2. b) Calculate the percentage change in real GDP (take Year 2 as the base year) between Year 1 and Year 2. c) Compute the GDP deflator for year 1 and year 2 and compute the rate of inflation from year 1 to year 2. Nominal GDP Y1= 1000+2000=$3000 Nominal GDP Y2= 2700+6000=$8700 Percentage change: 190% Real GDP Y1= 1500+4000=$5500 Real GDP Y2= 2700+6000=$8700 Percentage change: 58.18% GDP deflator Y1: 3000/5500=54.54 GDP deflator Y2: 8700/8700=100 Inflation: 83% 2 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com 3. (20 Points) Suppose the economy of Hope is represented by the following equations: AE=C+I+G C = 500 + 0.5YD YD =Y–T T=600 I=300 G=2000 a) (5 points) Given the above variables, calculate the equilibrium level of output. b) (5 points) Graphically illustrate the equilibrium level of output for this economy. c) (5 points) Now, assume that taxes increase from 600 to 700. What is the new equilibrium level of output? How much does income change as a result of this event? What is the multiplier for this economy? d) (5 points) (Graphically illustrate the effects of this tax increase on the demand line and Y. Clearly indicate in your graph the initial and final equilibrium levels of output. a) Y=2800+0.5(Y-600) 0.5Y=2500 Y*=5000 Multiplier is (1/0.5)=2 c) ∆Y=2*(-50)=-100 Y**=4900 3 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com 4. (15 Points) Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in government spending and reduction in the money supply (assume that GDP remains intact after all changes). Explain what effect this particular policy mix will have on investment and consumption. Do not forget to support your answer by a figure. 4 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com 5. (30 Points) Consider the following IS-LM model: C 400 0.75YD ; T 400 0.1 Y ; I 3001500i ; G 600 ; P 0.5 M d 3 Y 12000 i (real money demand); M s 3000 (nominal money supply). If you 1000 0.325 3 6000 solve this model, you find that IS equation is i is Y and i Y 1500 1500 12000 12000 LM equation. And equilibrium values are Y* 2500 and i* 0.125 (=12.5%). (a) (7 points) Suppose now that government spending is increased by 100 (from 600 to 700). What is the government spending multiplier? Calculate. (b) (8 points) Solve for new Y, i, C, and I and describe in words the effects of an expansionary fiscal policy. (c) (7 points) Go back to original question. Suppose now that there is a policy mix and that government spending is increased by 100 (from 600 to 700) and Nominal MS from 3000 to 3500. What is the mixed policy multiplier? Calculate. (d) (8 points) Solve for new Y, i, C, and I and describe in words the effects of an expansionary fiscal policy. One may find IS equation from income-expenditure equality. Y 400 0.75Y - 400 - 0.1Y 300 - 1500i 700 Y 1100 0.675Y - 1500i 0.325Y 1100 -1500i i 1100 0.325 Y 1500 1500 This is IS equation LM equation can be derived from the money market. 6000 3 Y 12000i 12000i 3 Y 6000 i 3 6000 Y This is LM equation 12000 12000 Equilibrium income and interest rate can be found via LM and IS equations. 1100 0.325 3 6000 Y Y 1500 1500 12000 12000 1100 6000 3 0.325 Y Y 1500 12000 12000 1500 14800 5.6 Y 5 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com Y* 2642.85 i * 0.1607 (=16.07%) Hence government spending multiplier is (2642.85 2500) /(100) 1.4285 (c) Mixed policy multiplier: The NEW IS equation is: i 1100 0.325 Y 1500 1500 This is new IS equation The NEW LM equation is: i 3 7000 This is new LM equation Y12000 12000 Equilibrium GDP and i are follows: 1100 0.325 3 7000 Y Y 1500 1500 12000 12000 1100 7000 3 0.325 Y Y 1500 12000 12000 1500 8800 7000 5.6 Y 12000 12000 Y * 2821.42 i* 0.1220 The mixed policy multiplier is (2821.42 2500) /(100 1000) 0.2918 6 Izmir University of Economics Department of Economics I. Hakan Yetkiner http://www.hakanyetkiner.com 6. (5 Points) Indicate for each of the following transactions whether they raise GDP or not. If your answer is YES, which component of GDP increases? a) b) c) d) e) The government gives you an unemployment benefit. You pay a broker who helped you with your purchase of bonds and stocks. You buy a DVD from a DVD pirate. You buy a new car. You sell your home-made cakes to a friend. a) NO. b) YES. c) NO. d) YES. e) NO. 7