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Final Exam
Economics 112
Principles of Macroeconomics
A. You read in the business section of the newspaper the following remarks,
“The Hong Kong Monetary Authority can easily get the economy out of a
recession without changing the fixed exchange rate with the US dollar. If
the HKMA purchases more Hong Kong stocks, they must print additional
Hong Kong Dollars to do so. We know this will lead to an expansion in
money supply and real activity in Hong Kong.” Is the commentator's
statement consistent with the ISX-LMX framework? Demonstrate why or
why not using the ISX-LMX graph for a small economy with fixed
exchange rates. Explain in 5 sentences or less.
B. You read in the business section of the newspaper, "Hong Kong has
suffered a drop in demand for goods and services producing a drop in
output and employment. Fortunately, Hong Kong's labor markets are
efficient. Real wages will fall soon to offset the drop in demand." Is this
statement consistent with the Aggregate Supply-Aggregate Demand model
with sticky wages? Demonstrate using the AS-AD curve and explain in 5
sentences or less.
C. You are an economic researcher for a minor government official in
Thailand. He wants to know what will be the short-term effects of several
policy changes on Thai nominal exchange rates, output, net exports and
consumption. The policy changes are an increase in taxes, an increase in
government spending or an increase in the money supply. Thailand is a
small open economy with flexible exchange rates. Fill in the following
chart with the effects of the policy with a + indicating the policy will cause
an increase in that variable, a – indicating the policy will cause a decrease
in that variable, and an o indicating no effect. No graphs or explanations
are necessary.
e
Y
C
NX
T
G
M
D. You are an economic researcher at a local bank. Over the newswire, you
read that the United States has begun bombing the Middle Eastern nation of
Iraq. This leads to speculation that the price of oil might rise leading to a
general increase in prices in the United States. Use the IS-LM model to
identify the effects of an increase in the price level on output (Y), interest rate
( r ), consumption and investment in a closed economy. Fill in the following
graph with a + (increase), - (decrease) or o (no change. No graphs or
explanation are necessary.
Y
r
C
I
P
E. The interest rate in Hong Kong is 10%. The interest rate in the US is 5%.
Currently, the exchange rate is 10 Hong Kong dollars per US dollar.
Calculate what the exchange rate will have to be in 1 years time for the
plan of buying US dollars, investing at interest in US dollars, and then
buying Hong Kong dollars to yield the same payoff as investing in Hong
Kong.
i. How many Hong Kong dollars will you have in 1 year if you invest
your million dollars at the HK interest rate?
ii. How many US dollars can you currently buy with your 1 million
HK dollars?
iii. How many US dollars will you have in one year’s time if you buy
US dollars and invest that money at the US interest rate?
iv. The number of US dollars received as in part iii. can be used to buy
a certain amount of HK dollars in one years time. What will the exchange
rate have to be in one year's time for the amount of HK dollars purchased
with the answer to iii. to be equal to the answer to i?
F. Consumption is a linear function of disposable income:
C = A + mpc (DI) = A + mpc(Y - T)
where mpc is the marginal propensity to consume. In Hong Kong, tax
payments depend on the income level. Assume that the tax is:
T=tY
where t is some fraction of income that is paid as taxes. Expenditure is
written:
Y = C + I + G + NX
and the ISX curve is then.
Y = MULT (A + I + G + NX).
Solve for MULT (the multiplier) when a) mpc = .5 and t = .15
b) mpc = .5 and t = 0. Why is the answer to a) smaller than the answer
to b?
G. There are two kinds of firms in Hong Kong. A fraction, s = .25, are unable
to change their prices rapidly in response to a change in input prices. These
firms set their prices such that they are equal to their expected input prices.
Expected input prices are equal to the expected price level:
p1 = PE
A second fraction, (1 -s), of firms will produce more than the long run rate
of output, Y, only if their price is greater than their actual input prices.
Actual input prices are equal to the aggregate price level:
p2 = P + 2(Y - Y)
The aggregate supply curve is:
Y = Y +  (P -PE)
What is ?
H. What is the difference between an inside lag and an outside lag?
I. The Hong Kong Economy
1. The government fixes the exchange rate at e = .15. At this exchange
rate the level of real net exports is zero (throughout this question, assume
that the domestic and foreign price levels are fixed at P = P* = 1.
NX = 1000(.15 - e)
Consumption is:
C = 30 + .6(Y-T)
Government spending is 50. The budget deficit is zero. The investment
function is:
I = 60 - 200 rHK
The Hong Kong interest rate is a markup over the interest rate
prevailing in global capital markets:
rHK = r* + 
If the global interest rate is r* = .05 and  = 0, what is output in Hong
Kong? If the money demand function is:
M = Y - 100 rHK
What will be the amount of money circulating in Hong Kong?
2. Now the government decides to increase spending to 150 without
raising taxes. The increase in the budget deficit also increases the
interest rate markup for Hong Kong. The new level of  = .05.
Solve for the new level of output, and money in Hong Kong. Draw
an ISX and LMX graph that shows the effects of these two
changes. Both the ISX and LMX lines will shift. Write at most 3
sentences explaining each shift.
3. The Hong Kong Monetary Authority decides to change the
exchange rate. The HKMA changes the exchange rate to e = .10.
Calculate the new output level and money supply (set G = 50 and r
= r*). Show how this change would cause the ISX and LMX curves
to shift. Write at most 3 sentences explaining each shift.
Allocation of Points:
A)
B)
C)
D)
E)
F)
G)
H)
I)
10
10
10
10
10
10
10
5
25
Total = 100.