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Exam in Macro B
FALL 2010
Short questions and short answers:
1,5 points
1. Assume that GDP(Y) = C + I + GC + GI + NX,
where GC = Government consumption and GI = government investment.
Assume that C=100, I=20, GC=40, GI=20, NX=10, T=70.
T = net taxes = taxes – transfers.
Assume that net foreign income from abroad (NFI)= net transfers from abroad (NFTr)=0.
Calculate National real saving, private real saving, and government real saving.
2+1 = 3 points
2A. In the Keynesian model for a closed economy, what is the effect of expansionary fiscal
policy (a higher G or a lower T) on the real interest rate, private investment, output, and
private consumption in the short run (when the price level is assumed to be fixed)?
Assume a simple Keynesian consumption function, which means that private consumption
only depends on private disposable income.
2B. According to the life-cycle model of consumption, what is the effect of lower taxes today
on private consumption today if lower taxes today mean higher taxes in the future?
4 points
3A. Use the classical model for the closed economy = Keynesian model for the closed
economy in the long run (when prices and wages are completely flexible) to analyze the effect
of expansionary fiscal policy (a higher G or a lower T) on output, and private investment.
3B. Use the classical model for the small open economy = Keynesian model for the small
open economy in the long run (when prices and wages are completely flexible) to analyze the
effect of expansionary fiscal policy (a higher G or a lower T) on output, real exchange rate,
and the trade balance.
2 points
4. Assume a country that constantly (for many years) is running huge government budget
deficits and finance these government budget deficits by printing new money. Use the
quantity theory of money to analyse the effects of a higher growth rate of the nominal money
supply. What is the effect on the inflation rate, on the nominal interest rate, and on the real
money demand? If the country has a currency that floats, do you expect the value of this
currency to depreciate or appreciate as consequence of higher growth rate of the nominal
money supply?
2 points.
5. Suppose that an economy has the Philips curve
   e  0.5(u  0.07)   1  0.5(u  0.07)
a. What is the natural rate of unemployment?
b. How much cyclical unemployment is necessary to reduce inflation by 5 percentage
points in one year?
3 points
6. Assume that the economy’s production function is:
Y  A  K 0,2  L0,8 . Assume that L / L = 0.02, K / K = 0.02 and Y / Y =0.03.
A. Use growth accounting to calculate A / A
B. Calculate the growth rate of labor productivity, Y/L:
Longer questions:
3+1+1= 5 points
7. Use the Solow-model with the following production function: Y  AK  L1 .
Assume as usual that every person in the economy is a worker.
Assume also that the growth rate in A is zero.
A
4
Saving rate (s)
0.5
0.5

Population growth rate (n)
0.0
0.1
Depreciation rate (  )
L(0)
100
7a. calculate the long-run equilibrium values for capital per worker (K/L), consumption per
worker (C/L), production per worker (Y/L), the real wage (W/P), and the real return on capital
(r =MPK-  ). Also calculate long-run equilibrium of GDP (Y).
7b. What is the effect on the long-run equilibrium values of K/L, Y/L, W/P, and the real
return on capital (r) if n increases? No need to calculate with numbers.
7c. What is the effect on the long-run equilibrium values of K/L, Y/L, W/P, and the real return
on capital (r) if A increases? No need to calculate with numbers.
4.5 points
8. Use the Keynesian model for a small open economy with its own currency.
Some of the assumptions of this model are:
Equilibrium in the goods market: Y = C(Y-T) + I(r=r*) + G + NX (real exchange rate)
Equilibrium in the money market: M/P = L(r=r*,Y)
Assumption 1: r is the real interest rate and r* is the real interest rate in the rest of the world.
Assumption 2: The domestic price level and the price level in the rest of the world are
constant in the short run.
A. Suppose the economy experiences a fall in demand for its export products.
What happens in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, to the nominal and to the
real exchange rate and to the trade balance (NX)?
Compare the old short-run equilibrium with the new short-run equilibrium.
Answer qualitatively: Has Y increased, decreased or is the same, etc.
B. Assume now that the CENTRAL BANK decreases the nominal money supply (M) and
thereby temporarily increases the nominal interest rate (above the world interest rate).
What happens in the short run (when the domestic price level and the price level in the rest of
the world are constant) to GDP (Y), private consumption, to the nominal and to the real
exchange rate and to the trade balance?
Compare the old short-run equilibrium with the new short-run equilibrium.
Answer qualitatively: Has Y increased, decreased or is the same, etc.
Answers:
Answer1:
National real saving= Y-C-GC= I + GI + NX = 20+20+10=50.
Private real saving = Y-T-C.
Y=100+20+40+20+10=190.
Thus, private real saving = 190-70-100=20.
Government real saving = T-GC=70-40=30.
Answer2:
Output, private consumption, and real interest rate up, and private investment down.
According to the life.cycle model no effect on current consumption.
Answer3A: No effect on output. Private investment decreases equally much that for example
G increases.
Answer3B: No effect on output. Trade balance decreases equally much that for example G
increases. The real exchange rate appreciates.
Answer4:
4.Higher money growth leads to a higher inflation and to a higher nominal interest rate (due to
the Fischer equation), and to a lower real money demand, and to a depreciating currency.
Answer 5:A. u=0.07, which is the natural rate of unemployment.
5B. To reduce inflation, the Phillips curve tells us that unemployment must be above its
natural rate of 7 percent for one year. We can write the Phillips curve in the form: Actual
inflation – last period’s inflation = 0.5(u-0.07). Since we want inflation to fall by 5 percentage
points, we want (actual inflation – last period’s inflation)=-0.05. Plugging this into the lefthand side of the above equation, we find that -0.05=-0.5(u-0.07). 0.1=u-0.07. Solving for u:
u=0.17. Hence, we need 10 percentage point-increase of cyclical unemployment above the
natural rate of 7 percent.
Answer6a: 1 procent. Answer6b: 1 procent.
Answer:
savum
7a.
k=(sA/(n+d))^2 400
y=Ak^0.5
80
c=(1-s)*y
40
W/P=0.5*y
40
r=
0.0
A0.5k^-0.5 - d
Y=y*L
8000
7b. k, y, and the real wage decrease, and the real return on capital increases.
7c. k, y, and the real wage increase, and the real return on capital stay constant.
Answer8A: Y goes down due to a fall in aggregate demand. Lower income lowers real money
demand which means a lower interest rate (below the world market interest rate) which means
that financial investments in Sweden are relatively unprofitable; hence the demand for the
currency decreases, which leads to a depreciation of the nominal and real exchange rate,
which increases NX.
GDP, private consumption and NX are unchanged but the nominal and real exchange rate are
depreciated.
Answer8B: Y, C, and NX decreases and currencecy appreciates.
EXAM FALL 2009. 1: Analysis of the labor market. 6 points
Suppose that a country invests a lot so that the capital stock (K) increases: Assume as usual:
perfect competition in the labor market and in goods market, and that the aggregate
production function is Y  A  K 1/2  L1/2
A. What happens to the labor demand curve when K increases?
Shifts out, in or stays constant? Explain why.
B. What is the effect on equilibrium employment and on the equilibrium real wage if we
assume that the labor supply curve has a positive slope; that is, if labor supply is assumed to
increase when the real wage increases. Show in a diagram if you can.
C. If we instead assume that the capital stock (K) decreases (because of structural change that
make the production facilities out of date):
What happens to employment and unemployment if the real wage is constant?
D. What are the effects on equilibrium employment and on equilibrium real wage if the
government cuts unemployment benefits? That is, if the government makes it less favorable to
be out of work?
Hint: Alterations of unemployment benefits should impact labor supply.
Quantitative question:
E. Assume that A= K=1 in the production function above. Assume also a vertical labor supply
curve Assume that the labor supply is equal to a 1000 workers.
Calculate the production level and the equilibrium real wage per worker. How large is capital
income, how big is total labor income?
Hint: the equilibrium real wage is the real wage that makes labor demand equal to labor
supply.
2. 3 points. Growth accounting question: Assume the production function in question 1.
A. If the number of workers (L) increases by 10 percent and K and total factor productivity
(A) are constant, by how many percent does Y increase?
How does production per worker change, in percent?
Hint: One way to solve exercise: assume that A=1, K=1, L0=1 and L1=1.10.
B. If both K and L change by 10 percent, and real GDP (Y) increases by 14 percent, what
must have happened to total factor productivity in percent?
3 points
3. China’s trade balance (and current account balance) shows a large surplus.
A. Does it mean that China’s national saving is larger, smaller or equal than domestic
investment in China?
B. Show with an equation how national saving, domestic investment and the trade balance
(NX) are related. Simplify by assuming that net foreign income (NFI) and net foreign
transfers (NFTr) are zero.
4. 3 points Use the Solow-model to analyze:
A. The effect of an increased saving rate on the steady-state levels of production per worker
(Y/L), capital per worker (K/L), the real wage per worker (W/P), and real rental price per unit
of capital (R/P).
B. The effect of a lower population growth rate on the steady-state levels of production per
worker (Y/L), capital per worker (K/L), the real wage per worker (W/P), and real rental price
per unit of capital (R/P).
C. The effect of a better technology on the steady-state levels of production per worker (Y/L),
capital per worker (K/L), the real wage per worker (W/P), and real rental price per unit of
capital (R/P).
Instruction: It is sufficient to answer: increase, decrease or stays constant.
No verbal explanation or diagrams are needed for maximum points.
3 points
5. Use the life-cycle model of consumption in which an individual consumes in two periods
and also receives income in the two periods. C1 (C2) is consumption in period 1 (2). Y1 (Y2)
is consumption in period 1 (2). Assume the standard utility function: U  C11/2  C 21/2 .
A. What will happen to current consumption (C1) if the real income received in the second
period of life (Y2) increases? Explain.
B. Assume that an individual is a borrower, what will happen to current consumption (C1) if
the real interest rate increases?
7 points
6. Assume the Keynesian model in the short run (when P is fixed) for a closed economy.
Equilibrium in this model is when the goods and money markets are in equilibrium.
Equilibrium in the goods market: Y=C(Y-T)+I(r)+G
Equilibrium in the money market: M S / P  (M / P)d
Assume:
The consumption function: C  100  0.85  (Y  T )
The investment function: I  200  25  r
Government purchases (G) and net taxes (T) are both 100.
The money demand function: ( M / P)d  Y  100  r
The money supply M S is 1000 and the price level P is 2.
A. Find the equilibrium interest rate r and the equilibrium level of income Y.
B. Calculate private saving, public saving, and national saving.
C. What is investment?
D. Suppose that government purchases (G) increases what happens to:
Equilibrium income (Y), equilibrium interest rate and to national saving:
Give qualitative answers: increase, decrease or stays constant.
You should be able to answer D even if you cannot calculate A.-C.
Answers;
Answer1: A. Shifts out. B. Employment increases and the real wage increases.
C. Employment decreases and unemployment arises. D. The labor supply curve shifts out and
employment increases and the real wage decreases. E. Production is 31.6. The real wage is
0.0158. Half the production is capital income: 15.8 and labor income is 15.8.
Answer2: A. Y increase by 2.5 percent. B. A must have increased by 4 percent.
Answer3: A. National saving is larger than domestic investment.
A. S=Y-C-GC= (I+GI)+NX or S=Y-C-G=I+NX.
Answer4: A. Up, up, up, down. B. Same as in A. C. up, up, up, constant.
Answer5: A. increase. B. decrease.
Answer6: A. Y=1100, r=6. B. Y-T-C=1000-950=50. T-G=0. National saving = 50
C. I = 50. D. both Y and r increase and national saving decreases.
Intermediate macroeconomics, REEXAM FALL 2009.
2 points.
1. If the CPI (=consumper price index) in 2006 was 100 and in 2007 was 104.5, and your
nominal hourly wage was 110 kronor in 2006 and was 112 in 2007.
What was the inflation rate between 2006 and 2007? By how many percent did the nominal
wage increase? How the real wage develop, in percentage terms.
2 points
2. When are fiscal policies expansionary? In other words, what is the criteria?
Points 4 (2+1+1)
3. Assume a country with floating exchange rate that is running a huge government budget
deficit (as a percentage of GDP), which is financed through printing new money. Thus, the
growth rate of the nominal money supply is high. What are the effects on the inflation rate,
and on the nominal interest rate, and on the exchange rate?
3A. Assume that the growth rate in nominal money supply (M) is 50 percent, that the velocity
of money (V) (unrealistically) is constant, that the growth rate of real GDP is minus 5 percent,
what is the rate of inflation according to the quantity theory of money?
3B. Assume that the real interest rate on government bonds is 2 percent and that the expected
rate of inflation equals your answer in A. What is the nominal interest rate according to the
Fischer equation?
3C. Assume that the rate of inflation in the rest of the world on average is 10 percent, do you
expect the currency to depreciate or appreciate or stay constant; by how many percent is the
expected depreciation/appreciation?
Points 8
4. Use the short-run Keynesian model for a small open economy with a floating exchange rate
(the Mundell-Fleming model).
This model is described by the equations:
Equilibrium in the goods market: Y = C(Y-T) + I(r=r*) + G + NX (real exchange rate)
Equilibrium in the money market: M/P = L(r=r*,Y)
Assumption 1: r is the real interest rate and r* is the real interest rate in the rest of the world.
Assumption 2: The domestic price level and the price level in the rest of the world are
constant in the short run. That is, the model is for the short run when product prices are
assumed to be fixed.
Use this model to answer the following questions.
A. Assume that government purchases (G) increases.
Compare the new short-run equilibrium after G has increases to the old short-run
equilibrium with respect to:
- GDP (Y)
- the nominal and the real exchange rate
- the trade balance
- the interest rate and private investment (I)?
- national, government, and private saving. Define these concepts!
B. Assume that nominal money supply (M) increases.
Compare the new short-run equilibrium after G has increases to the old short-run
equilibrium with respect to:
- GDP (Y)
- the nominal and the real exchange rate
- the trade balance
- the interest rate and private investment (I)?
Points 8
5. Use the Solow-model with the following production function: Y  AK  L1 .
Assume as usual that every person in the economy is a worker.
Assume also that the growth rate in A is zero.
Assume that the world consists of two countries: INEFFECTIVE and EFFECTIVE.
Parameter
INEFFECTIVE
EFFECTIVE
A
1
4
Saving rate (s)
0.25
0.25
0.5
0.5

Population growth
0.01
0.01
rate (n)
0.1
Depreciation rate (  ) 0.1
L(0)
200
-1a. calculate the long-run equilibrium values for capital per worker (K/L), consumption per
worker (C/L), production per worker (Y/L), the real wage (W/P), and the real return on capital
for the two countries. If you cannot answer with numbers, explain which country has higher
or lower values on the variables mentioned above for partial credit.
1b. Calculate long-run GDP (Y) for country INEFFECTIVE.
1c. When allowing for capital mobility between the countries; from what country will capital
move?
1d. What is the effect on the long-run equilibrium values of K/L, Y/L, W/P, and the real
return on capital if n increases? No need to calculate with numbers.
1e. What is the effect on the long-run equilibrium values of of K/L, Y/L, W/P, and the real
return on capital if the saving rate increases? No need to calculate with numbers.
Answers:
Answer1:
Inflation rate = 4.5 percent. Nominal wage increased by (2/110)*100 percent = 1.8 percent
Real wage decreased by about (1.8 – 4.5) percent = -2.7 percent.
Answer2: If the government budget is negative when evalutated at potential GDP.
Answer3:
High money growth leads to a high inflation and a high nominal interest rate (due to the
Fischer equation), and a depreciating currency.
A. 50+0=-5+inflation. Inflation is 55 percent.
B. r = I – inflation, 2=i-55, nominal (i)=57 percent.
C. Depreciates by 47 percent.
Answer4:
A. Y is unchanged. The nominal and real exchange rates are appreciated. NX has fallen.
The interest rate and private investment are unchanged.
National saving, Y-G-C, goes down. Government saving, G-T, goes down. Private saving,
Y-T-C(Y-T) unchanged.
B. Y goes up. The nominal and real exchange rates depreciates. NX increases.
The interest rate and private investment are unchanged.
Answer5:
SPARA
ineffective
EFFEKTIV
k=(sA/(n+d))^2 20.66
5.16
82.64
y=Ak^0.5
4.545
2.2716
36.36
c=(1-s)*y
2.2727
1.7036
27.27
W/P=0.5*y
2.2727
1.1358
18.18
r=
0.01
0.12
0.12
A0.5k^-0.5 - d
1b. k, y, and the real wage decrease, and the real return on capital increases.
1c. k, y, and the real wage increase, and the real return on capital decreases.
1a.
APRIL 2009 EXAM.
6 points
2. Consider a Cobb-Douglas production function with three inputs. K is capital (the number of
machines), L is “unskilled” labor (the number of workers without college degrees), and H is
“skilled” labor (the number of workers with college degrees). Think that H is a measure of
human capital in the economy. The production function is:
Y  K 0.4  L0.3  H 0.3
Assume that K=1, and that there are 100 unskilled workers in the economy, and 20 skilled
workers. Thus, this is the supply of unskilled labor and the supply of skilled labor in the
economy.
Assume that there are many firms in the economy which produces an identical good. That is,
assume perfect competition in the goods market. Also assume perfect competion in the 2 labor
markets, which for example means that there exist no labor unions. There exist 2 labor
markets: one for unskilled workers and one for skilled workers.
A.Calculate the equlibrium real wage for unskilled workers.
(The equilibrium real wage for a particular type of labor is the real wage that equates the
demand for this type of labor with the supply of this type of labor.)
(Hint: you find the equilibrium real wage by evaluating the marginal product of unskilled
labor where L=100 and H=20; that is, where the demand for these 2 types of workers equals
the supply of these types of labor.)
Also calculate the equilibrium real wage for skilled workers.
B. Now assume that L increases to 200 because of immigration.
What happens to the real wage for unskilled workers? (Increases, decreases,stays constant).
What happens to the real wage for skilled workers? (Increases, decreases, stays constant).
Calcule the new real wages for the 2 types of labor!
Also show the effects in a diagram that shows the labor market for “unskilled” workers and in
a diagram that shows the labor market for “skilled” workers (=workers with college degrees).
If you cannot calculate the new real wages you might be able to answer the question
qualitatively (that is, the real wage of “unskilled” increases, decreases or stays constant).
You might also be able to show the effect on the real wages of immigration in the diagrams.
C. If the real wage for “unskilled” labor cannot change because of minimum wage laws when
the number of “unskilled” workers increases (due to immigration), what happens to the real
wage for skilled workers. What happens to employment of “unskilled” workers?
8 points
3. Use the Keynesian model for a small open economy (the Mundell-Flemming model)
To answer the following questions.
Some of the assumptions of this model are:
Equilibrium in the goods market: Y = C(Y-T) + I(r=r*) + G + NX (real exchange rate)
Equilibrium in the money market: M/P = L(r=r*,Y)
Assumption 1: r is the real interest rate and r* is the real interest rate in the rest of the world.
Assumption 2: The domestic price level and the price level in the rest of the world are
constant in the short run.
C. Assume that the foreign demand for the country’s export products fall.
What will happen in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), to the nominal and to the real exchange rate
and to the trade balance? Also describe what the process!
B. Assume that actual GDP is below full-employment GDP. As a result, the government
decides to simulate aggregate demand by lowering taxes (T).
What will happen in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, to the nominal and to the
real exchange rate and to the trade balance? Also describe what the process!
C. Assume that actual GDP is below full-employment GDP. As a result, the government
decides to simulate aggregate demand by increasing the nominal money supply (M).
What will happen in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, to the nominal and to the
real exchange rate and to the trade balance? Also describe what the process!
D. Consider what will happen in the long run. Assume that the economy’s GDP is below the
full-employment GDP (Y). What will happen to nominal wage and to the price level?
What happens to GDP, private consumption, private investment, to the real exchange rate and
to the trade balance?
1point
4. In a closed economy, what do we mean by “crowding-out”?
Why might “crowding-out” be a problem?
1point
5. If inflation is 10 percent and the real interest is 12, what is the nominal interest rate?
3 points
6. Use 2-period consumption model from the book to answer the following questions:
A. If the individual’s utility function is such that he prefers/values current consumption
more than future consumption, do we know for sure that his current consumption will
be higher than his future consumption? Why or why not! Explain!
B. B. If the individual’s utility function is such that he prefers/values current
consumption more than future consumption, do we know for sure that his current
consumption will be higher than his future consumption? Why or why not! Explain!
1 points
7. Explain the expectation-augmented Phillips-curve! State it and explain it!
Answers:
Answer2:
A. Real wage for “unskilled” = 0.3*Y/L=0.3*(100**0.3)*(20**0.3)/100= 0.029
Real wage for “skilled” = 0.3*Y/H=0.3*(100**0.3)*(20**0.3)/20= 0.147
B. Real wage for “unskilled” = 0.3*Y/L=0.3*(200**0.3)*(20**0.3)/200= 0.018
Real wage for “skilled” = 0.3*Y/H=0.3*(200**0.3)*(20**0.3)/20= 0.181
C. The real wage for skilled workers stays constant. The employment of unskilled workers
stays constant if the real wage is constant.
Always show calculations. AUGUST EXAM 2009.
1. Price indices and national income accounting. 4 points
Consider a closed economy that produces two goods: cars and bread.
Year 2000
Year 2001
Price of a car
20,000 euro
21,000 euro
Price of a loaf of bread
10 kronor
15 kronor
Number of cars produced
100 cars
110 cars
Number of loaves of bread produced
100,000
90,000
Note: A loaf of bread is one piece of bread.
a. Calculate nominal GDP for 2000 and nominal GDP for 2001.
b. Calculate real GDP for 2001 (in 2000 year prices). By how many percent did real GDP
increase between 2000 and 2001?
By how many percent did the general price level increase according to the GDP-deflator?
Note: The GDP-deflator is a Paasche price index.
c. Calculate the value of CPI for 2001 when assuming that CPI for the year 2000 equals 100.
By how many percent did the general price level increase according to CPI?
Note: The CPI is a Laspeyres price index.
4 points
3. Use the quantity equation for money, which relates nominal money supply (M), the
general price level (P), real GDP (Y), and the velocity of money (V).
A. Calculate the growth rate in Y under the assumption that labor productivity increases by 1
percent and that growth rate of hours worked in the economy is 0.5 percent.
(If you cannot calculate this number invent a number to answer questions b. and c.)
Assume that V is constant and that the central bank has an inflation target of 2 percent.
B. What growth rate of the nominal money stock should the central bank choose to obtain its
inflation target of 2 percent?
C. If the inflation rate in Sweden equals 2 percent whereas it is 20 percent in Polen, what is
the expected percentage change in e (sloty/krona) if the real exchange rate is constant? Use
the concept “ the law of one price”.
1 points
4. Assume that the hourly wage is 100 kronor first of January 1990, and that it is 186 kronor
first of January 2000. Assume also that CPI was 100 first of January 1990, and that CPI is 150
first of January 2000.
Calculate the percentage changes of nominal hourly wage, of the price level, and the real
wage during the 1990s!
6 points
5. Use the Solow-model with the following production function: Y  AK  L1 .
Assume as usual that every person in the economy is a worker. Assume also that the growth
rate in A is zero.
A
4
Saving rate (s)
0.5
0.5

Population growth rate (n)
0.01
0.1
Depreciation rate (  )
N(0)
100
1a. calculate the long-run equilibrium values for capital per worker (k), consumption per
worker (c), production per worker (y), the real wage, and the real return on capital for the two
countries. 1b. Calculate long-run GDP (Y) for the 2 countries. Explain.
If you cannot answer with numbers, explain which country has higher or lower values on the
variables mentioned above for partial credit.
1b. What is the effect on the long-run equilibrium values of k, y, real wage, and the real return
on capital if n increases? No need to calculate with numbers. Who tend to welcome
immigration and whom tend to oppose immigration of workers and employer? Explain why.
1c. What is the effect on the long-run equilibrium values of k, y, real wage, and the real return
on capital if A increases? No need to calculate with numbers.
6 points
6. Use the Keynesian model for a small open economy (the Mundell-Fleming model)
To answer the following questions.
Some of the assumptions of this model are:
Equilibrium in the goods market: Y = C(Y-T) + I(r=r*) + G + NX (real exchange rate)
Equilibrium in the money market: M/P = L(r=r*,Y)
Assumption 1: r is the real interest rate and r* is the real interest rate in the rest of the world.
Assumption 2: The domestic price level and the price level in the rest of the world are
constant in the short run.
A. Assume that actual GDP is below full-employment GDP. As a result, the government
decides to simulate aggregate demand by lowering taxes (T).
What will happen in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, interest rate, to the
nominal and to the real exchange rate and to the trade balance? Also describe what the
process!
B. Assume that actual GDP is below full-employment GDP. As a result, the government
decides to simulate aggregate demand by increasing the nominal money supply (M).
What will happen in the short run (when the domestic price level and the price level in the
rest of the world are constant) to GDP (Y), private consumption, interest rate, to the
nominal and to the real exchange rate and to the trade balance? Also describe what the
process!
C. Consider what will happen in the long run. Assume that the economy’s GDP is below the
full-employment GDP (Y). What will happen to nominal wage and to the price level?
What happens to GDP, private consumption, private investment, to the real exchange rate and
to the trade balance?
answers:
answer1:
1. a. GDP(2000)=(20,000*100)+(10*100,000)=2,000,000 + 1,000,000=3,000,000.
GDP(2001)=(21,000*110)+(15*90,000)=2,310,000 + 1,350,000=3,660,000.
b. GDP 2001 in 2000 year prices =
=(20,000*110)+(10*90,000)=2,200,000 + 900,000=3,100,000.
Percentage increase in real GDP = (3,100,000-3,000,000)/3,000,000=0.03333.
In other words, real GDP increases by 3.33 percent between 2000 and 2001.
The GDP-deflator in 2001= Nominal GDP in 2001/Real GDP in 2001=
3,660,000/3100,000=1.18
The price level increases by 18 percent according to the GDP-deflator.
Note: a paasche index uses quantities of the final year as weights.
c. CPI (2001) = ((21,000*100)+(15*100,000))/ ((20,000*100)+(10*100,000))=
(2,100,000 + 1500,000)/3,000,000=3600,000/3000,000=1.2
The price level increases by 20 percent according to the CPI-index.
Answer3: A. 1,5 percent. B. 3.5 percent. C. Appreciation by 18 percent.
Answer4: 86, 50 and 36 percent.
Svar5:
savum
1a.
k=(sA/(n+d))^2 330
y=Ak^0.5
72.66
c=(1-s)*y
36.55
W/P=0.5*y
36.55
r=
0.01
A0.5k^-0.5 - d
1b. k, y, and the real wage decrease, and the real return on capital increases.
1c. k, y, and the real wage increase, and the real return on capital stay constant.
EXAM IN MACROECONOMICS INTERMEDIATE LEVEL AT KARLSTAD
UNIVERSITY, SPRING 2008.
Maximum points: 25 points. To pass 12.5 points are required.
1. 2 points. In case both borrowers and savers have fixed their respective nominal interest
rates, if the actual inflation rate becomes higher than the expected inflation rate, whom (of
borrowers and savers) become Happy and Sad? Explain why?
2. 2.5 points Inflation is ten percent country A and five percent in country B, what country do
you expect to have a higher nominal interest rate. Which of the two countries do you expect to
have a depreciating currency?
3. 2.5 points Use the phillips-curve theory to answer the following question: Can inflation fall
without a period of high unemployment (that is, unemployment above the natural rate)?
Explain in one or two sentences why or why not?
4. 5 points. Use the classical model = keynesian model for the long run, in which all prices are
totally flexible. In this model actual output equals potential output. Assume that the economy
initially is in an equilibrium, then the government increases G (=government consumption +
government investment). What is the effect on the variables below.
Write in increases, decreases, and unchanged in the table .
Closed economy
Small open economy
National Saving=….
Public saving= ….
Private saving = ….
Private consumption
The real interest rate
Private investment
The real exchange rate=…
-The trade balance
--
5 3 points What is the effects of a higher money supply in the classical model above; that is,
for the closed economy and for the small open economy? You may want to make a new table
to answer this question.
6. 10 points. Use the Solow-model with the following production function: Y  AK  L1 .
Assume as usual that every person in the economy is a worker. Assume also that the growth
rate in A is zero. Assume that the world consists of 2 economies: Rich and Poor
Parameter
SAVUM SPENDUM EFFICIENT
A
1
1
4
Saving rate (s)
0.5
0.25
0.25
0.5
0.5
0.5

Population growth
0.01
0.01
0.01
rate (n)
0.1
0.1
Depreciation rate (  ) 0.1
L(0)
100
200
-1a. calculate the long-run equilibrium values for capital per worker (k=K/L), consumption per
worker (c=C/L), production per worker (y=Y/L), the real wage per worker (W/P), and the real
rental price per unit of capital (R/P), which equals the real return on capital plus the
depreciation rate for the two countries: SAVUM and SPENDUM.
1b. Calculate long-run GDP (Y) for the 2 countries: SAVUM AND SPENDUM. Explain.
If you cannot answer with numbers, explain in words which country has higher or lower
values on the variables mentioned above in 1a. and 1b. for partial credit.
c. If we allow for capital mobility (K) between the countries, from what country (SAVUM
and SPENDUM) will the capital move? Why? Does capital mobility diminish initial
differences in k,y,W/P, and real return on capital?
d. If the saving rate is increased in country POOR to say 0.5. What happens to consumption
per worker during the transition to the new steady state? Does it increase, decrease or stay
constant? No need to do any calculation, but you may!
e. Can a country save too much? In other words, can a very high saving rate actually decrease
the steady-state level of consumption per worker. Explain with diagram and in words. No
need for numbers (but you may if you wish).
f. Assume another country: EFFICIENT. Under the assumption that this country is a closed
economy calculate capital per worker (k), production per worker (y=Y/L), consumption per
worker, real wage per worker, and the real rental price per unit of capital.
g. If now assuming 2 countries: SPENDUM and EFFICIENT, and allowing for capital
mobility (K) between these 2 countries. (Note: The country SAVUM does not exist any
longer.) Do you expect capital to move between the countries SPENDUM and EFFICIENT?
Explain.
If you cannot answer with numbers, explain in words which country has higher or lower
values on the variables for partial credit.
Answer:
1a.
k=(sA/(n+d))^2
y=Ak^0.5
c=(1-s)*y
W/P=0.5*y
r=
A0.5k^-0.5 - d
SAVUM
20.66
4.545
2.2727
2.2727
0.01
SPENDUM
5.16
2.2716
1.7036
1.1358
0.12
EFFICIENT
82.64
36.36
27.27
18.18
0.12
FALL 2008. EXAM.
5 points
1. Use the short-run Keynesian for a small open economy with a floating exchange rate (the
Mundell-Fleming model) to predict what would happen to aggregate real income (Y), the
exchange rate, and the trade balance in response to each of the following shocks:
A. A fall in consumer confidence about the future, which induces consumers to spend less and
save more.
B. A shift in consumer preferences toward environmentally friendly cars; many consumers
turn away from Swedish produced cars (Volvo and SAAB).
C. An increase in the real money supply.
3 points
2. Traveling in Mexico is much cheaper now than it was 10 years ago, says an American
friend. “Because ten years ago, a dollar bought 10 pesos; this year, a dollar buys 15 pesos. Is
your friend right or wrong? Given that total inflation over this period was 25 percent in the
US and 100 percent in Mexico, has it become more or less expensive to travel in Mexico for
Americans? Analyse how the real exchange rate between the Peso and American dollars has
changed.
4 points
3. The nominal interest rate is 12 percent per year in Canada and 8 percent per year in the
USA. Suppose that the real interest rate is the same in these two countries, and that
purchasing-power parity (The law of one price) holds.
A. Use the Fischer equation, what can you say about expected inflation in Canada and in the
USA?
B. What can you say about the expected change in the exchange rate between the Canadian
dollar and the US dollar?
C. A friend proposes a get-rich-quick scheme: borrow from a US bank at 8 percent, deposit
the money in a Canadian bank at 12 percent, and make a 4 percent profit. What’s wrong with
this scheme? What has your friend forgotten?
5 points
4. Jack and Jill both obey the two-period model of consumption. Jack earns $200 in the first
period and $200 in the second period. Jill earns nothing in the first period and $420 in the
second period. Both of them can borrow or lend at the interest rate. r?
a. You observe both Jack and Jill consuming $200 in the first period and $200 in the
second period. What is the interest rate r?
b. Suppose the interest rate increases. What will happen to Jack’s consumption in the
first period? To answer this question, you have to recall the expression for the optimal
consumption in the first period: That is the solution, to the problem:
Maximize U  c1  c21 under the restriction: c1 
c2
Y
 Y1  2 .
1 r
1 r
Instruction how to solve this problem: In case of a Cobb-douglas utility function (like the one
above), the share of expenditures on each good equals that good’s preference parameter in the
utility function. For example: If the individual maximizes U ( x, y )  x   y 
subject to the budget constraint: p x  x  p y  y  I
where y= quantity of good y, x=quantity of good x, p x = price of good x. p y = price of good
y. I = income. The optimal demand of x and y are such that:
px  x*
 I
(1   )  I
if   1    x* 
 x* 

px
p x  (   )
I
p y  y*
I

 y* 
 I
p y  (   )
if   1  

y* 
 I
py
c. What will happen to Jill’s consumption in the first period when the interest rate
increases? Is Jill better of or worse of than before the interest rate increases?
3 points
5. Assume two countries with the same production function: Y=F(A,K,L); this means e.g. that
totalfactorproductivity (A) is the same in the two countries. Moreover, we assume that the
saving rate is the same in the two countries and that the two countries are in their respective
long-run equilibria (steady states) according to the Solow-model. The only difference between
the countries is that they differ with respect to the long-run growth rate of the work-force
L
 n ):
(
L
A. Which country has the highest GDP per capita?
B. If we allow for capital- and labor mobility between these two countries:
(i). Capital (factories) will move from the country with high population growth.
(ii). Workes will move from the country with low population growth.
(iii). There will be no capital mobility between the countries.
(iv). Capital (factories) will mover from the country with a low population growth rate.
Choose one altenative above!
3 poäng
6. Assume that the economy has the following Phillips curve:
   1  0.5(u  0.05)
a. What is the level of the natural rate of unemployment?
b. By how many percentage points must the actual unemployment rate increase for the
inflation rate to be reduce by 5 percentage points.
c. In case inflationary expectations are rational instead of adaptive, is it possible for
inflation to fall without having a rising unemployment? Explain.
2 points
7. Assume that the government sell public telecom company to the private sector. Does such
actions by the government reduce the national debt as it is now measure? Do you think these
actions represent a true reduction in the government’s indebtedness? Explain!
Answer1:
A.If consumers decide to spend less and save more, C decreases. Output is unchanged. The
exchange rate depreciates, which causes an increase in the trade balance equal to the fall in
consumption.
B.implies that the NX falls at a given exchange rate. Output does not change, while the
exchange rate depreciates. The trade balance does not change, despite that the exchange rate
has depreciates. We know this since NX=S-I, and both saving and investment remain
unchanged.
C.An increase in money supply decreases interest rate, which leads to capital outflow, a
depreciating currency, the trade balance improves an income increases.
Answer2: Percentage increase in the real exchange rate = percentage increase in the nominal
exchange rate (Peso/USD) + domestic inflation in the US– foreign inflation = 50 % + 25
percent – 100 percent = - 25 percent. The real exchange rate of the dollar visavi the Mexican
peso depreciates by 25 percent. A depreciation of the real exchange rate makes foreign goods
more expensive and domestic goods cheaper. Thus, the friend should be wrong as it now
should be more expensive to travel in Mexico.
Answer3:
A. The expected inflation rate is 4 percentage points higher in Canada.
B.The Canadian dollar is expected to depreciate by 4 percent.
C. He does not take the expected depreciation of the Canadian dollar into account. Assume
that he borrows 1 US dollar from an American bank at 8 percent, exchanges it for 1 Canadian
dollar, and puts it in a Canadian bank. At the end of the year he will have 1.12 Canadian
dollars, which then is expected to be worth 1.08 US dollars, which is the amount owed to the
US Bank.
Answer4:
A. R=10 percent.
B. The rise in interest rates leads Jack to consume less today and more tomorrow. This is
because of the substitution effect: it costs him more to consume today than tomorrow
because of the higher opportunity cost in terms of foregone interest. We know Jack is
better off: at the new interest rate he could still consume 100 dollars in each period, so
the only reason he would change his consumption pattern is if the change makes him
better off.
C. Jill consumes less today while her consumption tomorrow can either rise or fall.
Answer5B. iv