Intermediate Macroeconomics

1. Multiple Choice

Answer ALL of the following questions by CLEARLY indicating on this script which response is the MOST correct.

1) Economists care about inflation because

a) inflation can add uncertainty to economic decision making.

b) inflation acts as a tax on money holdings.

c) inflation effects returns on monetary assets.

d) all of the above.

2) The main disagreement dividing macroeconomists is

a) whether interest rates are too low or not.

b) whether prices adjust quickly towards market equilibrium or not.

c) whether unemployment is costly in the long-run or not.

d) whether government expenditure on investments is productive or not.

3) The "income-expenditure" model (the "Keynesian-Cross" model)

a) is a model of short-run goods-markets equilibrium only.

b) is a good model for how changes in expenditure affect interest rate.

c) explains why increases in the money supply may cause inflation.

d) predicts a balanced-budget expenditure multiplier of less than one.

4) In the goods market,

a) Inflation uniquely determines the equilibrium level of employment.

b) Wage bargaining is central to our understanding of equilibrium.

c) The working age population that is employed is irrelevant.

d) The higher the interest rate the lower the equilibrium level of output.

5) A "liquidity trap" is

a) what always happens after a stock-market crash.

b) effectively modelled by assuming an horizontal LM curve.

c) the result of the central bank rigidly controlling interest rates.

d) all of the above.

6) The "Current Account" measures

a) the total value of current economic activity.

b) the total value of all currency in the economy.

c) payments to and from the rest of the world for current goods and services.

d) none of the above.

7) The more open an economy

a) the smaller the effect of a change in domestic demand on domestic output.

b) the larger the effect of a change in domestic demand on domestic output.

c) the smaller the effect of expected appreciations on interest rates.

d) the smaller the effect of expected depreciations on interest rates.

8) Labour market equilibrium

a) almost never occurs, even in the long-run.

b) is independent of the amount of mark-up of prices over marginal cost.

c) is independent of price-level expectations.

d) determines the natural level of output and unemployment.

9) The Aggregate Supply - Aggregate Demand (AS-AD) model

a) includes equilibrium in goods, asset and labour markets.

b) allows for variable interest rates, output, and price-level.

c) illustrates the importance of expectations for economic outcomes.

d) all of the above.

10) In the "Medium Run" of the AS-AD model

a) prices and price expectations adjust to return output to its "natural" level.

b) prices are always above price expectations.

c) domestic interest rates always equal foreign interest rates.

d) inflation is assumed to equal zero.

2. True, False, or Uncertain

Answer each of the following four (4) questions TRUE, FALSE, or UNCERTAIN and provide a short supporting explanation, using math and/or diagrams where appropriate, in the booklets provided. Unsupported answers will NOT be graded.

1) According to the Classical Model of the aggregate economy, changes in aggregate demand have no effect on the amount of output produced, only the average price-level may be affected.

2) Crowding out through interest rates occurs when expansionary fiscal policy causes interest rates to fall.

3) The relative bargaining power of workers versus firms, and thus the ability of workers to "bid up" the wage rate, depends on the unemployment rate.

4) According to the AS-AD model of the macro-economy, expansions of the money supply are not "neutral" but rather they will have medium and long-term effects on output and employment.

3. Problems

Answer each part of each of the Three (3) problems below in the booklets provided. (Marks allocated as indicated with each part.)

1) Consider the following representation of a model economy, as follows (all notation as in class),

C = 800 + 0.9(Y - T)          G = 10

I = 800 - 40i                     T = 10

Q = 0                               M/P = 1000

X = 0                               L(i, Y ) = 0.5Y - 50i

i) What is the equation for the IS curve in this model economy?

ii) What is the equation for the LM curve in this model economy?

iii) Solve for the economy's equilibrium income and interest rates.

2) Consider an "open" economy facing the following interest-rate parity condition (all notation as in class),

i_t = i^∗_t + (E^e_t+1 - E_t)/E_t

i) If the foreign interest rate (i^∗_t) is 6% and there is an expected appreciation of the domestic currency equal to 3%, what would the domestic interest rate be in equilibrium?

ii) If this economy entered into a fixed-exchange rate arrangement with the foreign nation, what would the domestic interest rate be in equilibrium?

iii) If the foreign interest rate rises, what are the implications for domestic monetary-policy under this fixed-exchange rate arrangement?

3) Consider another representation of a model economy, where the price level (P) is flexible, as follows, (all notation as in class),

C = 80 + 0.9(Y - T)                     L(i, Y ) = P(0.9Y - 3600i)

I = 10 - 360i                               MS = 1800

G = G^-                                       P = 2W

T = T^-                                        W/P^e = 0.4 + 0.0001Y

i) Derive the Aggregate Supply Curve for this economy.

ii) Derive the Aggregate Demand Curve for this economy.

iii) Solve for the Long-Run or "Rational Expectations" equilibrium level of output for this economy.