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Agricultural Economics 430

Macroeconomics of Agriculture

Fall 2009

Penson

Second Hour Examination

NAME:_____ANSWER KEY______

SID NUMBER: ______

This examination consists of six questions. Please read each question carefully. The term “describe fully” asks that you answer all aspects of the question. Avoid giving extraneous information (i.e., “filler”). Use graphs/formulas whenever possible to help tell your story. Use the back of the page if necessary. Good luck!

Question 1 _____ of 20 points

Question 2 _____ of 20 points

Question 3 _____ of 15 points

Question 4 _____ of 15 points

Question 5 _____ of 10 points

Question 6 _____ of 20 points

TOTAL _____ of 100 points

  1. Please complete the following table describing the short-run effects of specific macroeconomic policy actions with a “+” denoting an increase in the variable in each column heading and a “–” denoting a decrease. (20 points; 1 point each)

Macroeconomic
policy action / Exchange rate / Inflation rate / Unemploy-ment rate / Market interest
rate / GDP growth rate
Federal Reserve raises the discount rate / + / - / + / + / -
Congress and White House increases theincome tax rate / - / - / + / - / -
Federal Reserve buys government bonds / - / + / - / - / +
Congress and White House increase the level of government spending / + / + / - / + / +
  1. We have used IS/LM analysis to capture the equilibrium in the nation’s product and money markets. We also related this equilibrium to the individual markets and the actions of individual producers. Current macroeconomic policy consists of expansionary fiscal policy and expansionary monetary policy. (20 points)
  1. Please graph the effects of these policy actions on the general equilibrium in the nation’s money and product markets.

  1. Given the effects of the monetary and fiscal policy effects drawn in your answer to part a above, please illustrate the effects this would have on the U.S. wheatmarket in an open economy and the impact on an individual producer’s economic profit.

Average profit would increase from spread between yellow dots to the green dots and total profit will increase since the quantity produced increased.

  1. Please define or graphically illustrate (make sure you label graphs) each of the following terms: (15 points; 3 points each)

General equilibrium

Draw an IS-LM graph indicating that general equilibrium occurs where these two curves cross or intersect. Levels of interest rate and national income where the money and product markets are in equilibrium.

Inflationary gap

Draw an aggregate product market graph showing that aggregate demand equals aggregate supply where planned levels of spending exceed full employment output.

Total reserves

Element in the money supply equation reflecting the amount of hard money in the economy. When multiplied by the money multiplier, the level of total reserves determines the level of the money supply.

Cost push inflation

Draw the aggregate product market showing aggregate supply curve shifting to the left, pushing up the general price level. Can also show the labor market graph where a shift in the labor supply curve to the left or higher demand for labor pushes up wage rates in the economy.

Exchange rate

The rate of exchange in one currency for another. Influenced by US market interest rate relative to interest rate in the rest of the world.

  1. Given the following demand and supply equation for a market, please answer the questions below

MS = 1/rrm(TR)

MD = 45 –125(i) + 1.0(Y)

MS ≡ MD

where i represents the rate of interest, Y represents national income, rrm represents the fractional reserve requirment ratio, and TR represents total reserves.

Assume national income in 2008 was $1,200 and is projected to be 5 percent higher in 2009. Also assume the reserve requirement ratio is 0.25 and total reserves are equal to 140. (15 points)

(SHOW ALL WORK FOR FULL CREDIT)

  1. What market clearing interest rate would you project for 2009?

MS = (1/.25)(140) = 4(140) = 560

MD = 45 – 125(i) + 1.0(1.05(1200))

560 = 45 – 125(i) + 1260

125(i) = 45 + 1260 – 560

i = 745/125 = 5.96%

  1. What level of the money supply would be needed to achieve a market interest rate in 2009of 8 percent? (Hint: using percentage rather than decimal equivalent; e.g., using12 rather than .12)

MS = 45 – 125(8) + 1260

= 1305 – 125(8)

= 305

  1. Illustrate the curve that represents a series of equilibrium interest rates for a given set of national income levels?


  1. We discussed the “Big 5” macroeconomic variables and their effects on agriculture. Some of these variables have a bigger impact than others. Please identify each of these variables and the nature of their effect. Which variables do you expect have the biggest impact and which have a relatively minor impact? (10 points)

Interest rate – an increase in the interest rate will increase farm interest expenses, lower net farm income and depress farm land values.

Exchange rate – an increase in the value of the dollar relative to other currencies will dampen export demand for farm products, depress farm commodity prices and lower net farm income and farm land values.

Rate of growth in GDP – a decrease in this growth rate will lower disposable incomes, which shifts the demand curve for farm products to the left. The low income elasticity of demand for farm products will minimize this effect relative to other sectors in the economy. Lower commodity prices will reduce net farm income and affect farm land values as well.

Unemployment rate – an increase in the unemployment rate will affect the availability and wage rates for jobs off the farm sought by farm operator families. The level of off-farm income earned by farm operator families is generally higher than net farm income.

Inflation rate – an increase in inflation will be passed along to farmers in the form of high farm input prices. Remember farmers are price takers in these markets.

Interest rates, exchange rates and inflation rates have the biggest effect on agriculture while the unemployment rate (not all farmers also work off the farm) and rate of growth in GDP (low income elasticity) have the least effect.

  1. Given the following set of graphs, please briefly describe in the box below how you characterize the product market in this economy. Please graphically illustrate how you would change fiscal policy in the first graph below, indicating in the box which specific policy you chose and the impact on the federal budget. Then illustrate its effects on the remaining four graphs. (Hint: draw shifts in curves with directional arrows) (20 points)