Econ 1120 - INTRODUCTORY MACROECONOMICS
PRELIM #2 – Wissink–Fall 2016 –November 3

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Your LAST (FAMILY) NAME Your First (given) name

Your NetId:______Your Student Number:______

Instructions and Exam Taking Policy:

There are two sections in this exam. Answer all questions.

Part I: 14 multiple choice/fill in the blank questions @ 3 points each

Part II: 3 problems @ 20, 18 and 20 points each
Total Points = 100, Total Time = 90 minutes.

NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.

NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”.

NO GRAPHING CALCULATORS.

NO BOOKS. NO NOTES. NO HELP SHEETS.

NO TALKING TO EACH OTHER.

ChecktheTA’s name for the section you regularly attend (that is, where you will pick up your prelim):

One more time, please…

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Your LAST (FAMILY) NAME Your First (given) name

Your NetId:______Your Student Number:______

GRADING

MC/FIB (out 42 points)=______

Q1 (out of 20 points)=______

Q2 (out of 18 points)=______

Q3 (out of 20 points)=______

TOTAL SCORE: =______

[1]. Assume a “simple frugal un-governed closed economy” where the consumption function (in billions) is: C=500 + 0.6Y and desired investment, Id, is $100 billion. If current aggregate output/income is
Y = $1,200 billion, we can conclude that

  1. undesired changes in inventories will be zero.
  2. there will be an undesired rise in inventory.
  3. there will be an undesired fall in inventory.
  4. aggregate output/income will tend to fall.
  5. the economy is in equilibrium, so there is no tendency for aggregate output to change.

[2]. In the model of a “simple frugal governed open economy”, which one of the following would cause a parallel shift upwards of the entire consumption function?

  1. A rise in the marginal propensity to consume.
  2. A cut in the exogenous component of the tax function.
  3. A fall in income.
  4. An increase in government expenditures.
  5. None of the above.

[3]. The economy of Frant can be characterized completely by the following equations:
C = 100 + 0.8Yd; G = 500; T = 200; Id = 200.
The equilibrium level of aggregate income/output for the economy is:
$______

[4]. Assume an economy is in equilibrium at an output level of Y*=$1,600 billion. If government purchases (G) suddenly decrease by $200 billion, then at the original output level there is suddenly

  1. an unplanned increase in inventories.
  2. an unplanned inventory change of zero.
  3. an unplanned decrease in inventories.
  4. either an unplanned increase or decrease in inventories depending on the value of the MPC.
  5. an inflationary gap.

[5]. The economy of Ivyland is in equilibrium and can be completely described by the table. If full employment output, YFE, is equal to $4,000 then

IVYLAND (note that YFE = $4,000)
$Y / $C / $T / $Id / G
0 / 1050 / 100 / 50 / 400
1000 / 1550 / 100 / 50 / 400
2000 / 2050 / 100 / 50 / 400
3000 / 2550 / 100 / 50 / 400
4000 / 3050 / 100 / 50 / 400
5000 / 3550 / 100 / 50 / 400
6000 / 4050 / 100 / 50 / 400
  1. the economy of Ivyland must always equilibrate at Y=$4,000.
  2. the economy of Ivyland is currently experiencing higher unemployment than is consistent with full employment.
  3. the economy of Ivyland will have inflationary pressures.
  4. the economy of Ivyland is running a budget surplus.
  5. the economy of Ivyland must be experiencing unplanned accumulation of inventories.

[6]. Referring back to the information about Ivyland, if Ivyland were to simultaneously increase taxes to equal $1,100 and increase government expenditures to equal $1,400

  1. the economy would be unchanged.
  2. the economy would experience severe inflationary pressure.
  3. the economy would increase its projected deficit.
  4. the economy would get to full employment Y.
  5. the investment multiplier would change.

[7] Consider an economy completely described by the following two equations: S = -120 + 0.30Y and Id = 10 +0.10Y.
The “paradox of thrift” applied to this particular economy suggests that

  1. An exogenous increase in the desire to consume will make it so that in equilibrium people actually consume less.
  2. An exogenous increase in the desire to save will make it so that in equilibrium people actually save less.
  3. An exogenous increase in the desire to save will make it so that in equilibrium people save the same amount.
  4. An exogenous increase in desired investment leads to less saving in equilibrium.
  5. An exogenous increase in desired investment leads to less consumption in equilibrium.

[8]. Which one of the following is NOT included in what the U.S. government defines as M1?

  1. currency in circulation
  2. checkable deposits
  3. demand deposits
  4. savings accounts
  5. travelers checks

[9]. Assume banks hold no excess reserves and the required reserve ratio is 10%. If the Fed buys $10 million in securities from the public, but the public keeps only $8 million of the money received in checking accounts (and keeps the other $2 million as cash), then the maximum resulting increase in the money supply from this open market operation will be

  1. $8 million.
  2. $80 million.
  3. $10 million.
  4. $100 million.
  5. $82 million.

[10]. Suppose the required reserve ratio, rrr, is 15%. Suppose that when people in the particular economy of Mistrustville buy securities from the central bank they pay for them with dollars they keep at home under their mattresses, since they do not trust the commercial bankers. As compared to an economy where everyone keeps all their money as demand deposits in commercial banks and thus pays the Fed with their checking account money, the odd behavior of people in Mistrustville will tend to

  1. create inflationary pressures.
  2. make monetary policy less effective.
  3. make monetary policy more effective.
  4. make fiscal policy less effective.
  5. make fiscal policy more effective.

[11]. The Fed wants to decrease the money supply. In which answer below do both listed options have the potential to work, even if the Fed rarely uses them?

  1. The Fed sells securities to the public & lowers the required reserve ratio.
  2. The Fed sells securities to the public & raises the required reserve ratio.
  3. The Fed buys securities from the public & raises the required reserve ratio.
  4. The Fed buys securities from the public & lowers the required reserve ratio.
  5. The Fed buys securities from the public & lowers the discount rate.

[12]. Assuming money demand depends on all three variables we introduced, what is the chain of events that results from a Federal Reserve Bank open market sale of securities to the public?

  1. Aggregate output decreases, demand for money decreases, the interest rate decreases, planned investment increases, and aggregate output increases.
  2. Money supply decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.
  3. Money demand decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.
  4. Money supply decreases, the interest rate decreases, planned investment decreases, aggregate output decreases, and money demand decreases.
  5. Money supply decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and the money demand remains unchanged.

[13]. Consider our model of an economy where there is a “goods and services market” and a “money market” where money demand depends on the interest rate and aggregate output. Suppose the desired investment curve is very insensitive (that means steep) with respect to the interest rate. In such an economy

  1. the crowding-out effect caused by fiscal policy is small.
  2. the crowding-out effect caused by monetary policy is small.
  3. monetary policy is extremely effective.
  4. reducing the money supply will have a big impact on Y*, whereas increasing the money supply has very little impact on Y*.
  5. there is no feedback effect with either monetary or fiscal policy.

[14]. A policy mix of expansionary monetary and contractionary fiscal policies will lead to the following predictions on C=consumption, Y=income, r=interest rate, I=investment:

  1. Y and C increase; r and I decrease.
  2. Y increases, C decreases, r is uncertain and I is uncertain.
  3. Y and C are uncertain; r decreases and I increases.
  4. Y and C decrease; r and I increase.
  5. Y and r increase; C and I decrease.


1. Suppose that the following set of equations describe ALL the relevant information about the island nation, Grosse Rouge. Assume the fiat currency is called the dollar and its symbol is $.

  • Consumption function:
  • Desired Investment function: Id =
  • Government expenditures function: G =
  • Tax function: T =
  • Export function: EX =
  • Import function: IM =
  • The full employment level of national income is YFull employment = $5,000
  • The money market can be safely ignored for now.
  • Inflation is assumed to be non-existent.
  1. Determine the equation for the equilibrium level of national output(income), Y*. Show your work.
  2. Determine the equations for the following three multipliers: and and .

Suppose:
= 600 and = 500 and = 400 and = 100 and = 300 and = 200 and c = 0.75 and t = 0.20

  1. What is the value of Y* (rounded to 2 decimal points)?
  2. Graphically illustrate this equilibrium using the “Keynesian Cross” diagram.
  3. At Y*, is the government running a surplus or a deficit and of what magnitude?
  4. How could the government use fiscal policy via “G” to achieve full employment national output(income)? Be specific with your answer – that is, state by how much and in what direction G changes. Show your work.

Answers

Answers

2. Illustrated below is everything you need to know about the T-accounts for the Fed, the consolidated Commercial Banks, and one citizen (of many) named Eddy in a very small economy which uses the dollar($) as its currency. The required reserve ratio is 4%. The Fed’s discount rate is 3%. All OMO activity and loan activity in the economy is handled via demand deposits and all demand deposits stay in the banking system. Assume that commercial banks hold zero excess reserves and no vault cash.

Initial Position
Federal Reserve Bank(The Fed) / All Commercial Banks / Eddy
Assets / Liabilities+
Net Worth / Assets / Liabilities+
Net Worth / Assets / Liabilities+
Net Worth
Securities=$4000 / $80=Reserves / Reserves=$80 / $2000=DDp / DD=$150 / $0=Debts
$500=Currency / Loans=$1920 / $0=Net Worth / Securities=$50 / $240=Net Worth
$3420=Net Worth / Cash=$40
  1. What is the initial value of the money supply, M1?

FINAL Position for part (c)
Federal Reserve Bank(The Fed) / All Commercial Banks / Eddy
Assets / Liabilities+
Net Worth / Assets / Liabilities+
Net Worth / Assets / Liabilities+Net Worth
Securities= / =Reserves / Reserves= / =DDp / DD= / $0=Debts
=Currency / Loans= / $0=Net Worth / Securities= / $240=Net Worth
$3420=Net Worth / Cash=
  1. Suppose theFed decides to purchase $25 worth of securities from Eddy. In the end, by how much will the money supply have changed and in what direction as a consequence of this open market operation?
  2. Fill in all the missing values in the T-accounts.
  3. How would your answers to part (b & c) change if Eddy insisted the Fed pay him in newly printed currency/cash, which he would then keep in a vault in his house behind a picture of Alexander Hamilton?

FINAL Position for part (d)
Federal Reserve Bank(The Fed) / All Commercial Banks / Eddy
Assets / Liabilities+
Net Worth / Assets / Liabilities+
Net Worth / Assets / Liabilities+Net Worth
Securities= / =Reserves / Reserves= / =DDp / DD= / $0=Debts
=Currency / Loans= / $0=Net Worth / Securities= / $240=Net Worth
$3420=Net Worth / Cash=

3. Suppose the following information for the economy of Bennsylvania which uses the dollar ($) as its currency. Money supply is completely determined by the Fed. Assume all banks operate at zero excess reserves and that all money stays in the banking system as demand deposits of the public. There is no currency in circulation.
Currently:

  • Y*=$300,000 and YFE=$312,000
  • The investment multiplier is 4.00
  • The desired investment function is Id=10,000-10,000rwhere r is the interest rate (in decimal form)

Assume the following money market equations:

  • Money demand = MD = 9,000 –5,000rwhere r is the interest rate (in decimal form)
  • Total Reserves of the entire commercial banking system = 1,000
  • The required reserve ratio for the commercial banking system = rrr = 16%. = .16
  1. What is the current value of the money supply?
  2. Given the money supply, what is the current equilibrium interest rate?
  3. Given the current equilibrium interest rate, how much is Id?
  4. If the Fed wants to get the economy to YFE, by how much and in what direction would investment need to change via monetary policy?
  5. In order to achieve full employment output, should the Fed buy or sell securities?
  6. How many dollars of securities should the Fed either buy or sell (based on your answer above)?
  7. What is one reality wrinkle that could make The Fed’s impact on the economy weaker than this model predicts?

Answers

Answers

Econ 1120 Fall 2016 PRELIM 2 Answers

[1]. C. Aggregate desired expenditure is . However, only $1200 is actually produced. The economy is not in equilibrium and there will be an undesired fall in inventory.

[2]. B. A parallel shift upwards of the entire consumption function implies that consumption increases for any given income level. (A) Change in marginal propensity of consumption will change the slope of the consumption function. (B) A cut in the exogenous component of the tax function has the same effect as increasing autonomous consumption. (C) If income changes then consumption level moves along the line. (D) Increase in government expenditure would cause either shift downward (because of increase in interest rate) or moves along the curve (because of increase in income)

[3]. Set Y=C+I+G

=100+0.8Yd+200+500

=100+0.8(Y-T)+200+500

=100+0.8(Y-200)+200+500

=640+0.8Y

So 0.2Y=640

Y=3200

[4]. A. The fall in G decreases aggregated desired expenditure. Originally, aggregated desired expenditure is equal to Y. Now the desired expenditure is smaller. Therefore, there will be an unplanned/undesired increase in inventory.

[5]. B. When the closed economy is in equilibrium. From the table, the equilibrium aggregate output is . (A) The equilibrium aggregate output is not necessarily equal to . (C) The economy has inflationary pressures when. (D) Since G = 400 > T = 100 the economy is running a budget deficit. (E) If the economy is in equilibrium there is no unplanned change in inventories.

[6]. D. The balanced budget multiplier is 1. Current Y*=$3000. You need to get to YFE=$4000. So the needed change in Y*=1000. To get this with a balanced budget policy you would both increase T and increase G by $1000.

[7]. B. Graphing the saving and investment functions, it can be seen that, when the saving function shifts upwards, equilibrium savings will decrease.

[8]. D. Savings accounts are not liquid enough to be counted in M1. They are however counted in M2.

[9]. E. Money multiplier without excess reserve is 10 = 1/0.1 = 1/rrr. Although $10 million is given to the public from the Fed, only $8 million is subject to money creation because $2 million is held as cash. Therefore maximum increase in money is .

[10]. B. Money creation can be triggered only when people keep their money as demand deposit (so that bank can lend money to other people). If everyone hold money as currency, monetary policy would become less effective.

[11]. B The Fed can decrease the money supply by 1) increasing the reserve required ratio 2) increase the discount rate and 3) sells government securities.

[12]. B. Suppose money demand depends on interest rate, price level, and income level. If the Fed sells government securities to the public, money supply decreases and interest rate rises. Consequently, cost of investment becomes higher so that planned investment declines. Since Y = C + I + G (if the economy is closed) Y will also decrease and at the end money demand will decrease because income level falls.

[13]. A. The fiscal policy crowding-out effect is small when investment is insensitive to interest rate. We don’t talk about any monetary crowding out effect. If the investment curve is steep, then monetary policy (either expansionary or contractionary) is weak, since the change in the interest rate that comes from changing the money supply has very little impact on investment and so very little impact on Y*.

[14]. C. The expansionary monetary policy tends to increase Y and C while decreasing r and increasing I. The contractionary fiscal policy will decrease both Y and C and decrease r leading to an increase in I. Putting it together we know r will fall, I will rise and the jury is out on Y and C.