Econ 1120 – INTRO MACRO –Fall-2011 –November 9, 2011
Make-Up PRELIM #2 (Wednesday)
PRINT YOUR NAME: ______Your C.U. Netid: ______
YOUR C.U. STUDENT NUMBER: ______
Check YOUR TA’s NAME:
______TA= Minwook Kang (Tuesday sections)
______TA= Mirinda Lee Martin (Wednesday sections)
______TA= Lingwen Zheng(Thursday sections)
______TA= Yu Zhang (Friday sections)
INSTRUCTIONS:
There are two sections in this exam
- Part I: 15 multiple choice questions @ 3 points each
- Part II: 2 short answer question (17 points) + 2 Newspaper Articlequestions (19 points for each)
- ANSWER ALL QUESTIONS. TOTAL POINTS = 100. TOTAL TIME = 90 minutes.
- Prelim2 score weights 27.5% of final grade.
- Please write down your answers in different exam books with following order.
- Multiple choice questions in exam book1.
- Short Essay 1 in exam book2
- Short Essay 2 in exam book3
- Long Essay 1 in exam book4
- Long Essay 2 in exam book5
AGAIN, please….
PRINT YOUR NAME: ______Your C.U. Netid: ______
YOUR C.U. STUDENT NUMBER: ______
______TA= Minwook Kang (Tuesday sections)
______TA= Mirinda Lee Martin (Wednesday sections)
______TA= Lingwen Zheng(Thursday sections)
______TA= Yu Zhang (Friday sections)
GRADING------
______/45(mc) ______/17(short essay 1) ______/19(long essay 1) ______/19(long essay 2)
TOTAL: ______/100
------
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Part I: Multiple Choice.
Refer to the following graph and answer the following 3 questions.
- If the economy is at Point C but policy makers think that it is at Point B, this is
a)response lag
b)implementation lag
c)recognition lag
d)none of above
e)all of above
- If policy makers decide on a policy at point t3 but it does not affect the economy until period t5, then the policy choice is likely to be
a)destabilizing
b)stabilizing
c)optimal
d)automatically stabilizing
- Increasing taxes as a response to growing deficits during a recession is an example of
a)an automatic destabilizer
b)an automatic stabilizer
c)discretionary economic policy
d)response lags
e)none of the above
- Under the classical view of the labor market, what must be true about the unemployment level?
a)It is always zero
b)It is sometimes positive and sometimes zero depending on the state of the economy
c)It is always positive
d)Not enough information to define
- Suppose that at the current interest rate, there is an excess supply of money. Given this information, we know that there will be pressure for
a)bond prices to decrease and the interest rate to increase.
b)bond prices to decrease and the interest rate to decrease.
c)bond prices to increase and the interest rate to increase.
d)bond prices to increase and the interest rate to decrease.
e)the money demand function to shift to the right.
- When wage rates rise, the income effect suggests that people will work____ and the substitution effect suggests that people will work_. (B)
a)more; less
b)less; more;
c)more; more
d)less; less
e)Answers are dependent on personal preference.
- The effects of government intervention on household consumption and labor supply (assuming the substitution effect dominates):
An income tax rate ______will cause consumption to ______and labor supply to ______; Meanwhile, a(n) ______in transfer payments will cause consumption to ______
a)Increase; Decrease; Decrease; Decrease; Decrease
b)Decrease; Increase; Increase; Decrease; Increase
c)Decrease; Increase; Decrease; Increase; Increase
d)Increase; Decrease; Increase; Increase; Increase
- The aggregate demand curve _____ a market demand curve _____ it _____ the sum of all market demand curves in the economy.
a)is not; and; is not
b)is; and; is
c)is; but; is not
d)is not; but; is
e)none of the above
- Wages might be “sticky” – fail to adjust instantaneously to changes in the economy – for which of the following reasons?
a)Unions refuse to let wages drop.
b)An implicit understanding exists between firms and workers that firms will not do anything to harm workers relative to other workers in the same industry.
c)Because the economy changes all the time, firms have only imperfect information and may set wage rates too high or too low.
d)All of the above are explanations for why wages might be “sticky”.
- In 1979, people encountered the second oil crisis, which can be considered as negative supply side shock, and a financial “tsunami” happened in 2008, which might be thought of as a negative demand side shock. Based on the model, the price level would ____ during oil crisis and ____ during the financial tsunami; the output level would ____ during the oil crisis period and ____ during the financial tsunami.
a)decrease; decrease; decrease; decrease
b)increase; decrease; decrease; decrease
c)increase; increase; decrease; decrease
d)None of the above
- Which of the following statements about social security is false?
a)It is a pay-as-you-go system
b)It is a defined-benefit pension
c)Social security beneficiaries do not need to pay the tax.
d)The revenue source of Social Security is mainly from payroll taxes.
e)Both a and b
f)Both c and d
- Monetary policy is most likely to result in inflation when the aggregate supply curve is
a)vertical and the Fed lowers the discount rate.
b)vertical and the Fed raises the reserve requirement.
c)horizontal and the Fed sells securities.
d)horizontal and the Fed lowers the reserve ratio.
Refer to the following figure and answer the following 2 questions.
- If the economy is currently at Point B then
a)the economy is operating above full employment
b)the price level is likely to rise
c)aggregate supply shifts to the left and the economy ends up at Point A
d)all of the above
e)none of the above
- If the economy is at point C and the Fed increases money supply, the economy will move to Point __ in the short run and to Point __ in the long run.
a)C;C
b)A;A
c)B;A
d)A;C
15.If the long-run aggregate supply curve is vertical, which of the following can affect the long run output?
a) Government’s fiscal policy
b) Fed’s monetary policy
c) Technology improvement
d) Increase of Population
e) Both a and b
f) Both c and d
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Part II: Short Answer questions. 17 points
1.Phillips Curve (11 points)
a)Draw the Short-Run and Long run Phillips curves(5 points)
b)Please use a graph of aggregate supply and aggregate demand to illustrate why before 1970s the short run Phillips curve demonstrated the positive (or negative) relationship between the inflation rate and the unemployment rate.(6 points)
2.Theory of consumption(6 points)
What is the key difference between Keynesian theory of consumption and the life-cycle theory of consumption?
Part III: Long Answer questions (Newspaper Analysis)
1.Government Deficit(19 points)
According to the article, US gov't runs $1.3 trillion budget deficit in 2011, from the Yahoo Finance News on Oct. 14, please answer the following questions.
WASHINGTON (AP) -- The government ran a $1.3 trillion deficit for the budget year that ended last month, the third straight year it has operated more than $1 trillion in the red…….
Lawmakers are under pressure to agree by Thanksgiving on where they can cut $1.2 trillion over the next decade. If they cannot, automatic cuts to Medicare, defense spending and other critical areas of the budget would go into effect in Jan. 2013.
Total (tax) revenues increased 6.5 percent to $2.3 trillion for the budget year that ended Sept. 30; spending rose 4.2 percent to $3.6 trillion. (in last budget year)
The nation's debt is now $14.8 trillion. The enormity of that figure has stoked intense partisan debate in Congress over spending and taxes. Polls show growing voter anger with the inability of both parties to reach solutions to the country's budget problems.
Administration officials said Friday that Congress needs to reach an agreement through the supercommittee process but also should approve President Barack Obama's $447 billion jobs plan. But the measure fell short of gaining the 60 votes required to be called up for debate in the Senate.All 46 Republicans in the chamber opposed the measure, which seeks to pay for the plan by boosting taxes on the wealthy and corporations.
As members of the supercommittee deliberate in secret, party leaders have jousted in public over their conflicting priorities. For Republicans, that means no tax increases. For Democrats, it means no curbs on popular entitlement programs, such as Medicare, without tax increases.
The August budget deal is projected to trim future deficits by $2.1 trillion. That includes the cuts made by the supercommittee and another $900 billion in savings from caps on discretionary spending.
a)Assuming the marginal propensity to consume is 0.5, what amount of total GDP is created by government spending last budget year? For a dollar of government spending, how much did the US government need to borrow last budget year? (6 points)
b)Automatic cuts will go into effect in 2013, if lawmakers do not reach agreement about where to cut $1.2 trillion over the next decade. Deficit targeting policy is generally considered as auto destabilizer.Please use graph of aggregate demand and supply to illustrate why. (6 points)
c)Now you are told that marginal propensity to consume of the unemployed is 0.9 and 0.2 for the wealthy, and the government decides to charge a lump sum tax on wealth. What is the possible effect if the government increases taxes on the wealthy by 2 billion and spends 1 billion hiring previously unemployed workers? (7 Points)
2.Social Security (19 points)
According to the article, Social Security to hand out first raises since '09, from Yahoo Finance Newson Oct. 18, please answer the following questions.
WASHINGTON (AP) -- Social Security recipients will get a raise in January -- their first increase in benefits since 2009. It's expected to be about 3.5 percent.
…..
Monthly Social Security payments average $1,082, or about $13,000 a year. A 3.5 percent increase would amount to an additional $38 a month, or about $455 a year.
Most retirees rely on Social Security for a majority of their income, according to the Social Security Administration. Many rely on it for more than 90 percent of their income.
Mark Zandi, chief economist at Moody's Analytics, said the COLA (Cost of Living Adjustment) would give a boost to consumer spending next year, amounting to about $25 billion in government support, or 0.2 percent more economic growth, if beneficiaries spend it all. ……
……
Federal law requires the program to base annual payment increases on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Officials compare inflation in the third quarter of each year -- the months of July, August and September -- with the same months in the previous year.
If consumer prices increases from year to year, Social Security recipients automatically get higher payments, starting the next January. If price changes are negative, the payments stay unchanged.
"We're very concerned about that," said Web Phillips of the National Committee to Preserve Social Security and Medicare. "I think that what this illustrates is the dangers of trying to make Social Security policy in the context of deficit reduction."
a)Please use two consumption theories to explain why the retirees probably consume all or most of income from social security every year. (6 points)
b)In 1980s we had an oil crisis, and had a finance caused crisis in 2008. If the oil crisis is considered to be a supply side cost shock, and the 2008 crisis is a demand side cost shock, what do you expect about price level change tight after each of these 2 shocks? (6 points)
c)Basing on the mechanism of how Social Security payments are designed to reflect price changes (i.e. the cost of living adjustment or COLA), is it an auto stabilizer when recession happens? (7 points)
MC qution
(1) c
(2) a
(3) a
(4) a
(5) d
(6) b
(7) a
(8) a
(9) d
(10) b
(11) c
(12) a
(13) d
(14) c
(15) f
Short essay 1
Answers) In the figure, as the aggregate demand curve is shifting outward, both the inflation rate and economic output are increasing on the fixed aggregate supply curve. With the assumption that unemployment is negatively related with economic output, we can conclude that the unemployment rate and the inflation rate are negatively related. Students should be able to show this with shifts of the curves and to explain it verbally.
Short essay 2
Answer: life-cycle theory suggests that consumption and saving decisions are mainly based not only on current income but also on expectations of future (lifetime) income. However, Keynesian consumption theory think people’s consumption decision is mainly based on current income.
Long essay1
(a)
Given 3.6 (trillion) government spending and multiplier is (1/0.5)=2, the GDP created by government spending is 7.2 trillion. The deficit is 1.3 (trillion), so, for each dollar of government spending, US government need to borrow 1.3/3.6=0.361 dollars.
(b)
It is because, as the economy is in recession, income and tax revenue decrease. In the first graph, if we have supply side shock, then AS_0 will shift to AS_1. Or if demand side shock arrives,AD_0 will shift to AD_1. No matter recession is caused by demand side or supply side shock, income decreases in recession and thus deficit increases. If deficit targeting policy is enforced to reduce the deficit by decreasing government spending(or by increasing tax), then the AD curve will shift to the leftfurther. As indicated above, AD_1 shift to AD_2 in second figure. Hence income will decrease further by deficit targeting policy.
Conversely, if the economy is booming, a tax increase reduces the deficit, and thus deficit targeting policy allows more government spending and makes the AD curve shift to the right with higher output. Therefore deficit targeting policy amplifies the fluctuation of business cycle and is a destabilizer.
(c)
Intuitively, we shift the income from the wealthy to the poor. If we are only considering the multiplier effect, the output decreased owing to the tax on rich people is smaller than increased output created by job creation because of the different propensities to consume.
We can set up a simple economic model for this question and split the consumption in to 2 groups.
(Assume the tax is a lump sum tax, Tp and Tr, for poor and the rich. And there are two groups of consumption. Portion of the rich and the poor is 0.5 and 0.5.)
(In this question we do not need students to set up the model and should grade based on their reasoning.)
Consumption of the poor= C1 + 0.9*(Y-Tp)
Consumption of the rich = C2 + 0.2*(Y-Tr)
Y= 0.5(C1 + 0.9*(Y-Tp)) + 0.5(C2 + 0.2*(Y-Tr)) + I+G
Then the final equilibrium is
Y*=1/(1-0.5*0.9-0.5*0.2)*(0.5C1+0.5C2-0.5*0.9Tp-0.5*0.2*Tr+I+G)
So the government expanding multiplier is , 1/(1-0.5*0.9-0.5*0.2)=2.22
The Tax Multiplier for rich is -(0.5*0.2)//(1-0.5*0.9-0.5*0.2)=0.22
So 2 billion tax on the rich will decrease 2*(0.22)=- 0.44 billion GDP.
And 1 billion government spending on the poor will increase 1*(2.22)= (2.22)billion GDP.
So finally GDP increase by (2.22-0.44) = 1.78 billion, while we can have 1 billionin government surpluses.
Long essay2
- According to Keynesian consumption theory, people’s current consumption depends on current income such that it is not surprising that retirees spend all income from SS. As for the life cycle consumption theory, people have rational expectations and will plan to smooth their consumption over their lifetimes. They know they will earn more when they are of working age (before they retire), and, to smooth their consumption they will save before retiring, and consume those savings with SS income after retirement. So from the perspective of life time cycle consumption theory retirees will also spend all income from SS, particularly since it is paid out in equal installments each month for the rest of their life, so that by consuming all of it each month they are in fact selecting the smoothest consumption profile.
- Because the supply shock shifts the AS curve to left, we can expect price level to increase. On the other hand, a demand side shock shifts the AD to left, so it is expected that the price level decreases in the 2008 crisis.
- Yes. When people encounter a supply shock recession, output will decrease and prices will increase. The increase in SS payment shifts AD to right and alleviates the decrease of income. On the other hand, when we are in a recession where the price level goes down, the SS payment remains the same so that it won’t make AD shift to left and worsen the recession. Therefore the mechanism designed is auto stabilizer.
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