Hankamerschool of Business

BaylorUniversity

HankamerSchool of Business

Economics 3307

Macroeconomic Analysis

Fall 2002

Study Guide for Exam 1

Exam 1 will be given during regular class hours on Tuesday, October 3. I will provide blue books for your answers. You should bring pencils and/or pens.

Relevant material for the exam is in Chapters 1-5 of the Mankiw textbook. The questions on the exam will all be short essay questions. The questions will resemble the study questions over Chapters 1-5 that are posted to my web site (including the questions in the Study Guide and the End-of-Chapter questions).

Only material covered in class, and applications of that material, are directly relevant for the exam. This means that you DO NOT need to study carefully material in the textbook that was not mentioned in class (such as the material on the Cobb-Douglas production function on pp. 71-73). If you are uncertain as to whether material is relevant, e-mail me to ask about it.

The exam will consist of 10 short-essay type questions.

I will have office hours next week as follows:

Wednesday, October 2:1:30pm – 3:30pm

Thursday, October 3:9:00am – 11:00am; 1:00pm – 1:45pm

Here are some questions (sample answers follow) from recent exams:

1.(10 points) Explain how it is possible for Nominal GDP to be rising when the economy is in a recession.

2.(10 points) Explain how it is possible for the unemployment rate to rise at the same time the Real GDP is rising.

3.(10 points) U.S. Real GDP grew about 3.5% in the year 2000, while U.S. population grew about 1%. What was the growth rate of real income per person in the U.S. during the year 2000? Explain.

4.(10 points) Suppose workers in Germany earn higher real wages than workers in South Korea. Based on the material we have studied in Chapter 3, describe two possible explanations for this difference.

5.(10 points) President Bush is proposing a significant tax decrease. What are the likely implications of this policy for the real interest rate and investment spending? Explain.

6.(10 points) Since World War II, the average inflation rate in Italy has been much higher than the average inflation rate in Switzerland. Explain the cause of this difference. Your answer should refer to the equation of exchange.

7.(10 points) Suppose an innovation in the financial system (such as online banking and brokerage services) creates an exogenous decline in money demand. Explain the long-run implications of this change for the price level (P).

8.(10 points) Suppose that for many years inflation has been high in Thailand and low in Japan. Suddenly inflation in Thailand falls to a level equal to that in Japan. What are the implications of this change in inflation for the nominal exchange rate between the Thai Baht and the Japanese Yen? Explain.

9.(10 points) Suppose Brazil is running a large trade deficit. What does this fact imply about net foreign investment in Brazil? Explain.

10.(10 points) Suppose the U.S. Congress passes a large tax cut. What are the long-run implications for U.S. Net Exports, the U.S. real exchange rate, and the U.S. real interest rate? Explain.

Brief Sample Answers

1.In a recession Y is falling. If P is rising at a faster rate (in percentage terms) than Y is falling, Nominal GDP (which is equal to P·Y) will be rising.

2.According to Okun’s Law, the unemployment rate will rise if Real GDP is growing at a rate less than 3%.

3.GDP per person is Y/POP. The growth rate of Y/POP is approximately the growth rate of Y minus the growth rate of POP, which is 3.5%-1.0% = 2.5%.

4.Real wages can be higher because German workers are more productive (hence a demand curve for labor farther to the right), or because labor is more scarce in Germany (hence a supply curve for labor farther to the left).

5.A tax decrease reduces government savings (T-G) and overall savings (S). In the S,I graph, the S curve shifts left, which increases the real interest rate [r]. The higher r causes I to fall as the economy moves up and to the left along the I curve.

6.MV=PY. On average over long periods of time, sustained and substantial rises in P are caused by sustained and substantial rises in M. If V and Y are relatively constant, M is the primary determinant of P. Thus Italy had higher money growth than Switzerland.

7.MV=PY. If money demand falls, people don’t hold on to money as long before spending it. This makes velocity (V) rise. Given that Y is determined by F(K,L), and assuming M is constant, the rise in V causes P to rise.

8.Dynamic PPP says that the percent change in the nominal exchange rate is equal to the inflation differential. When Thai inflation exceeds Japanese inflation, the Thai Bhat loses value against the Japanese yen. If inflation in Thailand falls to equal that in Japan, the Bhat will stop losing value and stabilize against the yen. NOTE: According to dynamic PPP, the Bhat WILL NOT GAIN VALUE against the yen – it will only stop losing value.

9.A trade deficit implies NX < 0. Net foreign investment NFI = S-I. But NX = S-I = NFI, so we know NFI < 0. Brazil must have negative net foreign investment equal in value to the negative net exports.

1. The US is a large open economy. We must answer the question assuming the US is closed and assuming the US is a small open economy, then average the two answers.

The tax cut reduces S. In a closed economy, the S curve shifts left, r rises, and I falls.

In a small open economy, a reduction in S has no effect on r or I. NX and NFI fall, and the decline in NFI causes the real exchange rate () to rise.

Thus the net effects are as follows:

-r rises and I falls, but by less than in a closed economy

-NX and NFI fall, but by less than in a small open economy

- rises, but by less than in a small open economy.