Sample Midterm Exam
ECON 204: Intermediate Macroeconomics
Total Marks: 50Time: 40 Minutes
PART A: (3X5 = 15marks)
Explain your answer analytically. Provide necessary diagrams, reasons, and references where applicable to complete your answers. There are four questions in this part.
a)Twin Deficit
-When both trade deficit and budget deficit occur
b)In a Speech that Senator Robert Kennedy gave when he was running for president of the United States in 1968, he said the following about GDP:
[It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to the country. It measures everything, in short, except that which makes life worth-while, and it can tell us everything about American except why we are proud that we are Americans.
Was Robert Kennedy right? If so, why do we care about GDP?
-Higher GDP still ensures better material life, which essentially supports things to perform better that Kennedy mentioned
c)What is the role of constant returns to scale in the distribution of income?
A production function has constant return to scale (CRS) if an equal percentage increasein all factors of production causes as increase in output of the same percentage. If the production function has CRS, then total income in an economy of competitive profit maximizing firms is divided between the return to labor (MPL.L) and return to capital (MPK.K). That is, under CRS economic profit is zero.
PART B (25 marks)
a. Consider an economy described by the following equations:
Y = 5,000G=1,000T=1,000
C=250+0.75(Y – T)
If , then what are the changes in national saving, investment, the trade balance, and the equilibrium exchange rate.
If G=1000, then C=3250, =1, S=750, NX=0, I = 750 and
When T=1,250, then C=3062.5, =0.625, S=937.5, NX=187.5, I = 750
So,
b. Illustrate your findings by using a diagram for a small open economy
c. Suppose V is constant, M is growing 5 percent per year, Y is growing 2 percent per year, and r = 4.
i. Solve for i
ii. If the Bank of Canada increases the money growth rate by 2 percentage points per year, find i
iii. Suppose the growth rate of Y falls to 1% per year. What will happen to ?
What must the Bank of Canada do if it wishes to keep constant?
i. = m – g = 5 – 2 = 3%
i = r + = 5 +3 = 7%
ii. When, m = 2%, = m – g = (5+2) – 2 =5%, i0 = r + = 4 +5= 9%
i = i – i0 = 2%,if there is no output growth increase in money supply will be translated into interest rate
iii. If the Bank of Canada does nothing, =1. To prevent inflation from rising, the Bank of Canada must reduce the money growth rate by 1 percent point.
d. Suppose that the expected inflation rate is 10 percent in the United States and 5 percent in Canada. The real interest rate is 3 percent in both countries, and assume the purchasing power parity holds. What are the expected changes in the real and nominal exchange rates?
Differences in inflation rates will lead to expected changes in the nominal exchange rate. The CAD/$ rate should decrease by the differential in expected inflation, which is 5 percent (5-10). The real exchange rate is not expected to change unless there is a fundamental change to savings, investment, or demand for net exports.
1 |Fall 2008