ECO 302Name: ______
Spring 2003
Midterm #2 ID #: ______
Part I: Instructions: Write your answers in the spaces provided. Show your work whenever possible. Use the back of the pages if necessary.
Suppose the small, open economy of Country A is described by the following equations:
Yc = current income = 36
Yf = expected future income = 40
Cd = current desired consumption = (0.5)·[YDc + YDf] – 100·r
YD = disposable income = Y - T
Tc = Tf = taxes (c for current, f for future) = 20
Gc = Gf = government spending (c for current, f for future) = 20
Id = current desired investment = 4 + (0.2)·Yf – 100·r
rw = world real interest rate = .03
1.Fill in the blanks in the following table, and sketch in as accurately as possible the country's desired national savings and desired investment curves in the graph below:
If r = .02, then Id = ______.If r = .08, then Id = ______.
If r = .02, then S= ______.If r = .08, then S= ______.
The country's current account balance is ______.
2.Suppose the country's businesses decide to delay investment spending due to uncertainty in the economic environment, so the desired investment schedule becomes:
Id = -3 + (0.2)·Yf – 100·r. Show the impact of this change in the graph above.
3.Show the impact on the FE-IS-LM diagram of the change in desired investment in
question 2, assuming that markets will adjust rapidly.
4.Will the consumption function above satisfy the Ricardian Equivalence proposition? Explain briefly why you say it does or does not satisfy Ricardian Equivalence.
Instructions: Select the one best answer for each of the following questions. Record your final choice CLEARLY next to the questions.
1.Which variables are leading?
(i)stock prices
(ii)monetary growth
(iii) unemployment
a.only (i) and (ii) are true.
b.only (i) and (iii) are true.
c.(i), (ii), and (iii) are all true.
d.only (iii) is true.
e.only (i) is true.
2.We know a general equilibrium can always be attained in the IS-LM-FE diagram because:
a.changes in the money supply will cause the LM curve to shift automatically to where the IS and FE lines meet.
b.changes in the price level will cause the LM curve to shift to where the IS and FE lines meet.
c.changes in the real interest rate will cause the IS curve to shift to meet the LM and FE lines.
d.changes in the real wage will cause the FE line to shift to where the IS and LM curves meet.
e.none of the above.
3."Reverse Causation" is used to explain how a variable can be ______without being _____
a.leadinga cause of business cycle movement.
b.lagginga causeof business cycle movement.
c.leadingcounter-cyclical.
d.leadingan anticipation of business cycle movement.
e.none of the above.
4.Denmark is a small, open economy. Suppose its government passes a large tax cut, and that the Ricardian Doctrine does not correctly describe the reaction of Denmark's households to the tax cut. Because Denmark is small and not large, the tax cut has a ______effect on Denmark's current account surplus, and a ______effect on investment spending in Denmark than it would if Denmark were a large open economy.
a.larger positivelarger
b.smaller positivelarger
c.smaller negativesmaller
d.larger negativesmaller
e.none of the above
5.A shift to the right of the AS curve could be caused by:
(i)an increase in productivity (technology shock)
(ii)a tax decrease, if the Ricardian Doctrine is correct
(iii)a shift to the left of the money demand curve
(iv)a shift to the right of the desired investment curve
a.(iii) and (iv) are correct.
b.(i) and (iii) are correct.
c.(ii) and (iv) are correct.
d.(ii) and (iii) are correct.
e.only (i) is correct.
6.Every point along the AD curve represents a possible combination of ______where the ______markets are both in equilibrium.
a.price level and outputlevelslabor and product
b.real interest rates and price levelsasset and product
c.real interest rates and price levelsasset and labor
d.price level and outputlevelsasset and product
e.real interest rate and output levelslabor and product
7.In the Solow growth model, dynamic inconsistency is inefficient because:
a.the capital depreciation rate is higher than the savings rate in the steady-state.
b.households can increase both current and future consumption by reducing the share of income that is saved.
c.capital per worker is rising faster than the population growth rate.
d.a reduction of the population growth rate would allow for higher current consumption and higher future consumption.
e.none of the above.
8.If there is no long-run trend in interest rates, then the money market equilibrium equation says (after some calculus has been applied to it) that inflation will be equal to zero if:
a.the rate of money growth is equal to the growth rate of nominal GDP time the elasticity of money supply with respect to output.
b.the rate of money growth is equal to zero.
c.the rate of money growth is equal to the growth rate of real income times the elasticity of money demand with respect to real income.
d.the rate of money growth is equal to the elasticity of money demand with respect to real income.
e.none of the above.
9.The real business cycle theory of business cycles assumes that changes to the aggregate production function are the ultimate cause of business cycle movements. The basic real business cycle theory correctly predicts the direction of co-movement between output and ______, but incorrectly predicts the direction of co-movement between output and ______.
a.employmentaverage labor productivity
b.average labor productivityinvestment
c.real interest ratesreal wages
d.average labor productivityinflation
e.none of the above.
10.Suppose firms find output they had expected to sell accumulating in their warehouses as unsold inventories. It must also be true that:
a.the economy is operating at a point to the left of the IS curve.
b.the economy is operating at a point to the right of the FE line.
c.the labor market is not in equilibrium.
d.the economy is operating at a point to the left of the LM curve.
e.none of the above.
11.In the FE-IS-LM model (assuming markets always clear), which of the following statements about the effects of an increase in taxes will be true?
(i)The IS curve will shift to the right.
(ii)The increase in taxes will reduce desired consumption spending.
(iii)The price level will rise.
(iv)The change in taxes will be neutral.
a.only (i), (ii), and (iii) are correct.
b.only (i) and (iii) are correct.
c.only (ii) and (iii) are correct.
d.only (i) is correct.
e. none of the above.
12."Neutrality of money" means that changes in the money supply cause changes in:
a.real interest rates.
b.real GDP.
c.investment spending
d.the price level.
e.none of the above.
Output per workery=f(k)
y0
(n+)·k
k0Capital per worker
13.The graph above represents an economy according to the assumptions of the neoclassical (Solow) growth model. The economy begins at point F. If a natural disaster destroys half of the economy's physical capital, the effect on the graph would be shown as:
a.a downward shift of the f(k) line.
b.a shift upward of the (n+d) line.
c.a shift downward of the (n+d) line.
d.a movement of k0 to the left.
e.a shift downward of the s·f(k) line.
14.Which of the following possible causes for economic growth would fall under the category of "Total Factor Productivity"?
(i)investment in new capital
(ii)technological advance which improves productivity
(iii)increased labor force participation
(iv)error in measuring the amount of additional hours worked by some workers
a.only (ii) and (iii).
b.only (iv).
c.only (i).
d.only (i) and (ii).
e.only (ii) and (iv).
15.In the IS-LM-FE diagram, the effect of an increase in desired investment caused by more optimistic expectations of business opportunities is shown as:
a.a shift to the left of the FE line.
b.a shift to the left of the supply curve for real balances.
c.a shift to the right of the IS curve.
d.a shift to the right of the LM curve.
e.a shift to the right of the demand curve for real balances.
16.In the neoclassical (Solow) growth model, suppose countries A and B share the same initial capital/worker ratio, production function, population growth rate, and depreciation rate. (Assume this initial ratio is well below the steady-state level.) If country A has a higher savings rate than country B, then (compared to country B) country A:
(i)will have lower initial consumption/person.
(ii)will record faster growth of output per person.
(iii)will move towards a steady-state with more capital per worker.
a.only (ii) and (iii) are true.
b.only (i) and (iii) are true.
c.only (i) and (ii) are true.
d.all of the statements are true.
e.none of the above.
17.If the economy is operating to the right of the IS line, the ______market is not in equilibrium and there is ______.
a.productexcess supply of products
b.assetexcess demand for money
c.laborinvoluntary unemployment
d.assetexcess demand for non-monetary assets
e.laborexcess demand for labor
18.If a closed economy is operating at a point above i* [the interest rate at which real money supply Ms/P is equal to real demand for liquidity L(Y, i)], then the economy is operating ______and there is ______.
a.to the right of the LM curveexcess supply for money
b.to the left of the LM curveexcess supply of goods
c.to the right of the FE lineexcess demand for labor
d.to the left of the IS curveexcess supply of goods
e.none of the above.
19.A movement along the LM curve could be caused by:
a.a rise in the price level.
b.an increase in the money supply.
c.a change in households' desired portfolio allocation between money and non-monetary assets due to higher perceived risk of non-monetary assets.
d.a change in payments technology that makes it easier and cheaper to convert non-monetary assets into money.
e.none of the above.
20.When economic growth slowed down after 1973 in the USA and other developed countries, what was the predominant cause of the change?
a.stricter environmental standards for industry.
b.nobody really knows.
c.reduced investment in new capital.
d.deteriorating educational standards.
e.a slowing of population growth.
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