ECON 2000 Intermediate Macroeconomics Midterm Exam

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Department of Economics
Intermediate Macroeconomics I
2022 Winter
Assignment 1. Due at 6:00 pm on February 11 2022
Total 2 pages with 7 questions
Note: Students should show the step-by-step answers to the questions above. If only final
answers were provided, no marks will be counted for the question.
Question 1. (12 points, 3 points each)
Table 1: Quantity Consumed and Price of Good
Base Year
Later Year
Price of good A
100
200
Quantity of good A
100
200
Price of good B
100
100
Quantity of good B
100
100
In the table above, the citizens of country XYZ come to desire more of good A. As a result, the
quantity and price of the good both rise.
a. Compute nominal GDP in the base year and later year. (3 points)
b. Compute real GDP in the base and later years (in base-year prices). (3 points)
c. Compute the GDP deflator in the later year, using your answers to parts a and b. (3
points)
d. Compute a fixed-weight price index (for example, CPI) for the later year, using the
base-year quantities as weights. (3 points)
Answer:
a.
Base-year nominal GDP = 20,000.
Later-year nominal GDP = 50,000.
b.
Real GDP in base year = 20,000.
Real GDP in later year = 30,000.
c.
GNP deflator in later year = 1.667.
d.
Fixed-weight index = 1.50.
Question 2 (16 points, 4 points each). Assume that GDP (Y) is 5,000. Consumption (C) is given
by the equation C = 1,000 + 0.3(Y – T). Investment (I) is given by the equation I = 1,500 – 50r,
where r is the real interest rate in percent. Taxes (T) are 1,000 and government spending (G) is
1,500.
a. What are the equilibrium values of C, I, and r?
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b.
c.
d.
What are the values of private saving, public saving, and national saving?
Now assume there is a technological innovation that makes business want to invest
more. It raises the investment equation to I = 2,000 – 50r. What are the new
equilibrium values of C, I, and r?
What are the new values of private saving, public saving, and national saving?
Suppose a government moves to reduce a budget deficit.
Question 3 (12 points). A. Using the long-run model of loanable funds market developed in Chapter 3,
graphically illustrate the affect of reducing a government’s budget deficit by increasing (lump-sum) taxes
on household income. In the question, we assume that saving does not depend on interest rates. Be
sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction curves shift
v. the terminal equilibrium values.
b. State in words what happens to:
i. the real interest rate
2
ii. national saving
iii. investment
iv. consumption
v. output.
a.
b.
i. real interest rate decreases
ii. national saving increases
iii. investment increases
iv. consumption decreases
v. output is unchanged, fixed because it is determined by the factors of
production
Question 4 (10 points). Assume that the demand for real money balance (M/P) is M/P = 0.6Y-100i,
where Y is national income and i is the nominal interest rate. The real interest rate r is fixed at 3 percent
by the investment and saving functions. The expected inflation rate equals the rate of nominal money
growth. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P
be?
Question 5 (12 points, 6 points each). Consider a money demand function that takes the form
(M/P)d = Y/(3i), where M is the quantity of money, P is the price level, Y is real output, and i is
the nominal interest rate (measured in percentage points).
a. What is the velocity of money if the nominal interest rate is constant?
3
b. How will the level of the velocity of money change if there is a permanent (one time)
increase in the nominal interest rate, holding other factors constant? Explain your answer
based on the relationship between money demand and the nominal interest rate.
Answer: a. MV=PY, then V = PY/M = 3i
b. A one-time increase in the nominal interest rate will increase velocity by reducing the
demand for money. Money demand depends negatively on the nominal interest rate i, i is the
opp. cost of holding money. An increase in the nominal interest rate represents the increase in
the opportunity cost of holding money rather than bonds, and would motivate the typical
consumer to hold less of his/her wealth in the form of money, and more in the form of bonds
(or other interest-earning assets).
Question 6 (18 points). An economy begins in long-run equilibrium, and then a change in government
regulations allow banks to start paying interest on chequing accounts. Recall that the money stock is the
sum of currency and demand deposits, including chequing accounts, so this regulatory change makes
holding money more attractive.
a. How does this change affect the demand for money (5 points)?
b. What happens to the velocity of money (6 points)?
c. If the central bank keeps the money supply constant, what will happen to output and prices in
the short run and in the long run (7 points)?
Answer:
a. Interest-bearing checking accounts make holding money more attractive. This increases the
demand for money.
b. The increase in money demand is equivalent to a decrease in the velocity of money. Recall the
quantity equation
M/P = kY,
where k = 1/V. For this equation to hold, an increase in real money balances for a given amount
of output means that k must increase; that is, velocity falls. Because interest on checking
accounts encourages people to hold money, dollars circulate less frequently.
c. If the Bank of Canada keeps the money supply the same, the decrease in velocity shifts the
aggregate demand curve downward, as in Figure 9–6. In the short run when prices are sticky, the
economy moves from the initial equilibrium, point A, to the short-run equilibrium, point B. The
drop in aggregate demand reduces the output of the economy below the natural rate. Over time,
the low level of aggregate demand causes prices and wages to fall. As prices fall, output
gradually rises until it reaches the natural-rate level of output at point C.
4
Question 7. (20 points) Using the models learned in class, graphically illustrate and explain the
impact of the following policy and explain your answer.
Suppose the Bank of Canada reduces the money supply by 5%.
a. (6 points) What happens to the aggregate demand curves?
b. (7 points) What happens to the level of output and the price level in the short run and in
the long run?
c. (7 points) What happens to the real interested rate in the short run and in the long run?
Answer:
5
6
c.
7
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ECON 2000
Intermediate Macroeconomics
Midterm Exam Winter 2022
Short-answer questions
Note: You should show your step-by-step answers to the questions below. If only final
answers were provided, no marks will be counted for the question.
Question 1. (9 points) Suppose City A has the following values in its labour market.
Adult population = 50 million, the number of the unemployed = 2.5 million, and the number of the
employed = 35 million. What are the values of the following indicators?
a. (3 points) The labour force
b. (3 points) The unemployment rate
c. (3 points) The labour force participation rate
Question 2. (6 points) The overall level of prices in an economy can be measured by either
consumer price index (CPI) or the GDP deflator. What are the differences between these two
indicators?
Question 3 (11 points). Suppose an economy has the following Cobb-Douglas production function
Y = AK a L1-a
where ? = 0.3, A represents the level of technology, K = the level capital and L = the level of
labour.
What are the shares of total income for the owners of capital (K) and the owners of labour (L)?
What is the economic profit in the economy?
Question 4 (21 points) Consider a competitive economy in which factor prices adjust to keep the
factors of production fully employed and the interest rate adjusts to keep the supply and demand for
goods and services in equilibrium. The economy can be described by the following set of equations:
Production function: Y = AKa L(1 – a)
Income:
Y=C+I+G
Consumption:
C = C(Y – T)
Investment:
I = I(r)
where Y is income, K is capital, L is Labour, C is consumption, I is investment, G is government
spending, T is taxes paid, and r is interest rate.
Now suppose the government increases government spending (G).
a. (9 points) How does the increase in government spending, holding other factors constant, affect
the level of public saving, private saving, and national saving?
b. (12 points) Using the long-run model of the economy developed in Chapter 3, graphically
illustrate the impact of the increase in government spending. Be sure to label the axes, the curves,
the initial equilibrium values, the direction curves shift, and the terminal equilibrium values. State
in words what happens to (1) the real interest rate; (2) investment; (3) consumption; (4) Total output
Page 1
Question 5. (16 points) Suppose a country has a money demand function (M/P)d = kY, where k is a
constant parameter. The money supply grows by 12% per year, and real income grows by 4% per
year.
a. What is the average inflation rate? Explain. (5 points)
b. How would inflation be different if real income growth were higher? Explain. (5 points)
c. What is the velocity of money in the economy? Explain. (6 points)
Question 6. (18 points) Suppose that an economy is initially in long-run equilibrium. Assume that
the aggregate demand curve is Y = 3(M/P) and M = 2,000. The long-run aggregate supply curve is
vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 2.0.
a. If M decreases to 1,000, what are the short-run values of P and Y? (4
points)
b. Once the economy adjusts to long-run equilibrium at M = 1,000, what
are P and Y? (4 points)
c. Use a chart with curves of aggregate demand and aggregate supply
(both short run and long-run aggregate supply curves) to show the
impact of the increase of M on P and Y. (10 points)
Question 7. (19 points). Answer the following two questions related to the 1970s oil shock (oil
prices rose significnalty). Please illustrate and explain your answers by using figures with
aggregate demand and supply curves.
a. (10 points). Use aggregate demand and supply models to examine the impact of the 1970s
oil shock on output and the price level in both the short run and the long run.
b. (9 points). If the cenrtral bank used monetary policy to combat the effects of the oil
shock, should the central bank increase or decrease money supply? Use aggregate demand
and supply models to examine the impact of this stabilization policy on the price level and
output.
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