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Econ 1120 - INTRODUCTORY MACROECONOMICS
PRELIM #2 – Wissink - S2016 – April 14
________________________________________
Your LAST (FAMILY) NAME
____________________________________
Your First (given) name
Your NetId:_________________ Your Student Number:________________________________
Instructions and Exam Taking Policy:
There are two sections in this exam. Answer all questions.
Part I: 14 multiple choice questions @ 3 points each
Part II: 3 problems @ 19, 19, and 20 points each
Total Points = 100, Total Time = 90 minutes.
NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you
need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have,
raise your hand and wait for the proctor to come to you. Only one person can be out of the examination
room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.
NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”.
NO GRAPHING CALCULATORS.
NO BOOKS. NO NOTES. NO HELP SHEETS.
NO TALKING TO EACH OTHER.
Check the TA’s name for the section you regularly attend (that is, where you will pick up
your prelim):
DIS #
250, 251
252, 253
254, 255
256, 257
TA
Qilu Yu
Jose Lopes
Sujan Lamichhane
Nobu Kanazawa
Meeting Times
Location
M 8:00am-9:55am
Rockefeller 103
W 2:30pm-4:25pm
Baker Lab 119
F 9:05am-11:00am
Goldwin Smith G64
F 1:25pm-3:20pm
Rockefeller 102
One more time, please…
_____________________________________
Your LAST (FAMILY) NAME
_________________________________
Your First (given) name
Your NetId:_________________ Your Student Number:________________________________
GRADING
MC (out 42 points) =___________________
Q1 (out of 19 points) =__________________
Q2 (out of 19 points) =__________________
Q2 (out of 20 points) =__________________
TOTAL SCORE: =_____________________
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Part I: Multiple Choice. Do them ALL. Circle the letter for your answer.
1. For a simple frugal economy with no government and no
international trade, which one of the following statements is false?
A. At every level of aggregate output/income (Y), aggregate
desired expenditure equals consumption plus desired
investment.
B. At every level of aggregate output/income (Y), aggregate
output/income (Y) equals aggregate desired expenditure.
C. At every level of aggregate output/income (Y), aggregate
output/income (Y) equals consumption plus saving.
D. Saving is a leakage out of the spending stream.
E. If planned investment is exactly equal to saving, then aggregate
desired expenditure is exactly equal to aggregate
output/income (Y).
2. Suppose that the Norwegian economy can be characterized
completely by the following equations:
C = 100 + .8Yd; G = 500; T = 200; Id = 200. The equilibrium level
of output for the Norwegian economy is
A.
B.
C.
D.
E.
2,850.
3,200.
4,000.
4,800.
5,000
3. Given the Norwegian model above, at the equilibrium level of
output in Norway, saving equals
A.
B.
C.
D.
E.
630.
1,660.
850.
500.
0
4. The absolute value of the tax multiplier is smaller than the
government expenditure multiplier
A. because the federal government is bigger than the internal
revenue service.
B. because the immediate impact of an increase in government
expenditures adds fully into aggregate desired expenditures.
C. because people only pay their taxes on April 15.
D. because the immediate impact of a decrease in taxes adds fully
into aggregate desired expenditures.
E. because our tax system is progressive.
5. Refer to the table above for a closed economy. At an output
level of $2,400 billion, there is a tendency for aggregate
output(income)
A.
B.
C.
D.
E.
to fall.
to increase.
to remain constant.
to either increase or decrease.
to increase at an increasing rate.
Aggregate Output
(Y)
$3,000
$4,000
$5,000
$6,000
$7,000
$8,000
Consumption
$2,000
$2,800
$3,600
$4,400
$5,200
$6,000
Desired
Investment
$1,600
$1,600
$1,600
$1,600
$1,600
$1,600
6. Refer to the table above and assume there is no government and
no foreign trade in the model. If the economy is in equilibrium,
and desired investment increases by $100, then Y* will
A.
B.
C.
D.
E.
increase by $100.
decrease by $100.
increase by $500.
decrease by $500.
increase by $125.
7. Suppose the required reserve ratio is 10%. A $75 million cash
deposit into checking accounts at commercial banks of currency
currently held by people will allow commercial banks to
potentially create at most
A.
B.
C.
D.
E.
$675,000 in new money supply.
$6.75 million in new money supply.
$750 million in new money supply.
$675 million in new money supply.
$75 million in new money supply.
8. Consider Mistrustville. Its Fed has set its required reserve ratio,
rrr, at 15%. Suppose that when people in Mistrustville buy
securities from their Fed they pay for them with currency they
keep at home under their mattresses, since they do not trust the
commercial banks. As compared to an economy where everyone
keeps all their money as demand deposits in commercial banks,
and thus pays their central bank with their checking accounts, the
odd behavior of people in Mistrustville will tend to
A.
B.
C.
D.
E.
create inflationary pressures.
make monetary policy less effective.
make monetary policy more effective.
make fiscal policy less effective.
make fiscal policy more effective.
9. Susan offers you the following promissory note today: “I Susan
Soprano, promise to give you $1,000 two years from today.”
Suppose the current market interest rate is 4%. Which one of the
following is true?
A. Susan’s promise is worth less than $1000 today.
B. Susan’s promise is worth $1000 today.
C. Susan’s promise would be worth more today if the market
interest rate were 6% rather than 4%.
D. Susan’s promise would be worth more today if you received
the $1000 three years from today rather than one year from
today.
E. Susan’s promise is worth more than $1040 today.
10. Assume there are no leakages from the banking system and
that all commercial banks are fully loaned up. The required
reserve ratio is 16%. If The Fed sells $5 million worth of
government securities to the public, the change in the money
supply will be
A.
B.
C.
D.
E.
+31.25 million
-$16 million.
-$31.25 million.
-$80 million.
-$26.25 million.
11. Consider the typical model of an economy where there is a
goods and services market and a money market. Suppose the
desired investment curve is very interest rate sensitive. In such an
economy
A.
B.
C.
D.
the fiscal policy crowding-out effect is small.
the fiscal policy crowding-out effect is large.
monetary policy is extremely ineffective.
reducing the money supply will have a big impact on Y*,
whereas increasing the money supply has very little impact on
Y*.
E. there is no feedback effect with either monetary or fiscal
policy.
12. Refer to the figure on the right: _____________ ,
ceteris paribus, will likely decrease the equilibrium
interest rate without changing equilibrium money
holdings.
A.
B.
C.
D.
E.
An increase in money demand
A decrease in money supply
An increase in aggregate Y
A decrease in aggregate Y
An increase in money supply
13. Refer to the figure for the previous question: If the interest
rate is currently above 5%
A. there is excess money supply, so people will sell bonds, which
will lower the price of bonds and increase the interest rate.
B. there is excess money supply, so people will buy bonds, which
will increase the price of bonds and lower the interest rate.
C. there is excess money demand, so people will buy bonds,
which will increase the price of bonds and lower the interest
rate.
D. there is excess money supply, so people will buy bonds, which
will increase the price of bonds and increase the interest rate.
E. there is excess money supply, so people will sell bonds, which
will increase the price of bonds and lower the interest rate.
14. Assuming the fixed price model presented in class with a
money market and goods and services market, which one of the
following pairs of policy events will definitely lead to a decrease in
the equilibrium interest rate?
A. The Federal Reserve purchases government securities from the
public and the Federal Reserve increases the required reserve
ratio on demand deposits.
B. The Federal Reserve increases the discount rate and Congress
increases government expenditures.
C. The Federal Reserve purchases government securities from the
public and Congress decreases government expenditures.
D. The Federal Reserve sells government securities to the public
and Congress increases net taxes.
E. The Federal Reserve purchases government securities from the
public and Congress decreases net taxes.
Keep going….
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Part II: Make sure you read and do ALL parts of each question. Show as much work as
possible. TRY to get started on every question. Show us something. Write legibly and
remember to label all graphs and axes in diagrams.
1. Suppose an economy completely described the following equations:
C  [C  cYd ], I d  I , G  G, EX  EX , IM  IM , and T  [T  tY ]
Note: Yd refers to disposable income and there is no money market or inflation.
What is the definition for aggregate desired expenditure, AEd?
What is the expression for aggregate desired expenditure, AEd, given this model?
Derive the expression for equilibrium output/income Y*, given this model.
What are the expressions for the Government expenditure multiplier, KG, and the Tax multiplier, KT,
and the Balanced Budget multiplier, KBB, given this model?
e. Graph the “Keynesian Cross” diagram to represent this equilibrium.
f. In your diagram show how a decrease in subsistence consumption impacts the equilibrium.
g. Discuss this result in context of the “Paradox of Thrift”.
a.
b.
c.
d.
Answers:
Answers:
2. Assume the following balance sheets for The Federal Reserve, ALL Commercial Banks and Jane Q.
Public. Assume that the required reserve ratio equals 5% and that once money enters the banking system
as Demand Deposits it stays in the banking system, as do all loans and all monies received when loans are
used to make purchases. Also assume that all commercial banks operate with zero in excess reserves and
all commercial banks keep all their reserves at The Fed.
Federal Reserve (The Fed)
ALL Commercial Banks
Jane Q. Public
Assets
Liabilities+Net
Assets
Liabilities+Net
Assets
Liabilities+Net
Worth
Worth
Worth
Securities $125 $45 Reserves
Reserves $ 45 $900 DDeposits DDeposits $20 $ 0
Debts
$80 Currency
Loans
$855
Securities $50 $70
Net
in
Worth
circulation
a. What is the current value of the money supply?
Now…Consider what happens when The Fed buys $10 worth of government securities from Jane Q.
Public. Assume The Fed writes Jane Q. Public a check for $10; Jane immediately turns over her
government securities to The Fed and takes the $10 check and deposits it into her local commercial bank.
b. Fill in the balance sheets below for how things look immediately after these transactions.
Federal Reserve (The Fed)
Assets
Securities
Liabilities+Net
Worth
ALL Commercial Banks
Assets
Reserves
Reserves
Currency
in circ.
Loans
Liabilities+Net
Worth
DDeposits
Jane Q. Public
Assets
Liabilities+
Net Worth
DDeposits
Debts
Securities
Net
Worth
c. Fill in the balance sheets below for how things look at the final equilibrium position, assuming all
commercial banks are operating with zero in excess reserves and there are no leakages out of the
banking system.
Federal Reserve (The Fed)
Assets
Securities
Liabilities+Net
Worth
ALL Commercial Banks
Assets
Reserves
Reserves
Currency
in circ.
Loans
Liabilities+Net
Worth
DDeposits
Jane Q. Public
Assets
Liabilities+
Net Worth
DDeposits
Debts
Securities
Net
Worth
d. What has happened to the money supply, and by how much, as a consequence of The Fed’s Open
Market operation?
e. Identify two qualitatively different changes to the description of this economy which would decrease
the efficacy of The Fed’s Open Market Operation. Briefly defend your position.
3. Suppose the following information for the economy of Côte d’Ivy which uses the dollar ($) as its
currency. Currently Y*=$30,000 and YFE=$20,000. The investment multiplier is 5. The desired
investment function is Id=20,000-20,000r where r is the interest rate (in decimal form). Money supply is
completely determined by The Fed. Assume all banks operate at zero excess reserves and that all money
stays in the banking system as demand deposits of the public.
Assume the following money market equations:



Money demand = MD = 10,000 – 18,000r
Total Reserves of the entire commercial banking system = 230
The required reserve ratio for the commercial banking system = rrr = 5%. = .05
a.
b.
c.
d.
What is the current value of the money supply?
Given the money supply, what is the current equilibrium interest rate?
Given the current equilibrium interest rate, how much is Id?
If the monetary authorities (The Fed) want to get the economy to YFE, by how much and in what
direction would investment need to change via monetary policy?
e. In order to achieve full employment output, should The Fed buy or sell securities?
f. How many dollars of securities should The Fed either buy or sell (based on your answer above)?
g. What is one reality wrinkle that could make The Fed’s impact on the economy weaker than this model
predicts?
Answers:
Answers:
Answers to Econ 1120 Prelim 2 Spring 2016
1. B
If the economy is out of equilibrium, then the statement B need not be true. When output is greater than desired expenditure,
there is unplanned inventory investment. When desired expenditure exceeds output, inventory investment is smaller than the
desired level.
2. B.
Set Y=C+I+G
=100+0.8Yd+200+500
=100+0.8(Y-T)+200+500
=100+0.8(Y-200)+200+500
=640+0.8Y
So 0.2Y=6400
Y=3200
3. D
S=Y-T-C=3200- 200-100-0.8*(3200-200)=500.
4. B
When government spending increases, planned aggregate expenditure increases initially by the full amount of the rise in G.
When taxes are cut, the initial increase in planned aggregate expenditure is only the MPC times the changes in taxes.
5. C
When aggregate output equals $2400, AEd = C + Id + G = $2400. Since Y = AEd, the economy is in equilibrium and aggregate
output will have a tendency to remain constant.
6. C
The marginal propensity to consume can be calculate as follows: when output increases from 3000 to 4000, consumption
increases from 2000 to 2800. Therefore, the MPC is (2800-2000)/(4000-3000)=0.8. In turn, the multiplier is 1/(1-0.8)=5.
Therefore, Y* increase by 100*5=500.
7. D
Note that the money multiplier= 1/rrr= 1/0.1=10. So demand deposits can increase by 10*75=750 million. But since the initial
injection came from currency that was already in the money supply, the increase in the money supply is only 750 million – 75
million = $675million.
8. B
Needs text
9. A
This is a classic example of time value of money, which you will meet again if you take MBA core course in finance. Susan’s
promise will worth less than $1000. So B and E are incorrect. If the interest rate is higher, or time line is longer, her promise
will worth even less. Therefore, C and E are incorrect.
10. C
Selling securities will decrease the money supply. The amount is equal to 5/16%=31.25.
11. B
The crowding-out effect is bigger when investment is sensitive to interest rate. Therefore, B is correct but A is incorrect.
Monetary policy influences the economy through the interest rate. Therefore, the fact that investment curve is sensitive to
interest rate is good news for monetary policy.
12. D
Choices A, B and C will increase the interest rate. Choice E will increase money holdings.
13. B
Look at the figure. When the interest rate is higher than 5%, money demand will be smaller than money supply. Therefore,
there is excess money supply and C is incorrect. When interest rate is high, people will buy bonds and increase their prices,
which in turn decrease the interest rate.
14. C
Choice A is incorrect because an increase in the reserve ratio will increase the interest rate. B is incorrect because increasing
the discount rate will increase interest rate. D is incorrect because selling securities is also a contractionary monetary policy. E
is incorrect because decreasing the tax rate will increase income, which may increase money demand and interest rate.