SAMPLE MIDTERM EXAM
ECON 204: Intermediate Macroeconomics
Total Marks: 50
Time: 40 Minutes
PART A: (3X5 = 15 marks)
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 increase
in 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 = 5,000 G=1,000
C=250+0.75(Y – T)
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T=1,000
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?
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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.
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