ECON 001 - Principles of Macroeconomics Drake University, Fall 2013 William M. Boal

EXAMINATION 4

### Version A

I. Multiple choice [1 pt each: 17 pts total]

(1)d. (2)e. (3)a. (4)c. (5)a. (6)b. (7)b. (8)d. (9)a. (10)c.
(11)c. (12)c. (13)e. (14)d. (15)c. (16)b. (17)c.

II. Problems

(1) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$16 trillion.
2. up.
3. \$1.5 trillion.
4. increase.
5. \$2 trillion. (Find this by drawing the new expenditure line carefully.)
6. 4/3 = 1.333 = ΔY/ΔG.

(2) [Consumption function, Keynesian cross, Keynesian multipliers: 8 pts]

1. 0.7 = MPC.
2. 0.6 = MPC - MPI.
3. 2.5 = 1 / (1-MPC+MPI).
4. \$750 billion = \$300 × govt purchases multiplier.
5. \$120 billion = \$300 / govt purchases multiplier.
6. 1.5 = govt purchases multiplier - 1, or = (MPC-MPI) / (1-MPC+MPI).
7. \$200 = \$300 / tax cut multiplier.
8. \$300, because the balanced-budget multiplier always = 1.0.

(3) [Monetary policy rule: 8 pts]

1. 2.5 percent.
2. 5.5 percent, because real interest rate = nominal interest rate - inflation rate.
3. down (interest rates lowered without any change in inflation).
4. right (because lower interest rates would increase C, I, and X).

(4) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 5.

1. up, right, boom.
2. up, right, boom.
3. down, left, recession.
4. down, left, recession.

1. \$15.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$14.5 trillion (a decrease).
4. 7 percent, because inflation rate remains at 7%, has momentum in short run.
5. greater than the natural rate because GDP is less than potential GDP.
6. \$15.5 trillion, because eventually the inflation rate will fall until GDP once more equals potential GDP.
7. 3 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because GDP = potential GDP.

(6) [Fiscal policy, tax rates: 4 pts]

1. 12 percent = total tax owed / income.
2. \$6250 = \$6000 + 25 percent × \$1000.

(7) [Fiscal policy: 5 pts]

1. recession, because actual GDP < potential GDP.
2. deficit.
3. \$300 billion.
4. balanced budget.
5. \$0 billion.

(8) [Monetary policy: 6 pts]

1. increase, because the Fed pays for bonds with reserves.
2. decrease, because demand for money slopes down, so an increase in the money supply causes interest rates to decrease.
3. 0.15 percentage points. Find this by solving 0.03/\$100 billion = x/\$500 billion.
4. sell.
5. \$1500 billion. Find this by solving 0.03/\$100 billion = 0.45/x.
6. decrease, because banks pay the Fed for bonds with reserves.

III. Critical thinking [3 pts]

(1) Increased consumption has different effects on the economy in the short run and long run. In the short run, GDP can fluctuate around potential GDP. If the economy is initially in recession (that is, actual GDP is below potential GDP) then an autonomous increase in consumption can raise GDP and help the recovery. So in the short run, in a recession, increased consumption is good for the economy.

However, in the long run, GDP always returns to potential GDP, which is determined by the total available amounts of capital, labor, and technology, according to the aggregate production function. The GDP spending shares model shows that a rightward shift in the (C/Y) curve (that is, a reduction in saving) will raise the real interest rate and discourage investment spending. Less investment spending implies that the capital stock and therefore potential GDP will grow more slowly. So in the long run, increased consumption is bad for the economy.

### Version B

I. Multiple choice [1 pt each: 17 pts total]

(1)a. (2)f. (3)c. (4)d. (5)c. (6)a. (7)c. (8)f. (9)b. (10)b.
(11)e. (12)d. (13)g. (14)a. (15)c. (16)c. (17)b.

II. Problems

(1) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$17.5 trillion.
2. down.
3. \$1.0 trillion.
4. decrease.
5. \$1.5 trillion. (Find this by drawing the new expenditure line carefully.)
6. 1.5 = ΔY/ΔG.

(2) [Consumption function, Keynesian cross, Keynesian multipliers: 8 pts]

1. 0.6 = MPC.
2. 0.5 = MPC - MPI.
3. 2 = 1 / (1-MPC+MPI).
4. \$600 billion = \$300 × govt purchases multiplier.
5. \$150 billion = \$300 / govt purchases multiplier.
6. 1 = govt purchases multiplier - 1, or = (MPC-MPI) / (1-MPC+MPI).
7. \$300 = \$300 / tax cut multiplier.
8. \$300, because the balanced-budget multiplier always = 1.0.

(3) [Monetary policy rule: 8 pts]

1. 3.5 percent.
2. 8.5 percent, because real interest rate = nominal interest rate - inflation rate.
3. up (interest rates raised without any change in inflation).
4. left (because higher interest rates would decrease C, I, and X).

(4) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 5.

1. up, right, boom.
2. down, left, recession.
3. up, right, boom.
4. up, right, boom.

1. \$15 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$16.5 trillion (an increase).
4. 2 percent, because inflation rate remains at 2%, has momentum in short run.
5. less than the natural rate because GDP is greater than potential GDP.
6. \$15 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 8 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because GDP = potential GDP.

(6) [Fiscal policy, tax rates: 4 pts]

1. 9 percent = total tax owed / income.
2. \$2850 = \$2700 + 15 percent × \$1000.

(7) [Fiscal policy: 5 pts]

1. boom, because actual GDP > potential GDP.
2. surplus.
3. \$100 billion.
4. deficit.
5. \$200 billion.

(8) [Monetary policy: 6 pts]

1. decrease, because banks pay the Fed for bonds with reserves.
2. increase, because demand for money slopes down, so a decrease in the money supply causes interest rates to increase.
3. 0.06 percentage points. Find this by solving 0.03/\$100 billion = x/\$200 billion.
5. \$500 billion. Find this by solving 0.03/\$100 billion = 0.15/x.
6. increase, because the Fed pays for bonds with reserves.

III. Critical thinking [3 pts]

Same as Version A.

### Version C

I. Multiple choice [1 pt each: 17 pts total]

(1)c. (2)b. (3)a. (4)b. (5)e. (6)b. (7)b. (8)b. (9)c. (10)c.
(11)b. (12)c. (13)b. (14)b. (15)a. (16)a. (17)c.

II. Problems

(1) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$16.5 trillion.
2. up.
3. \$0.5 trillion.
4. increase.
5. \$1 trillion. (Find this by drawing the new expenditure line carefully.)
6. 2 = ΔY/ΔG.

(2) [Consumption function, Keynesian cross, Keynesian multipliers: 8 pts]

1. 0.3 = MPC.
2. 0.2 = MPC - MPI.
3. 1.25 = 1 / (1-MPC+MPI).
4. \$375 billion = \$300 × govt purchases multiplier.
5. \$240 billion = \$300 / govt purchases multiplier.
6. 0.25 = govt purchases multiplier - 1, or = (MPC-MPI) / (1-MPC+MPI).
7. \$1200 = \$300 / tax cut multiplier.
8. \$300, because the balanced-budget multiplier always = 1.0.

(3) [Monetary policy rule: 8 pts]

1. 3.0 percent.
2. 7.0 percent, because real interest rate = nominal interest rate - inflation rate.
3. down (interest rates lowered without any change in inflation).
4. right (because lower interest rates would increase C, I, and X).

(4) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 5.

1. down, left, recession.
2. down, left, recession.
3. down, left, recession.
4. up, right, boom.

1. \$16 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$15.5 trillion (a decrease).
4. 4 percent, because inflation rate remains at 4%, has momentum in short run.
5. greater than the natural rate because GDP is less than potential GDP.
6. \$16 trillion, because eventually the inflation rate will fall until GDP once more equals potential GDP.
7. 2 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because GDP = potential GDP.

(6) [Fiscal policy, tax rates: 4 pts]

1. 2 percent = total tax owed / income.
2. \$400 = \$300 + 10 percent × \$1000.

(7) [Fiscal policy: 5 pts]

1. recession, because actual GDP < potential GDP.
2. deficit.
3. \$100 billion.
4. surplus.
5. \$200 billion.

(8) [Monetary policy: 6 pts]

1. increase, because the Fed pays for bonds with reserves.
2. decrease, because demand for money slopes down, so an increase in the money supply causes interest rates to decrease.
3. 0.24 percentage points. Find this by solving 0.03/\$100 billion = x/\$800 billion.
4. sell.
5. \$2500 billion. Find this by solving 0.03/\$100 billion = 0.75/x.
6. decrease, because banks pay the Fed for bonds with reserves.

III. Critical thinking [3 pts]

Same as Version A.