ECON 001 - Principles of Macroeconomics Drake University, Fall 2014 William M. Boal

EXAMINATION 4

### Version A

I. Multiple choice [1 pt each: 16 pts total]

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

II. Problems

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

1. \$15.5 trillion.
2. up.
3. \$0.5 trillion.
4. increase.
5. \$1.0 trillion. (Find this by drawing the new expenditure line carefully.)
6. 2. (ΔY/ΔG = 1/0.5)

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

1. 0.85 = MPC.
2. 0.75 = MPC - MPI.
3. 4 = 1 / (1-MPC+MPI).
4. \$1200 billion = \$300 × govt purchases multiplier.
5. \$75 billion = \$300 / govt purchases multiplier.
6. 3 = govt purchases multiplier - 1.
7. \$100 = \$300 / tax cut multiplier.
8. \$300, because the balanced-budget multiplier always = 1.0.

(3) [Monetary policy rule: 8 pts]

1. 2.0 percent.
2. 5.0 percent, because real interest rate = nominal interest rate - inflation rate.
3. up, because "tightened" monetary policy means the interest rate is raised without any change in inflation.
4. decrease, because a higher interest rates would decrease C, I, and X.
5. unchanged, because inflation has momentum in the short run.

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

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

1. \$16.5 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. 6 percent, because inflation rate has momentum in short run.
5. greater than the natural rate because GDP is less than potential GDP.
6. \$16.5 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 once again GDP = potential GDP.

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

1. 10 percent = total tax owed / income.
2. \$3075 = \$3000 + 15 percent × \$500.

(7) [Fiscal policy: 5 pts]

1. recession, because actual GDP < potential GDP.
2. deficit.
3. \$400 billion.
4. deficit.
5. \$100 billion.

(8) [Monetary policy: 6 pts]

1. increase, because the Fed pays for bonds by giving banks more 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 by giving up reserves.

III. Critical thinking [3 pts]

(1) One should disagree with this claim. Whatever federal spending not paid for by taxes is not financed by creating money--it is financed by borrowing. So the federal deficit does not cause the money supply to increase, and therefore the deficit does not contribute to inflation. The federal deficit does however add to the national debt.

(2) The Federal Reserve "sets" interest rates by increasing or decreasing the money supply, not by telling banks what interest rates to charge. Because the demand for money slopes down, an increase in the quantity of money causes the interest rate to decrease while a decrease in the quantity of money causes the interets rate to increase. The Federal Reserve increases or decreases the money supply through "open market operations"--buying and selling bonds.

### Version B

I. Multiple choice [1 pt each: 16 pts total]

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

II. Problems

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

1. \$16.0 trillion.
2. up.
3. \$1.5 trillion.
4. increase.
5. \$2.0 trillion. (Find this by drawing the new expenditure line carefully.)
6. 4/3 = 1.333 (ΔY/ΔG = 2/1.5)

(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.
7. \$1200 = \$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. 6.5 percent, because real interest rate = nominal interest rate - inflation rate.
3. down, because "relaxed" monetary policy means the interest rate is lowered without any change in inflation.
4. increase, because a lower interest rates would decrease C, I, and X.
5. unchanged, because inflation has momentum in the short run.

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

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

1. \$16.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$17.0 trillion (an increase).
4. 3 percent, because inflation rate has momentum in short run.
5. less than the natural rate because GDP is greater than potential GDP.
6. \$16.5 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 5 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment, because once again GDP = potential GDP.

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

1. 15 percent = total tax owed / income.
2. \$9125 = \$9000 + 25 percent × \$500.

(7) [Fiscal policy: 5 pts]

1. recession, because actual GDP < potential GDP.
2. deficit.
3. \$300 billion.
4. deficit.
5. \$200 billion.

(8) [Monetary policy: 6 pts]

1. decrease, because banks pay for bonds by giving up reserves.
2. increase, because demand for money slopes down, so an decrease in the money supply causes interest rates to increase.
3. 0.09 percentage points. Find this by solving 0.03/\$100 billion = x/\$300 billion.
4. sell.
5. \$800 billion. Find this by solving 0.03/\$100 billion = 0.24/x.
6. decrease, because banks pay the Fed for bonds by giving up reserves.

III. Critical thinking [3 pts]

Same as Version A.

### Version C

I. Multiple choice [1 pt each: 16 pts total]

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

II. Problems

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

1. \$17.5 trillion.
2. down.
3. \$0.5 trillion.
4. decrease.
5. \$1.5 trillion. (Find this by drawing the new expenditure line carefully.)
6. 3. (ΔY/ΔG = 1.5/0.5)

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

1. 0.65 = MPC.
2. 0.60 = 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.
7. \$200 = \$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. 8.0 percent, because real interest rate = nominal interest rate - inflation rate.
3. up, because "tightened" monetary policy means the interest rate is raised without any change in inflation.
4. decrease, because a higher interest rates would decrease C, I, and X.
5. unchanged, because inflation has momentum in the short run.

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

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

1. \$16.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$18.0 trillion (an increase).
4. 2 percent, because inflation rate has momentum in short run.
5. less than the natural rate because GDP is greater than potential GDP.
6. \$16.5 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 once again GDP = potential GDP.

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

1. 19 percent = total tax owed / income.
2. \$19,140 = \$19,000 + 28 percent × \$500.

(7) [Fiscal policy: 5 pts]

1. boom, because actual GDP > potential GDP.
2. surplus.
3. \$100 billion.
4. balanced budget.
5. \$0 billion.

(8) [Monetary policy: 6 pts]

1. decrease, because banks pay for bonds by giving up reserves.
2. increase, because demand for money slopes down, so a decrease in the money supply causes interest rates to increase.
3. 0.15 percentage points. Find this by solving 0.03/\$100 billion = x/\$500 billion.
4. sell.
5. \$400 billion. Find this by solving 0.03/\$100 billion = 0.12/x.
6. decrease, because banks pay the Fed for bonds by giving up reserves.

III. Critical thinking [3 pts]

Same as Version A.