ECON 010 - Principles of Macroeconomics
Drake University, Fall 2024
William M. Boal

EXAMINATION 4
Answer Key

Version A

I. Multiple choice [1 pt each: 22 pts total]

(1)c. (2)b. (3)d. (4)b. (5)b. (6)b. (7)b. (8)a. (9)b. (10)b.
(11)b. (12)b. (13)a. (14)d. (15)b. (16)b. (17)c. (18)b. (19)b. (20)b.
(21)d. (22)b.

II. Problems

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

  1. $27 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. 0.9 = 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 deficit-neutral multiplier always = 1.0.

(3) [Monetary policy rule: 8 pts]

  1. 1.5 percent.
  2. 3.5 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 6.

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

(5) [Inflation adjustment: 16 pts] Begin by drawing the "inflation adjustment line" at the current rate of inflation, 3 percent.

  1. $28 trillion, where aggregate demand curve 1 intersects current inflation rate.
  2. equal to natural rate of unemployment because GDP = potential GDP.
  3. $29 trillion (an increase).
  4. 3 percent, because inflation rate has momentum in short run.
  5. less than the natural rate because GDP > potential GDP.
  6. $28 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
  7. 7 percent, where aggregate demand curve 2 intersects potential GDP.
  8. equal to natural rate of unemployment because once again GDP = potential GDP.

III. Critical thinking [4 pts]

(1) GDP will decrease in Canada. Falling incomes in the U.S. will cause imports from Canada to decrease. These are Canada's exports so GDP in Canada will also deccrease.

(2) Congress should enact a tax increase. A tax increase would decrease GDP (through the tax-cut multiplier) and push the aggregate demand curve back to the left, cutting off the boom. This is an example of countercyclical fiscal policy. (Graph should show aggregate demand shifting to the right, and then shifting back to the left with the tax increase.)

Version B

I. Multiple choice [1 pt each: 22 pts total]

(1)a. (2)a. (3)c. (4)d. (5)d. (6)e. (7)d. (8)b. (9)d. (10)a.
(11)a. (12)a. (13)c. (14)b. (15)c. (16)d. (17)a. (18)a. (19)d. (20)d.
(21)a. (22)d.

II. Problems

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

  1. $28 trillion.
  2. down.
  3. $1 trillion.
  4. decrease.
  5. $1.5 trillion. (Find this by drawing the new expenditure line carefully.)
  6. 1.5 (ΔY/ΔG = 1.5/1)

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

  1. 0.65 = 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.
  7. $200 = $300 / tax cut multiplier.
  8. $300, because the deficit-neutral 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. 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 6.

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

(5) [Inflation adjustment: 16 pts] Begin by drawing the "inflation adjustment line" at the current rate of inflation, 5 percent.

  1. $29 trillion, where aggregate demand curve 1 intersects current inflation rate.
  2. equal to natural rate of unemployment because GDP = potential GDP.
  3. $27.5 trillion (a decrease).
  4. 5 percent, because inflation rate has momentum in short run.
  5. greater than the natural rate because GDP < potential GDP.
  6. $29 trillion, because eventually the inflation rate will rise 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.

III. Critical thinking [4 pts]

Same as Version A.

[end of answer key]