Principles of Macroeconomics
Fall 2008
Midterm Exam 1
Statement of Academic Honesty:
This exam entirely reflects my own work. I have not given assistance to anyone, nor have I received assistance from anyone. I am not aware that any other students have done so.
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The small economy of Pizzania has only 3 firms: one that produces bread, one that produces cheese and one that produces pizza.
The bread company produces $100 of bread, of which $50 is sold to consumers and $50 is sold to the pizza company.
The cheese company produces $60 of cheese, of which $25 is sold to consumers and $35 is sold to the pizza company.
The pizza company takes the bread and cheese that it bought and produces pizzas that it sells to consumers for $200.
The table below gives information on bond returns from 2001-2005. For example, a 2-year bond covering the years 2001 and 2002 paid an annualized return of 7%.
Bond Purchased in Term Interest Rate (annualized)
2001 2 years 7%
2003 2 years 4%
2005 1 year 2.5%
a. What is the (annualized) return on a 5-year bond covering the period 2001-2005? Show your work.
b. What happened to investment over the period 2001-2005? Explain briefly.
c. What happened to bond prices over the period 2001-2005? Explain briefly.
d. What happened to aggregate expenditures over the period 2001-2005? Explain briefly.
Consider the following Keynesian Cross diagram.
a. What is the equilibrium level of GDP?
b. If GDP is equal to $300 million, what will happen to inventories? Give a precise numerical answer.
c. Calculate the multiplier for this economy. Show how you got your answer.
Private Banks can either hold deposits in reserve or make loans. Before last month, private banks in the United States never earned any interest on money that they held in reserve. However, last month the Central Bank began paying interest to private banks on reserves that they held.
a. What do you expect to happen to excess reserves as a consequence of this new policy?
b. Illustrate the effects of this policy change on the money market diagram below.
c. What happens to the interest rate as a result of the policy change?
d. What happens to aggregate expenditures as a result of the policy change?
In 1997, a town had a population of 200, of whom 100 were in the labor force; 90 were employed and 10 were unemployed. In 1998, there were only 70 people employed but all the unemployed people gave up looking for work and had not looked for a job for at least 4 weeks.
a. What was the unemployment rate in 1997? Explain.
Historically, the inflation rate in the UAE has been about 14%. Suppose that the predicted level of inflation in the UAE for 2008 was again 14%, but actual inflation turned out to be only 11%.
a. Does this drop in inflation help borrowers or lenders? Explain your answer.
A typical student buys two English textbooks, one math textbook and one economics textbook every year. This is the market basket used to track changes in textbook prices The table below shows prices covering two years.
Book 2002 Price 2003 Price
English $50 $55
Math $70 $72
Economics $80 $90
a. Using 2002 as the base year, calculate the price index for 2003. Show your work
b. Using 2003 as the base year, calculate the price index for 2002. Show your work.
c. Based on your answer in (a), calculate the 2003 inflation rate in textbook prices.
d. Based on your answer in (b), calculate the 2003 inflation rate in textbook prices.
e. Jamal is a math major who buys only one English book and one economics book, but two math books every year. Will the rate of inflation he faces be higher or lower than
Indicate one answer for each of the 5 scenarios below. (Answers may be used more than once or not at all).
a. Increases the demand for money b. Decreases the demand for money c. Increases the supply of money d. Decreases the supply of money
1. The Central Bank raises the discount rate. _______
2. The price level increases. _______
3. More shops begin to accept credit cards. _______
4. The Central Bank sells bonds. _______
5. Jeremy buys bonds from the Central Bank. _______
Problem 9 (5 points)
The diagrams below show the demand and supply of money in two different economies.
Alphaland Betaland
