Principles of Macroeconomics
Fall 2010
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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Name: __________________________________________________
The table below shows the (nominal) salaries of various US presidents, along with the relevant CPI. The base year is 1983.
President Year Salary CPI
Washington 1789 $25,000 8.54
Lincoln 1860 $25,000 8.06
McKinley 1900 $50,000 8.14
Roosevelt 1945 $75,000 18.00
Kennedy 1961 $150,000 29.62
Nixon 1970 $250,000 40.51
Obama 2009 $400,000 215.54
a. What can you say about inflation overall from 1789 to 1860?
b. Which president earned the highest real salary? You may add to the table to explain.
c. Convert President Kennedy’s salary to 2009 dollars.
Problem 2 (10 points)
Answer the following questions on time value of money.
a. Project A costs $20 today but generates revenue of $75 in one year. Project B generates revenue of $101 today but costs $50 in one year. If the interest rate is 10%, which project is more profitable? Show your calculations.
Suppose that the economy faces a sustained decline in consumer spending.
a. Illustrate the effect on the AD/AS diagram below.
i. What happens to GDP? __________
ii. What happens to the price level? ___________
iii. Does the change in (ii) help borrowers or lenders? __________
iv. What happens to the unemployment rate? __________
b. Considering your answers in (a), illustrate the effect on the money market below.
i. What happens to the interest rate? __________
ii. What happens to investment spending? __________
c. Suppose specifically that the output gap is $150 billion and that the MPC is equal to 0.8.
i. Calculate the increase in government spending needed to raise GDP by $150 billion.
ii. Calculate the decrease in taxes needed to raise GDP by $150 billion.
Recall the quantity equation of money MV =PY.
a. Suppose that there is a decline in the amount of output available on the marketplace, with no change in the money supply (or the velocity of money). What happens to the price level? Explain briefly.
Problem 5 (10 points)
Classify each of the items below with the relevant change in the UAE’s GDP. Answers may be used more than once or not at all.
a. An increase in C b. An increase in I c. An increase in G d. An increase in NX e. No change in GDP
____ A new computer is produced but remains unsold at the end of the year.
____ Ahmed sells 50 acres of property to his neighbor.
____ The real-estate agent earns a commission on the sale of Ahmed’s property.
____ Hanan purchases 1000 shares of stock in Etisalat
____ Dates are produced in the UAE but sold in Oman
The article below was excerpted from a US newspaper a few weeks ago. Below the article, circle the word that would logically complete each sentence.
China posted a trade deficit – yes, I did mean deficit – in March, of $7.2 billion. That's the first monthly deficit since 2004. It couldn't come at a better time, for China that is. Beijing is in the middle of a dispute with the US over the value of its currency, and the deficit takes a bit of steam out of the American position that the yuan is grossly ___1___. Politicians in Washington have insisted that China purposely keeps the yuan at an artificially ___2___ level, giving its ___3___ an unfair cost advantage in global markets and fueling China's persistent trade ___4___. If those were to vanish, so does the American argument.
But that's not likely to be the case. The March trade deficit does not settle the controversy about China's currency regime.
The reason is that there is widespread agreement among economists that the March deficit is not an indication that Chinese ___5___ are
becoming less competitive. The March figure could well be a one time event, since the deficit was actually caused by an unusually large level of ___6___ (up 66%), especially of the raw materials needed to fuel China's infrastructure boom. However, investment in those
infrastructure programs is expected to decline as 2010 progresses. Also, recovering demand in the U.S. will likely lead to healthier Chinese ___7___ – meaning China's trade balance probably will quickly return to a ___8___.
With that expectation, economists are not changing their view that China will need to allow the yuan to ___9___ to fight inflationary pressures and slow down a potentially overheating economy.
1. Overvalued Undervalued
2. High Low
3. Exports Imports 4. Surpluses Deficits 5. Exports Imports 6. Exports Imports 7. Exports Imports 8. Surplus Deficit 9. Appreciate Depreciate
10. If the current account deficits continue, then China’s net capital outflows are likely to ___
Problem 7 (10 points)
BMW stock tends to move together with the rest of the economy – when the economy is booming, BMW stock is high and when the economy is in recession, BMW stock is low. By contrast, Apollo group is a firm that specializes in downsizing and layoffs. Apollo’s stock value is high when the economy is in recession and low when the economy is booming.
South Korea and Canada are major trading partners. The diagrams below show the demand and supply for Canadian dollars, with the exchange rate e expressed as Korean won per Canadian dollar.
a. Suppose that inflation in Canada grows at a slower rate than inflation in South Korea.
i. Illustrate the effect on the diagram above.
ii. What happens to the value of the Canadian dollar? __________
iii. What happens to Canadian exports to Korea? __________
b. Suppose that there is a recession lowering GDP in South Korea.
i. Illustrate the effect on the diagram above.
ii. What happens to the value of the Korean Won? __________
iii. What happens to Canadian imports from South Korea? __________
iv. What happens to aggregate expenditures in Canada? __________
Extra Credit (+5 points max)
