Principles of Macroeconomics
Fall 2008
Midterm Exam 2
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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Suppose that the government of Nepal wants its currency to appreciate. Discuss three distinctly different approaches that the government could use to increase the exchange rate. Your answers may not involve fixing the exchange rate or using a pegged exchange rate.
Approach 1:
Approach 2:
Consider a Keynesian model where as usual AE= + + +C I G NX . In this economy:
(
)
5000 0.9 1000
C= + Y−
2000 I =
(
)
9000 0.1 1000
G= − Y−
0 NX =
a. Find the Keynesian Equilibrium level of GDP Y.
b. What is the government spending multiplier in this economy? Explain how you know.
c. In this example, the government collects $1000 of tax revenue. In the Keynesian equilibrium, does the government then run a surplus or a deficit? How much?
Suppose that the interest rate in the US is r=0.05 but that the interest rate in in Europe is 0.054
w
r = . The exchange rate between dollars and Euros this year is 0.66. Next year, the dollar is expected to appreciate a bit, and the new expected exchange rate is 0.68.
a. Calculate the percentage return for an American investor who invests $1 in the US.
b. Calculate the percentage return for an American investor who invests $1 in Europe assuming that he begins with US currency and converts back to US currency.
c. How much money would an investor need to invest for this difference in returns to be $100,000?
d. Explain the behavior of investors in this case that would make the returns equal again. Where do investors invest? What happens to the price of these assets? What happens to the return on these assets?
e. Suppose that both interest rates are fixed by the government permanently but that the exchange rate can change. Would you expect to see the dollar appreciating or
Suppose that the government of Ecoland makes a strong effort to lower its price level and the rate of inflation that it experiences.
a. What will happen to the unemployment rate? Explain briefly how you know.
b. What will happen to the value of Ecoland’s currency? Explain briefly how you know.
c. What will happen to Ecoland’s net exports as a result of the change in (b)?
The graph below shows the basic trend in nominal GDP (PY) and the money supply in the United States over the last 50 years or so.
Use the AD/AS model discussed in class to work each scenario below. Unless stated otherwise, assume that the IS curve is downward sloping and the LM curve is upward sloping. There is no partial credit for these questions. Only your final answer counts.
A surge in consumer confidence causes autonomous consumer spending a to increase. Wages and prices are flexible.
1. The level of output Y
a. increases b. decreases c. does not change d. uncertain 2. The interest rate r
a. increases b. decreases c. does not change d. uncertain 3. The price level P
a. increases b. decreases c. does not change d. uncertain 4. The real money supply
a. increases b. decreases c. does not change d. uncertain
Concerns about the economy cause the exogenous demand for money m0 to increase. Nominal wages are rigid downward and the AD curve initially intersects the AS curve on the upward sloping part of the AS curve.
5. The level of output Y
a. increases b. decreases c. does not change d. uncertain 6. The interest rate r
a. increases b. decreases c. does not change d. uncertain 7. The price level P
a. increases b. decreases c. does not change d. uncertain 8. Bond prices
a. increase b. decrease c. do not change d. uncertain
As the result of a drop in oil prices, the demand for labor increases. Wages and prices are flexible.
9. The level of output Y
a. increases b. decreases c. does not change d. uncertain 10.The interest rate r
a. increases b. decreases c. does not change d. uncertain 11.The price level P
a. increases b. decreases c. does not change d. uncertain 12.Consumption spending
perceived “brain drain” among workers. Wages and prices are flexible.
13.The level of output Y
a. increases b. decreases c. does not change d. uncertain 14.The interest rate r
a. increases b. decreases c. does not change d. uncertain 15.The price level P
a. increases b. decreases c. does not change d. uncertain 16.The unemployment rate
a. increases b. decreases c. does not change d. uncertain
Because of fears about the safety of agriculture, NX decreases. At the same time, to boost the economy, the government increases government spending G. Nominal wages are rigid
downward and the AD curve initially intersects the AS curve on the upward sloping part of the AS curve.
17.The level of output Y
a. increases b. decreases c. does not change d. uncertain 18.The interest rate r
a. increases b. decreases c. does not change d. uncertain 19.The price level P
a. increases b. decreases c. does not change d. uncertain 20.Bond prices
a. increase b. decrease c. do not change d. uncertain
Government spending G increases. For this problem only, assume that demand for money does not depend on the interest rate (h = 0). Nominal wages are rigid downward and the AD curve initially intersects the AS curve on the upward sloping part of the AS curve.
21.The level of output Y
a. increases b. decreases c. does not change d. uncertain 22.The interest rate r
a. increases b. decreases c. does not change d. uncertain 23.The price level P
