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Winter Quarter 03

STUDENT NAME: ..

Economics 301 HonorsProfessor Michael G. HadjimichalakisFinal Exam

ANSWER ALL QUESTIONS

1. 20 PointsSuppose that because of concerns about U.S. corporate governance and the integrity ofU.S. accounting practices, the American public becomes more risk averse in the sensethat wealth holders increase their demand for money. With the help of two separate IS-LM-BP diagrams:

a.

(8 points) Explain what will be the effect on the (U.S.) interest rate, i, nationaloutput, Y, and the international value of the U.S. dollar if the exchange rate, e, isfreely flexible.

b. (8 points) Explain what will be the effect on the same economic variables if theUnited States is committed to a fixed exchange rate.

c. (4 points) What policy implication can you infer from your answers to a and babove?

2. 15 PointsSuppose that foreign interest rates rise, say, because foreign countries pursueexpansionary fiscal policies. With the help of an IS-LM-BP model applicable to theUnited States, explain how the U.S. interest rate(s), the U.S. national output, and theexchange rate will be affected if the exchange rate is flexible.

3. 15 PointsSuppose that because of geopolitical concerns, the animal spirits of U.S. entrepreneursfall. With the help of appropriate IS-LM-BP diagrams, explain and compare the effectsof such a shock on (i, Y, e) in the United States under fixed and under flexible exchangerate regimes.

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4. 20 Points

a. Suppose that because of tensions in the Middle East, the price of both importedand domestic oil in the United States rises. With the help of IS-LM &AD-ASdiagrams, explain the impact on the U.S. interest rate and price level.

b.

Suppose that the economy starts at full-employment equilibrium and thenconsumer and business confidence fall. With the help of an AD-AS diagram andany other necessary diagram, explain why the move back to full-employmentequilibrium will be a crawl rather than a gallop.

5. 20 Points(Note that the following parts are unrelated.)

a. Explain what is meant by real interest rate parity and how you can combine theconcepts ofnominal interest rate parity and the real exchange rate to derive real

interest rate parity.b. Respond to the following statement with the help of appropriate graphs: Sincemoney is neutral, there is no point at all in the Fed trying to use monetary policyto affect output.

c. Explain when and under what conditions fiscal expansion causes completecrowding out.

6. 10 PointsWith the help of an IS-LM diagram, explain why it is better to target (keepunchanged) the interest rate rather than the quantity of money when the economy isprone to LM-sector shocks.

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STUDENT NAME: ..Economics 301 Honors Exam #1

Professor Michael G. Hadjimichalakis February 11, 2003


1. 20 PointsSuppose that there is a bubble in the stock market and the bubble bursts. A burstingbubble can be both an IS-sector shock and an LM-sector shock. With the help of twoseparate IS-LM diagrams, explain how the shock would work its way through theeconomy in each case (that is, in your answer, be specific about the channels throughwhich this shock affects the economy.) Assume there is no change in monetarypolicy.

2. 20 Pointsa. (8 points.) Explain in words the following concepts. Be clear about the economic

policy with which they are associated:(i) Crowding out of investment;(ii) Crowding out of net exports.

b. (12 points. With the help of an IS-LM diagram, explain the economic policy youidentified in part a.

3. 15 PointsWith the help of an appropriate IS-LM diagram, explain why the mix of monetaryand fiscal policy matters (beyond its immediate effects on national output.)

4. 20 pointsSuppose that (i) the tax rate on corporate profits is reduced and (ii) the animalspirits of entrepreneurs improve (rise.)a. With the help of a model (diagram) of a profit-maximizing firm, explain the

effects of these two shocks will have on investment demand.b. With the help of an IS-LM diagram, explain the effects of these shocks on the

interest rate and national output.

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5. 10 points

With the help of an IS-LM diagram, explain the liquidity effectand the real-incomeeffectof an open-market purchase of U.S. Treasury securities by the Fed.

(Question # 6 on next page)

6. 15 PointsThe following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in $billions and i as a percentage. For example, if i were 6 percent, it wouldappear as 6, not as 0.06.)

Real (IS) SectorC = 800 + 0.85YD ConsumptionYD = Y - TA + TR Disposable IncomeTA = 200 + .25Y TaxesTR = 600 Transfer Payments

I = 10010i InvestmentG = 1,400 Government PurchasesNX = -250 Net Exports

Financial (LM) SectorMd = 7000.20i + 0.10Y (Real) Money DemandMs = 350 + 14NBR + 4i (Real) Money SupplyNBR = 70 (Real) Nonborrowed Reserves

Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real) investment,I. Show your work and explain it using graphs.

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Spring Quarter 02

STUDENT NAME: ..

Economics 301 Honors Exam #1Professor Michael G. Hadjimichalakis May 7, 2002


1. 10 Pointsa. The U.S. Labor Department announced this morning that labor productivity rose

8.6 percent last quarter, the fastest pace in 19 years.Explain the difference between labor productivity and multi-factor productivity(also called total factor productivity.)

b. Also explain what factors can make labor productivity increase.

2. 20 Points

a. Use the national income and product accounting identities to answer this part of the question:Assume that the government increases its level of purchases by $60 billion. As aresult, the budget deficit increases by $20 billion, savings fall by $10 billion,disposable personal income increases by $15 billion, and the trade (currentaccount) deficit increases by $5 billion, or, the current account surplus falls by$5 billion. By how much have the following variables changed? (a) nationalincome, (b) investment, (c) consumption? Show all your calculations.

b. With the help of an IS-LM diagram (as well as any other necessary relationship),(i) first, derive the effects of an increase in government expenditure on theinterest rate and the level of income, and (ii) second, confirm the effects on Y, I,and NX you derived, or, in the case of NX, that was given to you in part (a).Hint: Use part b as your guide to the accuracy of your answer to a.

3. 20 PointsSuppose that the goods and services market is currently in equilibrium at the full-employment level of output (potential output) and that the government is running abudget surplus.a. (13 Points) Now suppose that a terrorist attack reduces consumer confidence and

the animal spirits of entrepreneurs. With the help of an IS-LM diagram, explainthe effect on the equilibrium levels of the interest rate, and output.

b. (7 Points) Explain what will be the effect on the government budget balance.Characterize such an effect.

4. 15 PointsWith the help of an IS-LM diagram, explain why you agree or disagree with thestatement: The mix of monetary and fiscal policy does not matter if the alternativemixes all result at the full-employment level of national output.

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5. 15 Points

Suppose that at the end of 2002, the Federal Reserve decides to use open marketoperations to reduce nonborrowed reserves.

a.

Explain what action the Federal Reserve must take to reduce nonborrowedreserves.b. With the help of an IS-LM diagram, explain the liquidity effect and the real

income effect of a reduction in nonborrowed reserves.

6. 20 Points

The following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in billions and i as a percentage. Percentages are written in this format:For example, ifi were 5 percent, it would appear as 5, not as 0.05.)

Real (IS) SectorC = 700 + 0.85YD ConsumptionYD = YTA + TR Disposable IncomeTA = 200 + 0.25Y TaxesTR = 600 Transfer PaymentsI = 25010i Investment

G = 1,200 Government PurchasesNX = - 100 Net Exports

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Financial (LM) SectorMd = 7500.20i + 0.10Y (Real) Money DemandMs = 400 + 14NBR + 4i (Real) Money SupplyNBR = 70 (Real) Nonborrowed Reserves

Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real)investment, I. Show your work and explain it using graphs.

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STUDENT NAME: ..Economics 301 Honors Final ExamProfessor Michael G. Hadjimichalakis June 10, 2002


1. 20 Points

Consider the United States the home country and suppose that nominal interest rate parityholds. Now, suppose that because of concerns about the integrity of U.S. accountingpractices and corporate governance, international investors consider U.S. assets (say,bonds) riskier.

Use the IS-LM-BP model applicable to the United States to explain the effects of thisshock on the (U.S.) real GDP, the nominal interest rate, and the international value of thedollar.

2. 15 Points

Suppose that as a result of September 11, the marginal productivity of labor falls becausefirms have to divert resources to security, which is an intermediate, not a final, good.

a. Use an IS-LM, AD-AS model with a short-run aggregate supply curve to explainthe effect on real GDP, the price level and the interest rate

b. Suppose the Fed wants to return output to its original level. Explain what the Fedmust do and what the effect on the price level will be. Illustrate the result of theFed action graphically.

3. 20 Points

Recently, the U.S. stock market has been falling because of concerns about theaccounting practices of U.S. firms and the accuracy of reported corporate profits.

a. Explain the channels through which a fall in the stock market affects the demandfor goods and services.

b. Use your results in part a and a standard IS-LM, AD-AS model to explain theeffects of the fall in the stock market on real GDP, the price level, and the interestrate.

4. 15 Points

Suppose that the animal spirits of entrepreneurs rise and, in addition, the president andthe U.S. Congress agree on a reduction in the tax rate on business profits.

a. Use a model of a profit-maximizing firm to explain the effects of these shocks,each examined separately, on investment in plant and equipment.

b. Incorporate the results of your answer in part a into an IS-LM-BP model toexplain the effects on real GDP, the interest rate, and the exchange rate.

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5. 15 Points

Suppose that by 2003 the U.S. economy returns to full employment. Suppose it also facesinflationary pressures, forcing the Fed to embark on a tightening monetary policy. Withthe help of one IS-LM-BP graph, explain the effects on the economy of Hong Kong,

which pegs the Hong Kong dollar to the U.S. dollar, and on the economy of Thailand,which permits the Thai baht to float.

6. 15 Points

Note that parts a and b are not related.

a. Explain when (under what circumstances) money is neutral by examining anincrease in nonborrowed reserves in an AD-AS model.

b. Give and explain three reasons why wages may be rigid, resulting in involuntaryunemployment.

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Autumn Quarter 01

STUDENT NAME: ..Economics 301H Final ExamProfessor Michael G. Hadjimichalakis December 14, 2001


1. 20 PointsRecently (a) the Fed has been increasing nonborrowed reserves and (b) energy priceshave been falling. With the help of AD-AS, IS-LM diagrams (one set of graphs foreach shock), explain the differences and similarities between these two shocks.

2. 15 PointsThe price level is falling in Japan, that is, there is deflation in Japan. Real GDP isalso falling in Japan.

a. With the help of an AD-AS diagram, explain the difference between "baddeflation" and "good deflation." Include in your answer a discussion of thetype of shocks that cause each type of deflation.

b. There is some debate in Japan about whether the ongoing deflation is of thegood or bad type. Which type of deflation (on net) do you think Japan isexperiencing, the good or bad type? What evidence supports yourconclusion?

3. 15 PointsRespond to the following statement with the help of the appropriate graph or graphs:

"Since money is neutral, there is no point at all in the Fed trying to usemonetary policy to affect output."

4. 20 PointsSuppose that because of increased uncertainty in financial markets, U.S investorsmove to safer and more liquid assets thereby increasing the U.S demand for money.With the help of an IS-LM-BP diagram applicable to the United States of today,explain how this change in the portfolio preferences of the public will affect theinterest rate, the exchange rate, and the real GDP. Under these circumstances,explain what the Fed should do and why.

5. 15 PointsRecently the U.S. policymakers have been using both monetary and fiscal policy tojumpstart the economy. With the help of an IS-LM-BP diagram applicable to theUnited States of today, compare the international effects (i.e., on e and NX) of anincrease in the money supply versus tax cuts.

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6. 15 Points

Recently the Fed has been pushing down the federal funds rate. With the help of anIS-LM-BP model, explain the effect on a small country (or region, such as HongKong,) that pegs its currency to the U.S. dollar.

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STUDENT NAME: ..Economics 301H Exam # 1Professor Michael G. Hadjimichalakis November 6, 2001


1. 20 PointsCurrently, the U.S. economy is operating below potential (below full employment.)Suppose the goal of policymakers is to return the economy to full employment. Withthe help of an IS-LM model, compare the effects on the following variables of usingmonetary policy (to return the economy to full employment) versus using income taxcuts for households: consumption, investment, net exports.

2. 20 Points

A fall in the stock market, caused by an increased perception of risk of investing instocks and bonds, can directly affect both the IS and LM curves, that is, it can be bothan IS and LM shock. Explain how. Then, explain how each of these shocks affects iand Y.HINT: Answer the question by examining two cases (shocks). First, an increase inthe (perceived by the public) risk of investing in stocks and bonds. Second, a fall inthe market value of stocks and bonds.

3. 15 pointsa. (5 points) Explain the difference and the similarity between a debt buyback by the

U.S. Treasury and an open market purchase of Treasury securities by the Fed.b. (10 points) In the context of the IS-LM model, what difference does it make if the

U.S. Treasury uses the budget surplus to reduce taxes as opposed to buying backthe debt?

4. 15 PointsSuppose that the U.S. Congress approves (passes) President Bushs proposed cut tax

on business profits.a. Use a model of the profit-maximizing firm to explain what will happen to the

demand for plant and equipment by firms (that is, investment).b. With the help of an IS-LM diagram, explain what will happen to the equilibrium

levels of the interest rate and national output.

5. 15 PointsSuppose that the economy is prone to real-sector shocks, say, in consumerconfidence and animal spirits of entrepreneurs. Explain whether it is better for theFed to target (keep fixed) the interest rate or the quantity of securities it holds, i.e. BF.

6. 15 Points

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The following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in billions and i as a percentage. For example, ifi were 5 percent, it wouldappear as 5, not as 0.05.)

Real (IS) Sector

C = 900 + 0.80YD ConsumptionYD = YTA + TR Disposable IncomeTA = 250 + 0.25Y TaxesTR = 650 Transfer PaymentsI = 22010i Investment

G = 1,100 Government PurchasesNX = - 80 Net Exports

Financial (LM) SectorMd = 6000.25i + 0.10Y (Real) Money DemandMs = 200 + 15NBR + 4i (Real) Money Supply

NBR = 65 (Real) Nonborrowed Reserves

Calculate the equilibrium level of the interest rate, i, real GDP, Y, and (real)investment, I. Show your work and explain it using graphs.

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Winter Quarter 01

Economics 301H Exam # 1

Professor Michael G. Hadjimichalakis February 6, 2001


1. 20 Points

The lead article in the Wall Street Journal on February 1, 2001 asserted that a fallin the animal spirits of entrepreneurs is at the root of (the reason for) the Fed'srecent move to lower interest rates.a. With the help of a model of a profit-maximizing firm, explain the effect of a

fall in animal spirits on investment demand.

b. With the help of an IS-LM diagram, explain the effect of a fall in animal spiritson the interest rate, and (real) national product. (Assume that, originally, theeconomy was operating at the full-employment level.)

c. Using the same IS-LM diagram, explain what the Fed must do to restorenational output to its original level.

2. 20 Points

The stock market has fallen considerably in recent months. With the help of anISLM diagram, explain the effect of a fall in the stock market on the interest rateand national output. In your answer you should be specific about the channelsthrough which a fall in the stock market affects aggregate demand.

3. 20 Points

Suppose that because of turmoil in the financial sector, the demand for securitiesfalls and the demand for money rises. With the help of an IS-LM diagram, explainwhether it is better for the Fed to target (i.e., keep fixed) the quantity of money orto target the interest rate. You answer should include an explanation of theappropriate actions of the Fed in each case.

4. 10 Points

"A one-time sale of U.S. Treasury securities by the Fed will result in a liquidityeffect and a real income effect." Explain

5. 10 Points

"A reduction in consumer confidence has a cyclical effect on the budget"

6. 20 Points

The following equations describe an economy. (Think of C, I, G, NX, etc., asbeing measured in billions and i as a percentage. For example, if i were 5 percent,

it would appear as 5, not as 0.05.)Real (IS) Sector

C = 950 + 0.80YD Consumption

YD = Y - TA + TR Disposable Income

TA = 200 + 0.25Y Taxes

TR = 600 Transfer Pa mentsFinancial (LM) Sector

Md = 550 - 0.251 + 0. l 0Y (Real) Money Demand

Ms = 150 + 15NBR + 4i (Real Mone Su la. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show your

work and explain it using graphsb. Suppose that the consumption equation changes to

C=850+0.80YD

After explaining what may have caused this change,

Answer the following without making any numerical calculations:Suppose that there are two alternative proposals for economic policy designed torestore national output to its original level (the level you found in your answer to a,

above):

The first is for the Administration and the U.S. Congress to change income taxrates.

The second alternative is for the Fed to use monetary policy.

Explain each of these policies and their respective effects on the composition of

aggregate demand (i.e., on I and NX.)

Economics 301 Honors Final Exam

Professor Michael G. Hadjimichalakis March 12, 2001


1. 20 Points

Proponents of income tax cuts for households argue that income tax cuts will stimulatea sluggish (slowing down) economy in much the same way that the Kennedy-Johnsontax cut cuts stimulated the U.S. economy in the early 1960s. But during the Kennedy-Johnson years the U.S. was bound by the Bretton-Woods Agreement to a fixedexchange rate, while now we are in a regime of floating exchange rates.With the help of appropriate IS-LM-BP diagrams, explain and compare the effects of

income tax cuts on the national product, interest rate, and the exchange rate in the caseof a large country:a. committed to a flexible exchange rate, and

b. committed to fixed exchan e rate.

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b. Explain what is meant by real interest rate parity and how you can combine theconcepts ofnominal interest rate parity and the real exchange rate to derive realinterest rate parity.

2. 15 Points

According to a front-page article in The Wall Street Journal, on February 1, 2001, theanimal spirits of U.S. entrepreneurs have fallen recently. With the help of an IS-LM-BP model applicable to the U.S., explain the effects that a fall in the animal spirits willhave on the national output, the interest rate, and the exchange rate.3. 20 Points

"Expansionary demand management policies always increase nominal GDP but notreal GDP." Explain the meaning of this statement with the help of AD-AS diagram(s.)Your answer should include the meaning ofneutrality of money and completecrowding out, and, of course, whether and under what circumstances these resultsoccur.4. 15 Points

In a press release after the FOMC meeting on January 31, 2001, the Federal Reservestated that "consumer confidence has eroded further, exacerbated by rising energy

costs." With the help of one AD-AS diagram, explain how these shocks affect theeconomy.5. 15 Points

Since 1995, there has been a considerable increase in labor productivity in the U.S.With the help of an IS-LM-AD-AS model, explain the effects of an increase in themarginal productivity of labor on national output, the price level, and the interest rate.

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Spring Quarter 2000STUDENT NAME: .Economics 301 Honors Final ExamProfessor Michael G. Hadjimichalakis June 5, 2000


1. 20 pointsIn June 1999, the Federal Reserve began raising U.S. interest rates in an effort to cooldown an overheated (in its view) U.S. economy. With the help of IS-LM-BP curves,explain the effect that the change in U.S. monetary policy would have:a. On small countries that let their currencies float against the U.S. dollar;b. On small countries that peg their currencies to the U.S. dollar.

2. 20 pointsSuppose that the animal spirits of entrepreneurs in the United States fall. With the

help of an IS-LM-BP graph applicable to the United States, explain the effects on theinterest rate, output, and the exchange rate.

3. 20 pointsa. In his Humphrey-Hawkins testimony on February 17, 2000, Alan Greenspan said:

"An increase in the overall rate of inflation in 1999 was mainly a result of higherenergy prices." With the help of an IS-LM--AD-AS diagram, explain the effect ofhigher energy prices on real GDP, the price level, and the interest rate.

b. Greenspan went on to say that "total unit labor costs increases wereextraordinarily low.." What factors affect unit labor costs? Why, do you think,did unit labor costs decline in the second half of the year, as Greenspan indicatesin his remarks?

4. 20 pointsSuppose that because of utterances by Fed chairman Greenspan, the American publicbecomes more risk averse in the sense that wealth holders increase their demand formoney and reduce their demand for securities. With the help of IS-LM, AD-ASdiagrams, explain the effects on the interest rate, output, and the price level.

5. 20 pointsIt has been established that in recent years the Beveridge curve has shifted inward andthat the asymmetry in the wage (and price) response to excess demand and excesssupply has become less pronounced.a. What factors have most likely shifted the Beveridge curve inward? Explain in

detail.b. What factors have caused the reduction in the asymmetry of the wage and price

response to excess demand and excess supply? Explain in detail.c. What is the economic significance of these changes?

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STUDENT NAME: .Economics 301 Honors Exam #1Professor Michael G. Hadjimichalakis May 2, 2000


1. 20 pointsa. A fall in the stock market can directly affect both consumption and investment.

Explain how.b. Suppose the economy is currently at full employment and the goal of the Fed is

use open market operations to maintain full employment. With the help of an IS-LM diagram, explain how the Fed would respond to a large fall in the stockmarket.

2. 20 points

With the help of an IS-LM diagram, explain why you agree or disagree with thefollowing statement: "The mix of monetary and fiscal policy does not matter if thealternative mixes all result in the same level of output."

3. 20 pointsSuppose that the tax rate on business profits is reduced.a. Use a model of the profit-maximizing firm to explain what will happen to the

demand for plant and equipment by firms (that is, investment).b. With the help of an IS-LM diagram, explain what will happen to the equilibrium

levels of the interest rate and national output.

4. 20 points"If the economy is prone to real-sector shocks, the Fed should target (keep fixed) thequantity of money, but it should target the interest rate if the shocks are expected tocome from the money sector." Explain whether you agree or disagree with thestatement.

Continued on back

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5. 20 pointsThe following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in billions and i as a percentage. For example, if i were 5 percent, you

would write i = 5)

Real (IS) SectorC = 850 + 0.80YD ConsumptionYD = Y -TA + TR Disposable IncomeTA = 200 + 0.2Y TaxesTR = 800 - 0.05Y Transfer PaymentsI = 200 - 10i InvestmentG = 800 Government PurchasesNX = -50 Net Exports

Financial (LM) SectorMd = 500 - 0.25i + 0.10Y (Real) Money DemandMs = 100 + 12NBR + 4i (Real) Money SupplyNBR = 75a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show and

explain your work.b. Suppose that the government reduces the lump-sum component of total taxes

from 200 to 150. Calculate and explain the effect on the equilibrium level of: (1)the budget surplus or deficit; and (2) investment.

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Autumn Quarter 1999

STUDENTS NAME:

Economics 301 Honors Final ExamProfessor Michael G. Hadjimichalakis December 10, 1999


1. 20 pointsIn October 1999 Robert Mundell received the Nobel Prize in economics for hisresearch on how macroeconomic policies work in a global economy. AmongMundell's contributions were the results that:

a.

In a small country with free capital flows and flexible exchange rates, fiscalpolicy is powerless to affect output.b. In a large country with free capital flows and flexible exchange rates, fiscal

policy is less potent than in a closed economy.

With the help of appropriate graphs explain these results.

2. 20 points

Suppose that in the year 2000 the U.S. economy unexpectedly weakens and inresponse, the Fed pushes down U.S. interest rates. With the help of IS-LM-BPcurves, explain the effect that the change in U.S. monetary policy would have:a. on countries that peg their currencies to the U.S dollar;b. on countries that let their currencies float against the U.S. dollar.

3. 20 pointsa. Suppose that the Fed believes that productivity has increased. If the Fed's goals

are price stability and full employment, explain with the help of an AD-ASdiagram what it should do.

b. Suppose that the Fed turns out to be wrong and productivity has not increased.Explain with the help of an AD-AS diagram what will be the consequences of itspolicy actions.

4. 15 pointsa. In the last few years the U.S. economy has been operating at close to full

employment with very low inflation rates. Give and explain three possiblereasons for such performance.

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b. What is meant by efficiency wages? Combine the concept of efficiency wageswith the concepts ofadverse selection, loyalty, and shirking to explaininvoluntary unemployment.

5. 15 pointsSuppose that money demand rises because wealth holders become more risk averse.With the help of IS-LM, AD-AS diagrams, explain the effects on the interest rate,output, and the price level.

6. 10 points

Two goals of monetary policy in the United States are price stability and fullemployment. Are these goal always consistent (compatible) with each other? Explainwith the help of AD-AS graphs.

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STUDENTS NAME: Economics 301 Honors Exam #1Professor Michael G. Hadjimichalakis November 2, 1999


1. 20 pointsSuppose that the Japanese government decides to cut the income tax rate in Japan, assome American economists, notably Martin Feldstein, have recommended.a. With the help of an IS-LM diagram explain the effect of the tax rate on the

interest rate and the level of output in Japan.b. Explain the two types of "crowding out" that would result from a tax cut.

2. 10 pointsExplain whether you agree or disagree with the statement: "A balanced-budget

amendment mandating annually balanced budgets can turn a minor downturn in theeconomy caused by a fall in consumer confidence into an accelerating recession."

3. 15 pointsa. With the help of a Keynesian-Cross diagram, explain the channels through

which a fall in the stock market would affect aggregate demand and theequilibrium level of output.

b. Extend your analysis in (a) by using an IS-LM diagram to explain the effect of afall in the stock market on the interest rate and real income (output.)

4. 15 pointsThere is widespread belief that because of Y2K fears currency in circulation will risein the fourth quarter of 1999.a. With the help of an equation of the money supply process, explain what willhappen to the money supply if currency in circulation rises and the Fed does notintervene. Also, use an IS-LM diagram to explain the effect on the interest rate andoutput.b. In recent comments on this issue, Federal Reserve governor Edward Kelly said:"We [the Federal Reserve] will, of course, be ready if people want to hold more cashon New Year's Eve 1999 and we will be prepared to lend whatever sums may be

necessary through the discount window or to provide needed reserves to the

banking system's open market operations."With the help of an equation of the money supply process, explain how the Fedwould provide the reserves to which Governor Kelly refers. Also explain how thisaction by the Fed will affect the economy.

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5. 20 points

Suppose that the "animal spirits" of entrepreneurs fall.a. With the help of a model of a profit-maximizing firm, explain the effect of this

fall on investment demand.

b.

With the help of an IS-LM diagram, explain the effect on the interest rate and(real) national product.c. With the help of an IS-LM diagram, explain why in such case it is better for the

Fed to target (keep fixed) the quantity of money than to target the interest rate.

6. 20 pointsThe following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in billions and i as a percentage. For example, ifi were 5 percent, youwould write i = 5.)

Real (IS) SectorC = 850 + 0.80YDwhereYD = YTA + TR Disposable IncomeTA = 160 + 0.2Y TaxesTR = 500 Transfer PaymentsI = 24010i InvestmentG = 850 Government PurchasesNX = - 40 Net Exports

Financial (LM) SectorMd = 4500.25i + 0.10Y (Real) Money DemandMs = 970 + 5i (Real) Money Supply

a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show andexplain your work.

b. Suppose Congress and the Administration agree to raise G to 910.(1)Calculate the effects on the interest rate and real GDP and illustrate

graphically.(2)Calculate and characterize the effect on investment in plant and equipment, I.

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Winter Quarter 1999

STUDENTS NAME: Economics 301 Honors Final Exam

Professor Michael G. Hadjimichalakis March 19,1999

ANSWER ALL QUESTIONS1 15 points

Hong Kong, a small country with fixed exchange rates, (the Hong Kong dollar ispegged to the U.S. dollar) is currently in recession. With the help of IS-LM-BPgraphs, explain whether monetary or fiscal policy would work to jump-start theeconomy.

2. 20 pointsIn his Humphrey-Hawkins testimony in February 1999, Fed Chairman Alan

Greenspan pointed out that there was an increase in demand for money by the U.S.public in 1998 because of a desire for safer and more liquid assets (because ofincreased uncertainty in financial markets.)With the help of an IS-LM-BP diagram applicable to the United States, explain howthis change in the portfolio preferences of the public will affect the interest rate, theexchange rate, and real GDP. Under these circumstances, explain what the Fedshould do and why.

3. 15 pointsOfficial data indicate that between 1996 and 1998 the U.S. economy has experienceda "significant" increase in the marginal productivity of labor. With the help of an IS-LM, AS-AD diagram, explain how this increased productivity affects the interest rate,the real GDP, and the price level.

4. 10 pointsHow can you explain a situation in which both the interest rate and real GDP arefalling?

5. 15 pointsExplain the effect of an inward shift of the Beveridge curve on NAIRU and theassociated inflation rate.

6. 15 pointsa. What is nominal interest rate parity? When does it hold?b. Explain how you can combine the concepts nominal interest rate parity and the

real exchange rate to establish real interest rate parity. Define the terms you use.

7. 10 pointsGive and explain three reasons why wages may be rigid, resulting in involuntaryunemployment.

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STUDENTS NAME: Economics 301 Honors Exam #1Professor Michael G. Hadjimichalakis February 16,1999

ANSWER ALL QUESTIONS1. 20 pointsThe following equations describe an economy. (Think of C, I, G, NX, etc., as beingmeasured in billions and i as a percentage. For example, ifi were 5 percent, youwould write i = 5.)

Real (IS) SectorC = 850 + 0.80YDwhereYD = YTA + TR Disposable IncomeTA = 220 + 0.2Y Taxes

TR = 8200.05Y Transfer PaymentsI = 10010i InvestmentG = 900 Government PurchasesNX = - 30 Net Exports

Financial (LM) SectorMd = 5500.25i + 0.10Y (Real) Money DemandMs = 150 + 12NBR + 4i (Real) Money SupplyNBR = 77 Nonborrowed Reserves

a. Calculate the equilibrium level of the interest rate, i, and real GDP, Y. Show andexplain your work.

b. Suppose that money demand changes toMd = 586 - 0.25i + 0.10Y

(1) First, explain what may have caused this change.(2) Second, find the new levels ofi and Y.(3) Find and characterize the effect on the budget surplus/deficit.Again, show and explain your work.

2. 20 pointsThe U.S. economy is currently operating at full employment and the goal of monetarypolicy is to maintain full employment with price stability. With the help of an IS-LMgraph, explain how the Fed, using open market operations, would have to respond toan increase in consumer confidence in order to achieve its goal.

3. 20 pointsSuppose that, while the economy is operating at full employment, the U.S. Congressand the Administration agree to reduce income tax rates across the board. With thehelp of an IS-LM graph, explain what the Fed will do if its goal is to maintain full

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employment with price stability. Also, explain whether such a "policy mix" is goodfor the U.S. economy.

4. 15 pointsUse a model of a profit-maximizing firm to explain how investment demand will be

affected in each of the following cases, considered separately:a. Pre-tax business profits rise.b. The tax rate on business profits rises.c. The "animal spirits" of entrepreneurs fall.

5. 15 pointsSuppose that in the near future the economy is prone to money demand shocks due tovolatility in domestic and foreign financial markets. With the help of an IS-LMgraph, explain why targeting (keeping fixed) the interest rate is a better monetarypolicy than targeting the quantity of money.

6. 10 pointsSuppose that because of Y2K fears currency in circulation rises. Assuming that theFed does not react, explain what will happen to money supply.

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