Econ 1120 – INTRO MACRO – Fall-2011 –October 6, 2011

PRELIM #1 (THURSDAY)

PRINT YOUR NAME: ____________________________________ Your C.U. Netid: _____________

YOUR C.U. STUDENT NUMBER: ____________________________

Check YOUR TA’s NAME:

_____________TA = Minwook Kang (Tuesday sections)

_____________TA = Mirinda Lee Martin (Wednesday sections)

_____________TA = Lingwen Zheng (Thursday sections)

_____________TA = Yu Zhang (Friday sections)

INSTRUCTIONS:

There are two sections in this exam

· Part I: 20 multiple choice questions @ 3 points each

· Part II: 3 short answer questions (5, 10, 9 points each) + Newspaper Article question @ 16 points

· Please number exam books from 1 to 5. Write down your answers of

· multiple choice in book1

· short essay 1 and 2 in book2

· short essay 3 in book3

· long essay 1 in book4

· long essay 2 in book5.

· ANSWER ALL QUESTIONS. TOTAL POINTS = 100. TOTAL TIME = 90 minutes.

· Prelim 1 counts for 27.5% of the final grade.

AGAIN, please….

PRINT YOUR NAME: ____________________________________ Your C.U. Netid: _____________

YOUR C.U. STUDENT NUMBER: ____________________________

_____________TA = Minwook Kang (Tuesday sections)

_____________TA = Mirinda Lee Martin (Wednesday sections)

_____________TA = Lingwen Zheng (Thursday sections)

_____________TA = Yu Zhang (Friday sections)

GRADING----------------------------------------------------------------------------------------------------------

_____________/60 (mc) ________/5 (q1) ________/10 (q2) ________/9(q3) ________/16 (q4)

TOTAL: ___________/100 --------------------------------------------------------------------------------------------------------------------------

1

Part I: Multiple Choice.

[endnoteRef:1]. Suppose pizza and soda are complements. What can we conclude? [1: 1. B]

a)An increase in the price of soda will cause increase in the demand for pizza.

b)An increase in the price of soda will cause decrease in the demand for pizza.

c)An increase in the price of soda will cause increase in the supply for pizza.

d)An increase in the price of soda will cause increase in the supply for pizza.

[endnoteRef:2]. Which of the following would be most likely to cause the demand for cars to decrease? [2: .D]

a) An increase in the price of car

b) An increase in the price of steel used to make cars

c) An increase in income, assuming car is a normal good

d) An increase in the price of oil

[endnoteRef:3]. The government imposes a maximum price on apartments that is ABOVE the equilibrium price. You accurately predict that [3: .A]

a) The law will have no economic impact

b) The law will create a surplus of apartments

c) Renters will find that landlords start offering to furnish the apartments

d) Landlords are less likely to do routine maintenance work in the apartments

e) None of the above

[endnoteRef:4]. When aggregate output is larger than planned aggregate expenditures, unplanned changes in inventories in the economy should be: [4: .A]

a)positive

b)zero

c)negative

d)it depends

[endnoteRef:5]. Which of the following activities affects real GDP? [5: B.]

a) A drug dealer sells $500 worth of illegal drugs.

b) General Motors builds a new plant in Tennessee.

c) Company A issues new shares of stock to finance the construction of a plant.

d) You bought a used textbook at the price of $500.

e) All of the above

f) None of the above

[endnoteRef:6].When a production possibilities frontier is bowed out, the opportunity cost [6: .B]

a) Of one good in terms of the other is constant.

b) Of one good in terms of the other depends on how much of each good is being produced.

c) Of the first good in terms of the second good increases as more of the second good is produced.

d) All of the above

e) None of the above

[endnoteRef:7].Which of the following is an automatic stabilizer to the economy? [7: .D]

a) In an expansion, government spending increases as inflation increases.

b) In recessions, taxes fall and government expenditures rise.

c) Personal income tax brackets are tied to the overall price level.

d) Both b and c.

e) Both a and c

f) Both a and b

[endnoteRef:8].Suppose the Consumption function was defined as C = 300 + 0.9(Y-T). Suppose further that investment spending (I) is fixed at 100, and government expenditure (G) is fixed at 250. What is the MPS? What is the investment multiplier? What is the government expenditure multiplier? [8: .A]

a) 0.1; 10; 10

b) 0.4; 2.5; 2.5

c) 0.1; 2.5; 9

d) None of above

[endnoteRef:9].If a U.S. firm owned by a U.S. citizen located in India exports laptops to France, which of the following is correct? [9: .C]

a) Laptops are included in U.S real GDP.

b) Laptops are included in U.S nominal GDP.

c) Laptops are included in U.S GNP.

d) None of the above

e) All of the above

[endnoteRef:10].Which one of the following is NOT an intermediate good or service? [10: .D]

a) Wood a pencil manufacturer purchases to make pencils.

b) Milk used by Ben & Jerry to make ice cream.

c) Coffee beans Starbucks purchases to make coffee

d) Shovels purchased by a construction firm for use in building houses.

[endnoteRef:11].Suppose the required reserve ratio, RRR, is 20% and that all banks hold zero in excess reserves. Assume that once money enters the banking system it stays in the banking system. Suppose the Federal Reserve decides to do an Open Market Operation and buys $70 billion of Treasury bonds from the students in Econ 1120. By doing so, the money supply, M1, will [11: .F]

a)not change.

b)decrease by $70 billion.

c)decrease by $350 billion.

d)increase by $280 billion.

e)decrease by $280 billion.

f)none of the above.

[endnoteRef:12].Which one of the following is primarily a normative question? [12: A]

a)Should the government provide health insurance for any individual who cannot afford it?

b)What will happen to the speed with which new drugs are developed if the government places price controls on prescription drugs?

c)Why is the infant mortality rate higher in the United States than in most other developed countries?

d)Will physicians’ incomes increase or decrease if national health insurance is instituted in the United States?

[endnoteRef:13].If discouraged workers quit looking for jobs after the only employer in their town closes the factory and moves to another country, then: [13: .D]

a) Those people are considered as unemployed because of a structural change in industry.

b) Those people are still in the labor force.

c) This situation can be easily improved through monetary policy.

d) None of the above

MMT BANK

Assets

Liabilities and Net Worth

Reserves = ___________

$800 = Demand Deposits of Public

Loans = _____________

$400 = Net Worth

[endnoteRef:14].Refer to the table above for MMT Bank. The required reserve ratio is 25%. If MMT is just meeting its reserve requirement and has no excess reserves, its loans equal [14: .B]

a) $900

b) $1,000

c) $600

d) None of the above

[endnoteRef:15].Consider a closed economy (i.e. no exports or imports) with government. Which of the following will occur when the economy is in equilibrium? [15: .C]

a) S=I

b) G=T

c) S + T=I + G

d) None of the above

e) All of the above

[endnoteRef:16].Which of the following factors does not shift the demand curve for money? [16: .C]

a) changes in real income

b) changes in the price level in the economy

c) changes in the interest rate

d) changes in the federal funds rate

[endnoteRef:17].What is likely to increase equilibrium GDP the most? [17: .A]

a) The government increases spending by $1,000 and cuts taxes by $100.

b) The government cuts taxes by $1,000 and increases spending by $100.

c) The government increases spending by $1,000 and increases taxes by $1,000.

d) Both a and b

[endnoteRef:18].Because the Consumer Price Index (CPI), as formulated by the U.S. Bureau of Labor Statistics, uses a base year bundle to compare prices in the base year against prices in some other year, the [18: .A19.A20.A

Short essay questionsPPF

a-i) point A is inefficient.a-ii)point B is infeasible.b-i) PPF1 is original production possibility frontier. If new technology happens in clothing industry, then PPF1will shift upward to PPF2. Put it in words, we still have same output if all resources are devoted to chocolate only, but once we start to produce clothes, given any certain level of chocolate produced, new technology produces relatively more amount of clothes than before.b-ii) Decrease in labor force makes every output on the frontier drop, so PPF1 will shrinks to PPF3.

GDPGDP contains products traded with price on the market only, and it thus doesn’t include pollution, as it is important for measuring people’s living. Additionally, income distribution is also an important issue. If 90% wealth is owned by 10% of population in a country, this will make GDP lost its power in capturing people’s welfare. GDP can’t reflect income distribution problem too.(There are many reasons in text books making GDP not perfect index measuring people’s welfare.)CPI is fixed weight index, which uses the fixed basket of products at base year to represent market basket. To calculate CPI, we need to use price in different years to derive the value of market basket. In contrast to CPI, GDP deflator uses extensive and none- fixed weighted method to measure overall price level.CPI is fixed weighted measure, so it ignores the substitution effect while price changes. Given price increase, quantity, which is traded before in lower price, enlarges the total amount consumed. Hence, CPI tends to overestimate the inflation level.

Demand and SupplyThere are two technologies to electricity. However, cost of technology for green electricity is higher so marginal cost to produce green electricity is higher. The slope of electricity produced by green technology is steeper than traditional technology, shown in figure (A). Combining supply of electricity produced by traditional technology, we can get market supply. Supply and demand are drawn in (c).The equilibrium happens at market supply equals to demand. Equilibrium price is denoted as Q_old in (c). Market price is P_old. (Q_old=QT+QG).After government’s subsidy, the supply curve of green electricity shifts right and thus aggregated supply curve also shifts right. This increases total equilibrium quantity from Q_old to Q_new and decreases price from p_old to p_new. As observed, the market of green electricity increases from QG to QG*.

Long essay questions(1)(1) discount rate (2) required reserved ratio (3) open maker operation. All those tools will affect the monetary supply and then have influence on interest rate. To be more specific, because discount rate is the borrowing rate from Fed, if this rate is high, bank would hold more excessive reserve such that less money will flow into the whole circulation system. On the other hand, required reserve ratio directly regulates banks to hold certain amount of reserve, which also controls the amount of money allowed to whole circulation system. Finally, open market operation is trying to control the monetary supply by buying or selling securities (bonds) on the market.In the 3-panel diagrams, the interest rate is already close to 0. Given interest rate 0, investment approaches to point A, where is the limit of investing. Now Increasing money supply further won’t push investment to a higher level and thus won’t increase output. The conventional tools of Fed’s exert through monetary market which always goes through interest rate to affect investment. Since interest rate is zero, main conventional tools may lose their potency.

(2)(a) The plan goes though fiscal policy by increasing government expenditure to hire more people working for government. Referring to the following diagram, G will increase to G*, and this shift AE up to a new level. Equilibrium output will increase from Y to Y*. If government finances the expenditure from tax, we still have higher income generated by budget balance policy, because budget-balance multiplier effect, which equals to 1 in given models.

(b) Assuming we are at income Y1 initially. If government increases expenditure from G1 to G2, the output will increase from Y1 to Y2 and then induce the increase of monetary demand. At this time, higher interest triggered by higher money demand won’t reduce investment greatly, while investment function is very steep. Alternatively speaking, investment is not sensitive to change of interest rate now, and crowding out effect is very small. AE may only shift back a little bit because investment decreases from I1 to I2.

However, if the crowding out effect is very large, investment reduces significantly. AE curve may shift unfavorably. For example, if we keep increase expenditure from G2 to G3, then income increases from Y2 to Y3, new money demand will increase the interest to r3, which enormously drops investment from I2 to I3. Final equilibrium will falls into Y3* given lower business investment. The final result that Y3*< Y2 is not what government wants. If investment is very sensitive to change of interest rate, the crowding out effect would be high. Fiscal policy may have unfavorable results.

]

a) CPI tends to exaggerate the impact of inflation.

b) CPI tends to understate the impact of deflation.

c) CPI will be a much broader measure of inflation, as compared to the implicit GDP deflator index.

d) CPI is currently computed every week by Bureau of Labor Statistics.

45⁰

Aggregate expenditures ($millions)

AE0

250

150

250

Aggregate Output ($) millions)

19.Refer to the figure above. Assume government expenditure, investment, exports and imports are constant with zero tax. If the MPC increases to 0.5, equilibrium aggregate output

a) increases

b) remains the same

c) decreases

d) cannot be determined from the given information

20.Following question 19, we can conclude that

a) the old government multiplier is smaller than new government multiplier.

b) the old government multiplier is larger than new government multiplier.

c) the old government multiplier equals to new government multiplier.

d) we need more information to answer if the older government multiplier is larger or not.

Part II: Short Answer questions. 25 points

1. Production Possibility Frontier (5 points)

Consider an economy producing only chocolate and clothing. Chocolate is produced with land and labor as inputs, while clothing is produced with capital and labor as inputs.

a. Draw the PPF assuming the usual “bowed-out” shape, putting chocolate on the horizontal axis and clothing on the vertical axis. (1 point)

i) Indicate a point on graph at which production is inefficient. Label this point as A. (1 point)

ii) Indicate a point on graph at which the combination of outputs is infeasible. Label this point as B. (1 point)

b. Draw the possible consequences of the following on the economy’s PPF. Assume each event below occurs separately (and not in combination with other events noted), and use a separate diagram for each answer.

i) A new technology appears in the clothing industry making it possible to use less of each input to make the same amount of output.(1 point)

ii) The economy wide labor force shrinks over the next year due to vigorous enforcement of a new stricter immigration policy.(1 point)

2. GDP and Inflation (10 points)

a. GDP is not a perfect welfare index (not a perfect index to measure people’s welfare). Please list 2 reasons why it is not perfect. (4 points)

b. Pease explain the differences between GDP deflator index and CPI. (4 points)

c. Why does the CPI tend to overestimate the level of inflation? (2 points)

3. Demand and Supply (9 points)

Suppose the market (output) for “green” electricity is currently very small because the cost of generating the electricity via solar and wind technologies is higher compared to the cost of electricity generated by traditional technologies. Suppose that the government decides to promote green electricity production by subsidizing the price of their inputs – i.e. they tell the windmill and solar panel companies that they will reimburse them for the cost of any labor they use in the production process, making it essentially free to them.

a. First, assume there are two firms, one of which uses green technologies and the other of which uses traditional technologies to produce electricity. Please draw the supply curve for each company, basing on the information provided. (3 points)

(Please follow the usual convention of putting the price on vertical axis.)

b. Graph the total market supply and the market demand curves before the government subsidy, showing the market equilibrium quantity and price and the quantity which each firm will produce in equilibrium. (4 points)

(You need to make the equilibrium consistent with the statement that green electricity market (output) is small.)

c. Show graphically the effects of the government subsidy to production costs for the green electricity producer. (3 points)

Part III: Long answer questions (Newspaper Analysis) 16 points

1. “How Much More Can the Fed Help the Economy?” (8 points)

Read the following excerpt from the article, How Much More Can the Fed Help the Economy?, from the New York Times on August 24 and answer the following questions.

With the risk of another recession on the horizon, many economists and investment analysts are hoping that Ben S. Bernanke will signal on Friday that the Federal Reserve is ready to step in once again and save the economy from disaster. After all, Congress seems wholly unwilling to engage in fiscal stimulus, and instead is planning further fiscal tightening.

But there are reasons to believe the Fed’s remaining tools may be losing their potency. Monetary policy works best when the Fed cuts interest rates, giving banks a good opportunity to extend more loans. If more loans go out to people and companies, those people and companies can buy more goods and services, creating more demand and eventually more jobs.

Interest rates are already at zero, though (and have been for a while), so the Fed cannot lower them any further. That’s why the Fed has engaged in more unusual — in some cases, unprecedented — measures.

a Please list 3 ways that can be used by Fed to affect monetary market and explain how they work. (4 points)

b Now the market interest is already zero. Draw a graph (or graphs) illustrating what the article claims about Fed’s tools using the models taught in ECON 1120 and also explain how what you have drawn explains what is said in the article. (You need to use the 3 panel diagram of the “monetary market”, “investment market”, and “aggregate expenditure and real output” to analyze the article’s claim.) (4 points)

2. “Employers Say Jobs Plan Won’t Lead to Hiring Spur?” (8 points)

Economists estimated that President Obama’s plan, costing an estimated $447 billion if it were ever fully adopted, could create anywhere from 500,000 to nearly two million jobs next year.

Most of those jobs would be added, economists say, as workers spend the additional take-home pay that would result from a proposed payroll tax cut for employees. As consumers increase spending, that can prompt more hiring by retailers, washing machine makers, restaurants and more.

Some of the new jobs would also probably come from measures like the proposed $35 billion to retain or hire teachers, police and firefighters, as well as $30 billion to refurbish school buildings and $50 billion to build or repair highways, railroads, transit systems and waterways.

a. Please use any diagram you learned to illustrate President Obama’s plans spurring the economy, and explain why the plan can or cannot generate a larger benefit (income) than it cost (tax needed to cover the Job Plan Bill). (Assume for now that there is no feedback effect from monetary policy on investment.) (4 points)

b. Let us relax the assumption of no feedback from the monetary market (so now the monetary market does affect investment). Now you are given the investment function diagram below. Use the 3 panel diagram to illustrate a situation in which the “crowding out” effect will be very large, so fiscal policy doesn’t work; thus, government can’t use fiscal policy forever. What has to be true for this to occur? (4 points)

Investment

Interest Rate