Econ 1120 – INTRO MACRO – Fall-2011 –October 17, 2011Make-UP PRELIM #1 (MONDAY)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 + Newspaper Article question @ 10 points each ANSWER ALL QUESTIONS. TOTAL POINTS = 100. TOTAL TIME = 90 minutes. Prelim1 score weights 27.5% of final grade.

1

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----------------------------------------------------------------------------------------------------------

_____________/6 0 (mc) ________/ 5 (q1) ________/1 0 (q2) ________/1 0 (q3) ________/1 5 (q4)

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

2

Part I: Multiple Choice.

1. If desired (planned) aggregate expenditures exceed actual aggregate output/income at the current level of Y, thenA. inventories build up above desired levels, so firms will cut production.B. inventories fall below desired levels, so firms will cut production.C. inventories fall below desired levels, so firms will increase production.D. inventories build up above desired levels, so firms will increase production.E. firms change their desired amount of investment.

2. Which will cause a movement along the demand curve (not moving the demand curve) and cause an increase in the quantity demanded for pizza?A. An increase in the price of hamburgers, a substitute.B. A decrease in the price of buffalo wings, a complement.C. A decrease in the price of pizza.D. None of the aboveE. All of the above

3. Hurricane Katrina caused some oil refineries to close down. Assuming that demand for gasoline did not change, the shift in supply implies that in equilibrium:A. the price of gasoline increased and the quantity of gasoline increased.B. the price of gasoline increased and the quantity of gasoline decreased.C. the price of gasoline decreased and the quantity of gasoline increased.D. the price of gasoline decreased and the quantity of gasoline decreased.E. the price of gasoline and the quantity of gasoline remainned unchanged

4. Which of the following is an automatic stabilizer to the economy?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. All of the above

3

5. Suppose the required reserve ratio, RRR, on demand deposits is 20%. Suppose that people in the particular economy of Mistrustville tend to sell securities to the central bank for paper money and then they keep all this money under their mattresses, since they do not trust the commercial bankers. As compared to an economy where everyone deposits all of what they get in cash immediately at one of the economy’s commercial banks, the behavior of people in Mistrustville will tend toA. increase the value of the money multiplier.B. make monetary policy less effective.C. make monetary policy more effective.D. make fiscal policy less effective.

6. If no foreign companies produce in IthacaLand, but many of the IthacaLand's companies produce abroad, thenA. IthacaLand's GNP will tend to exceed its GDP. B. IthacaLand's GDP will tend to exceed its GNP. C. IthacaLand's GNP and GDP will tend to be equal. D. IthacaLand's GDP will tend to be equal to its national saving.

Cornell BANKAssets Liabilities and Net Worth

Reserves = ___________

$800 = Demand Deposits of Public

Loans = _____________ $400 = Net Worth

7. Refer to the table above for Cornell Bank. The required reserve ratio is 25%. If HSBC is just meeting its reserve requirement and has no excess reserves, its loans equalA. $900.B. $1,000.C. $600.D. none of the above.

8. Suppose the Consumption function was defined as C = 300 + 0.8(Y-T). Suppose further that investment spending (I) is fixed at 100, the government expenditure is fixed at 250. What is MPS? What is the investment multiplier? What is the government expenditure multiplier?A. 0.2; 5; 5B. 0.4; 2.5; 2.5C. 0.1; 2.5; 9

4

D. None of above

5

9. Which of the following individuals is considered unemployed according to the way the U.S. calculates its official statistics?A. A former blue-collar worker, now out of work for half a year, who starts to enjoy staying

at home and has stopped looking for work 6 weeks ago.B. A 15-year-old who lost his job from a local restaurant and is actively looking for another

one.C. A college sophomore, who is actively looking for an unpaid summer internship on Wall

Street.D. A Chrysler auto worker, just laid off last week, who is trying to get back into his old job

or find a new one and is searching.E. All of the above

10. A horizontal demand curve is called:A. perfectly elastic.B. downward sloping.C. upward sloping.D. perfectly inelastic.

11. Which of the following are examples of intermediate goods? A. a book written by your favorite author purchased by youB. dough bought by a housewife to bake a cake for her daughter’s birthdayC. dough bought by a chef to bake a cake at his restaurantD. a set of screwdrivers purchased by a small firm

12. If disposable income is less than gross income because income is taxed by the government, and the tax rate is increased, then we can concludeA. The MPC has to go downB. The MPS has to go upC. The government spending multiplier is lowerD. The tax multiplier is lowerE. All of the aboveF. None of the above

6

13. If nominal GDP has increased, then we can safely conclude that:A. Everybody in the economy is better offB. Price levels are higherC. There is more unemploymentD. None of the aboveE. All of the above

14. Consider the typical model of an economy where there is a goods and services market and a money market. Suppose the desired investment curve is very sensitive to interest rate (i.e. a small change in the interest rate has a large effect on the level of investment). In such an economyA. the fiscal policy crowding-out effect is small.B. the fiscal policy crowding-out effect is large.C. monetary policy is extremely ineffective.D. reducing the money supply will have a big impact on Y*, whereas increasing the money

supply has very little impact on Y*.

15. Refer to the table for all the information you need on a simple frugal economy with no government. At an aggregate output level of $100 billion, the unplanned change in inventory is A. -$20 billion. B. -$80 billion. C. -$30 billion. D. $120 billion.

16. Using the table and its information again, the equilibrium level of aggregate output, Y*, in the economy isA. $100 billionB. $300 billionC. $400 billionD. $500 billion

7

17. The Production Possibility Frontier (PPF) will shift inward as a result of:A. a decrease in consumption.B. people quit jobs in the computer industry to accept jobs in the steel industry.C. a large union goes on strike.D. migration out of the country.E. All of the above

18. Which of the following factors does not shift the demand curve for money?A. changes in real incomeB. changes in the price level in the economy C. changes in the interest rate D. all of the above

19. Suppose the money supply is set by the Federal Reserve. When the Federal Reserve buys a government bond from the private sector, the money supply isA. Not affectedB. First decreased, then increased C. DecreasedD. Increased

20. Which of the following is a normative question?A. Why do gasoline prices increase before holiday weekends?B. What will happen to gasoline consumption if excise taxes on gasoline are increased?C. To reduce the regressive nature of the gasoline excise tax, should a portion of the

gasoline excise tax paid by low-income individuals be refunded to them to make it fair?D. How will the price of oil be affected by the tension in Iran?

8

Part II: Short Answer questions. 30 points

1. Fiscal Policy (10 points)If it has been determined that the aggregate consumption function of the country is C = 800 + (0.8)(Y-T), what can you say about households' tendency to consume, what can you say about households' tendency to save?

Assume that the government expenditure is given by G=350, taxes by T=170 and Investment I=0.

a. Suppose the government wanted to increase the country's GDP by $100 billion. What two tools can it use to do that? (4 points)

b. Using only the first tool you listed, how large of a change will the government need to achieve its target of $100 billion? (3 points)

c. Using only the second tool you listed, how large of a change will the government need to effect to achieve it target of $100 billion? (3 points)

9

2. GDP (10 points)The small and isolated island of Bithaca has no contact with the outside world. Only two firms

operate in this economy: Joe & Bros. Farm which produces wheat, and Big Bakery, which makes

bread (the only final product in the economy) using the wheat provided by Joe & Bros. Farm. The

following data are given for the year 2005.

Joe & Bros. Big Bakery

($) ($)

Total output 50,000 150,000

Total Expenses

Wages 27,000 51,500

Rent & Interest 4,000 9,000

Intermediate Goods Purchased 0 ?

a. What is the value of the intermediate goods purchased by Big Bakery? (2 points)

b. What is the value added to GDP by Joe & Bros.? (2 points)

c. What is the value added to GDP by Big Bakery? (2 points)

d. What is the GDP for Bithaca? Show your calculations. (2 points)

e. Assume that although Big Bakery produces $150,000 worth of bread it is only able

to sell $125,000. The remaining $25,000 thousands worth of bread is stored. What is

the GDP of Bithaca now? (2 points)

10

3. A Congressional Super Committee (10 points)

Suppose Congress has convened a “super committee” tasked to decrease the nation’s federal deficit by $1 trillion next year. Further suppose that the MPS is 0.5.

a. Suppose the super committee makes a commitment to achieve this reduction by spending cuts alone. What is/are the appropriate multiplier(s) to use, (expressed both as a formula and numerically), and what is the effect of the cuts on GDP? (consider “first round” direct effects only) (3 points)

b Suppose that instead they achieve this reduction by tax increases alone. What is/are the appropriate multiplier(s) to use (expressed both as a formula and numerically), and what is the effect of the increases on GDP? (consider “first round” direct effects only) (3 points)

c. Suppose that instead they achieve this reduction by equal cuts in spending and increases in taxes. What is/are the appropriate multipliers to use (expressed both as a formula and numerically), and what is the effect of the cuts and increases on GDP? (consider “first round” direct effects only) (4 points)

11

Part III: Long Answer questions (Newspaper Analysis) 10 points

1. “Inflation Rise Puts Fed in Bind?”

Read the following excerpt from the article, Inflation Rise Puts Fed in Bind, in WSJ blog on August 24 and answer the following questions.

The chances of a new bond-buying program will remain low until inflation pressures ease for at least several months, or the economy falls into a much sharper decline. The Fed aims to keep inflation a bit below 2%, so easing policy further when inflation is already in that territory risks pushing inflation above the Fed's comfort zone.

"Should the economy slip into recession … then they could easily overlook the high inflation data, knowing it will eventually follow the economy lower," said Michael Feroli, chief U.S. economist at J.P. Morgan Chase. "However, if growth simply remains mired in the doldrums then the failure of core inflation to move lower could slow the degree to which the Fed provides further monetary stimulus."

a Please explain why a bond-buying program is a tool for Fed to spur the economy. (You need to use 3 panel diagrams of “monetary market”, “investment market” and “aggregate expenditure and real output” to answer the question.)(4 points)

b. What other two tools could the Fed use to stimulate the economy and how do they work? (4 points)

c. Name at least one other policy that could be used to stimulate the economy and show graphically how it works. (2 points)

12

13

11. C2. C3. B4. D5. B6. A7. B8. A9. D10.A11. C12.F13.D14.B15.B16.D17.D18.C19.D20.C

Short essay question 1According to equation, it is obvious to see that 1 dollar increase in income will increase the 0.8 dollar of consumption for households, and thus the marginal propensity to consume is 0.8. Since MPS+MPC=1, we can conclude that marginal propensity to save is 0.2. Alternatively speaking, households tend to save 0.2 dollar out of 1 dollar increase in income.

a. The most common tools for government are increasing government expenditure and decreasing tax for stimulating country’s GDP.

b. Given MPC is 0.8, the government multiplier is 1/(1-0.8)=5. To make GDP increase by 100 billion, government spending (expenditure) need to increase by 100/5=20 billion.

c. Similarly, the tax multiplier is -0.8/(1-0.8)= -4. For 100 billion increase in GDP, government needs to reduce tax by 100/4=25 billion.

Short essay question 2a. The intermediate goods are material used produce final output. Since we only have two firms in this

simple economy, the intermediate good is wheat bought by Big Bakery. The value of intermediate good is 50,000.

b. The intermediate value for Joe&Bro. is 0, so the value added is (50,000-0)=50,000

c. The total output of Big Bakery is 150,000, so the value added is (150,000-50,000)=100,000d. For calculation of GDP, only final good counts. So GDP is 150,000e. GDP is still 150,000. The remaining 25,000 is categorized as inventory.

Short essay question 31. Given MPS=0.5 and MPS+MPC=1, so the marginal propensity to consume is 0.5. Therefore the

government spending multiplier is 1/(1-MPC)=2. Decreasing spending cuts alone to achieve 1 trillion decrease in deficit will reduce GDP by 1 * 2 =2 (trillion).

2. The tax multiplier is - MPC/(1-MPC)= -0.5/(1-0.5)= -1. Hence increasing tax alone for 1 trillion will decrease GDP by 1*1= 1 (trillion).

3. Now 1 trillion reduction of deficit is split into 0.5 trillion decrease in spending and 0.5 trillion increase in tax. The government spending multiplier and tax multiplier remain at 2 and -1 respectively. So the total decrease on GDP is (0.5)*2 + 0.5*1=1.5 (trillion)

Long essay 1a. Buying bonds, Fed is injecting the money into the market and having bond back. People or institution

who selling bond to Fed, will receive the money, and the money will flow into the circulation system of the banks. The whole circulation process increases the money supply and lowers the interest rate. As shown in the following graph, investment increases from I* to I** as interest rate decreases from r* to r**, and the increase of investment shift aggregate expenditure up. Under a new level of investment, the

new equilibrium output will increase from Y* to Y**. (There is possible a second round effect from increase of monetary demand, which is caused by new level of income. Regarding this, The Aggregate expenditure may move down a little bit, but in general we expect first round effect is more dominant.)

b. Discount rate and required reserved ratio are also tools having influence on the monetary supply and then interest rate. To be more specific, because discount rate is the borrowing rate from Fed, if this rate is high, banks 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. By controlling the amount of money available for monetary circulation system, Fed control the supply of monetary market and therefore has the power to affect investment by increasing or lowering interest rate.

c. Government can use fiscal policy to stimulate economy. Take increasing government spending for example. If the original income is Y1, income will shift to Y2 after government expending increases from G1 to G2. This also will trigger second round effect which is resulted from increasing monetary demand, increasing interest rate and lowering the investment. If second round effect happens, then the AE will shift back, but, as long as the investment is extremely sensitive to interest rate or there no extreme shift of monetary demand, the first round effect is expected to dominate second round effect.

10

(B)

(A)Y* Y

AEAE=C+I*+G

(C)

r

M

Ms

Mdr

r

I

Ms

I* I**

r*

r**

AE=C+I**+G

Y**

(A)

Y1 Y

AEAE=C+I1+G1

(C)

r

M

MsMd(Y1)

r1

r

I I1

Ar2

I2r1r2Md(Y2)

Y2

AE=C+I1+G2

AE=C+I2+G2

(B)

Y2*