Concordia UniversityDepartment of Economics

ECON 203 – INTRODUCTION TO MACROECONOMICSFall 2011 Midterm Exam VERSION B

Instructor: AncaAlecsandru

STUDENT NAME: _____________________________________________________

STUDENT NUMBER: __________________________________________________

Please read all instructions carefully.

1. This is a 60 minute-exam. The questions are worth 100 marks altogether. 2. Answers all questions.

You are allowed to use a non-programmable calculator. You may use either pen or pencil to provide your answers

Part I - Multiple choice questions (3 marks per question)

1. Empirical data show that a strong, positive relationship exists between personal consumption expenditures and:A) the level of personal disposable income.B) planned investment spending.C) the real interest rate.D) progressive taxes.

2. If nominal GDP increases by 10 percent from one year to the next but real GDP is unchanged then:A) Factor costs have not changed but net indirect tax rates have increased by 10 percent.B) Factor costs have increased by 10 percent but net indirect tax rates have not changed.C) All the above.D) The GDP deflator has increased by 10 percent.

3. An effective expansionary fiscal policy will:A) reduce a structural deficit.B) increase the structural deficit but reduce the cyclical deficit.C) reduce a cyclical deficit, but necessarily increase the total (actual) deficit.D) always result in a balanced budget once full-employment is achieved.

4. A fall in the Canadian price level will cause:A) exports to increase and imports to decrease.B) both exports and imports to decreaseC) exports to decrease and imports to increase.D) both exports and imports to increase.

5. For a given fluctuation in autonomous expenditure, economies with steeper AE functionswill:A) experience smaller business cycle fluctuations in real GDP and employment.B) experience the same business cycle fluctuations in real GDP and employment.C) experience larger business cycle fluctuations in real GDP and employment.D) experience stable real GDP and employment with no business cycle fluctuations.

6. Assume the government runs budget surplus. The result is:A) an increase in the total of outstanding government bonds.B) the paradox of thrift.C) a decrease in the public debt.D) the money-fund effect.

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7. One of the early signs that an economy should increase its level of aggregate output is generally:A) a surplus of consumer goods on the market.B) a reduction in the overall price level.C) an unplanned reduction in business inventories.D) the willingness of firms to increase their level of investment in plant and equipment.

8. Other things equal, the multiplier effect associated with a change in government spending is:A) equal to that associated with a change in investment or autonomous consumption.B) greater than that associated with a change in investment.C) less than that associated with a change in investment.D) the same as that associated with a change in taxes.

9. To say investment and part of consumption are autonomous means that:A) investment determines consumption expenditure.B) both are determined independently of national income.C) they are interrelated.D) consumption expenditure determines investment.

10. All of the following are components of investment except:

A) increases in plant and equipment

B) inventory expansion

C) residential housing construction

D) purchases of stocks and bonds

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Part II – Answer all questions

Question #1 – Explain whether this statement is true or false. Marks are based solely on explanation. No marks will be awarded by simply stating “true” or “false” without explanation.

1.In a closed economy without government, if investment demand is given the slope of aggregate expenditure is determined by the consumption function.

Answer: In a closed economy, there is no international trade, no exports or imports. The AE function is C+I+G and only C has an induced componentC=C0+MPC*YI and G are autonomous, constant.

2.Changes in the unemployment rate are result of differences between the rates of growth of labour force and employment.

Answer:True, the unemployment rate is #unemployed/labour force or (labour force-#employed)/labour force. Changes in this rate will be determined by changes in the labour force and employment.

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Question #2 – Current events

1. “U.S. consumers stepped up their spending on retail goods in September, a hopeful sign for the sluggish economy.

They spent more on autos, clothing and furniture last month to boost retail sales 1.1 per cent, the Commerce Department said Friday. It was the largest gain in seven months.

Auto sales rose 3.6 per cent to drive the overall September increase. Still, excluding that category, sales increased a solid 0.6 per cent. […]”

(U.S. retail sales see largest gain in 7 months, The Globe and Mail, Oct 2011)

Refer to the excerpt above to explain the changes in the US economy (on aggregate expenditure and equilibrium output). What component of aggregate expenditure changes? Justify your answer. You could also illustrate the changes graphically, using the AE curve. (5 marks)

Consumption spending has increased which made the AE curve shift up and increase.Production has increased as a result.

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2.[…]The slowdown in the United States is dragging on longer than expected, cutting deeply into Canada's exports, the Bank of Canada said Thursday in its semi- annual outlook. But at the same time, inflation is heating up in Canada, driven by energy prices, the bank says. Total inflation is expected to surge close to 3 per cent near the end of this year.(U.S. slowdown cutting deeply into Canadian exports, The Globe and Mail)

Refer to the excerpt above to explain how the slowdown in the US and the rise in oil prices would affect our Canadian economy. For simplicity, assume that before these changes the Canadian economy was in the short run and long run equilibrium. Discuss the effects on the inflation rate and the unemployment rate. You could also illustrate the changes graphically, using the AD/AS/LAS curves (5marks)

AS shifts left since production costs have , AD shifts down since our exports have . But based on the article, inflation is expected to rise by 3%, so the AS shift must be larger than the AD shift.

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Question #3 Policies (Total=25 marks) The following equations describe the economy of Country A:

C = 4500 + 0.5Yd

I = 1500The government collects taxes T=1500 (which are lump-sum, constant taxes, no induced-taxes, or t=0) and spends G=2500. Only the consumers pay taxes.NX=100 Yd stands for disposable or after-tax income.

i. Find the equilibrium output in this economy. Show your calculations. (5 marks)

Y= C+I+G+NX=4500+0. 5(Y-1500)+1500+2500+100=4500-750+1500+2500+100-0. 5Y=7850-0.5YSo, Y=7850/(1-0.5)=15,700

ii. What is the value of the autonomous expenditure multiplier? (5 marks)1/(1-MPC)=1/(1-0.5)=2

iii. Provide a brief intuitive description (no rounds necessary) for why the multiplier in (ii) is larger than 1. (5 marks)

An increase in expenditure in one industry will generate further increases in income and expenditure in other industries.

iv. Suppose government spending G increases from 2500 to 2700 due to a war with Country B. Find the new equilibrium Y and calculate the effect of such a policy on BB (government budget balance). (5 marks)

2 methods: the increase in Y =the increase in G* the multiplier=200*2 =400, so the new Y=16,100OR repeat point (i) with the new G and get Y=8050/0.5=16,100.BB=T-G=1500-2700=-1200 deficit

v. If Country A is 5% below its targeted income What changes in government expenditures are required to achieve this target? (5 marks)

Now the economy is at 95% capacity, the potential Y is Yactual/0.95=16,100/0.95=16,947.37 Therefore, the needed change in Y is 847.37. For this the increase in G should be 847.37/2=423.7 (the increase in Y divided by the multiplier).If you used Y=15,700 than Y potential is 15,700/0.95=16,526.315 and the increase in G is (16,526.315 -15,700)/2=413.15.

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Question # 4 Unemployment (total: 25 marks)

Consider the following data collected from a country.Total population 1,107,000Population under 15 years of age or institutionalized 275,000Adults that are not in the labour force 231,000Unemployed 43,000Part-time workers looking for full-time jobs 20,000

i. Calculate the size of the labour force. (5 marks)

Labour force =1,107,000-275,000-231,000=601,000

ii. Calculate the unemployment rate. (5 marks)

Unemployment rate=(#unemployed/labour force)*100=(43,000/601,000)*100=7.15%

iii. Now suppose 9,500 of the unemployed workers are so discouraged that they have given up looking for work. They decide to go back to school full-time. Find the new unemployment rate. (5 marks)

Unemployment rate= [(43,000-9,500)/(601,000-9,500)]*100=(33,500/591,500)*100=5.66%

iv. True or false: "Low unemployment rates imply more people are working"– justify your answer (5 marks)

The number of employed stayed the same in this case (558,000), just the unemployment rate changed. ORThe unemployment rate shows the #of unemployed RELATIVE to the labour force, if both change we can get a different rate, but no conclusion can be drawn for the #EMPLOYED.

v. Assume that the Structural Unemployment rate is 4% and Frictional Unemployment rate is 1%. Calculate the Natural rate of unemployment and the Cyclical unemployment rate (use your result from point (ii.) for that). (5 marks)

Actual/Total unemployment=7.15%, Natural rate of unemployment=4%+1%=5%, Cyclical Unemployment=7.15%-5%=2.15%.

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