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(ECON216)[2009](s)midterm~2047^_10244.pdf
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Econ 216 Managerial Macroeconomics
Spring, 2009
Midterm Exam

1. (20%) True and False. Briefly explain your answers.

a. The difference between adaptive and rational expectation in response to a demand shock in an AD-AS model is that with adaptive expectation the pace of adjustment towards the medium and long run output will be slower and will take place via shifts in the AD curve.



Ans:
False: With adaptive expectation, it takes more time for the economy to adjust to the medium and long run output, but this comes as a result of shifts in SRAS curve which is the function that has expected P explicitly imposed.
b. As in microeconomics, the AD-curve is downward sloping since consumers buy less goods when they are expensive.



Ans:
False: the AD-curve is downward sloping because higher a price level reduces the real supply of money (M/P). To restore the equilibrium in the money market the interest rate has to increase, so the amount of money demanded in equilibrium is equal to the amount of real money -now lower-. A higher interest rate reduces the level of investment, which implies a lower aggregate demand.
c. One advantage of open market purchases over lowering discount rate is that the Fed fund rate will always be reduced in the former, but not necessarily so in the latter.



Ans:
True: funds injected in into the banking system via open market purchases of securities will increase the supply of non-borrowed reserves and hence lower the Fed fund rate. Lowering discount rate will depend on whether it is low enough (compared to the Fed fund rate) to induce discount lending.
d. Other things being the same, markets where demand curves are flatter will result in lower real wages.



Ans:
False: With flatter demand curves, demand is more elastic and hence smaller the incremental mark-up(price over MC smaller). Since real wage W/P = 1/(1+), smaller the , higher the real wage.

2. (25%) Suppose the structure of an economy is defined by:


C = Ca + 0.8(Y - T)
Ca = 260 C 10r
T = 200 + 0.2Y
(M/P)d = 0.25Y C 25r
Ms/P = 2000
I = 1900 C 40r
G = 1800
NX = 700 C 0.14Y

a. Derive the equation for the IS curve.

b. Derive the equation for the LM curve.

c. Compute the equilibrium interest rate (r) and real output (Y).

d. Suppose consumer and business confidence decline, resulting in decreases in amounts of autonomous consumption Ca and investment by 40 and 60, respectively. Suppose also that the natural output equals the amount of Y calculated in part c. What would be the amount of a cut in autonomous tax that is required to restore real output to its natural level?



Ans:
(a) Y=C+I+G+NX. Thus, Y=(260-10r)+0.8(Y-(200+0.2Y))+(1900-40r)+1800+(700-0.14Y). So, IS: Y=9000-100r.

(b) (M/P)d=Ms/P. Thus, 0.25Y-25r=2000. So LM: Y=8000+100r.

(c) IS intersects LM => 9000-100r=8000+100r. 1000=200r. r=5. Y=8500.

(d) With the negative demand shock, the new IS: Y