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Econ 1120-INTRODUCTORY MACROECONOMICS

PRELIM #2-Wissink-Spring 2017 – April 13

Clearly Print Your LAST(family) Name: ______________________________________________________

Clearly Print Your First Name: ___________________________________________________

Your Cornell NetId: ___________________ Your Student Number: __________________________

There are two sections in this exam. Answer all questions.

Part I: 17 multiple choice questions @ 3 points each

Part II: 2 problems @ 22 and 27 points, respectively

TOTAL POINTS = 100, TOTAL TIME = 90 minutes.

NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.

NO CELL PHONES, NO IPODS OR SIMILAR DEVICES WITH CALCULATOR “APPS”.

NO GRAPHING CALCULATORS.

NO BOOKS. NO NOTES. NO HELP SHEETS.

NO TALKING TO EACH OTHER.

“X” the SECTION you regularly attend (that is to say, check where you will pick up your prelim):

|"X" |DIS # |TA |Meeting Times |Location |

|  |250, 251 |Jee Hun Choi |Mondays 8:00-8:50; 9:05-9:55 |Goldwin Smith G64 |

|  |252, 253 |Ye Susan Yu |Wednesdays 2:30-3:20; 3:35-4:25 |Rockefeller Hall 105 |

|  |254, 255 |Ikchan An |Fridays 09:05-9:55; 10:10-11:00 |Rockefeller Hall 104 |

|  |256, 257 |Khai Sim |Fridays 1:25-2:15; 2:30-3:20 |Rockefeller Hall 104 |

One more time, please…

Clearly Print Your LAST(family) Name: _______________________________________________________

Clearly Print Your First Name: ___________________________________________________

Your Cornell NetId: ___________________ Your Student Number: __________________________

GRADING

MC (3 each, total of 51) =___________________

Q1 (out of 22 points) =_________________

Q2 (out of 27 points) =_________________

TOTAL SCORE: _____________________

Part I: Multiple Choice. Do them ALL.

CIRCLE the letter for your answer.

_____________________________________________

[i]. If the consumption function for the economy is:

C = 500 + 0.4Yd, then the saving function, S, is:

A. S = -500 + 0.6Yd.

B. S = -500 - 0.6Yd.

C. S = -500 + 0.4Yd.

D. S = 500 + 0.4Yd.

E. S = 500 + 0.6Yd.

[ii]. Assume a simple linear frugal ungoverned closed economy where the consumption function (in billions) is: C = 500 + 0.6Y and desired investment, Id, is $100 billion. If current aggregate output/income is Y = $1,000 billion, we can conclude that

A. undesired changes in inventories will be zero.

B. there will be an undesired fall in inventory.

C. there will be an undesired rise in inventory.

D. aggregate output/income will tend to fall.

E. the economy is in equilibrium, so there is no tendency for aggregate output to change.

|All Figures in Billions of Dollars |

|Aggregate Output (Y) |Aggregate Consumption |Desired |

| | |Investment |

|200 |240 |20 |

|300 |320 |20 |

|400 |400 |20 |

|500 |480 |20 |

|600 |560 |20 |

|700 |640 |20 |

[iii]. Refer to the table for all the information you need on a simple linear frugal economy with no government or international sector. At an aggregate output level of $600 billion, the unplanned change in inventory is

A. +$20 billion.

B. +$40 billion.

C. +$60 billion.

D. -$40 billion.

E. -$20 billion.

[iv]. Assume the “Keynesian” AEd multiplier is 3.0. If desired investment falls by $20 million while exogenous exports rise by $50 million (other things remaining constant), by how much will the equilibrium level of income (Y*) rise?

A. It doesn’t rise, Y* falls.

B. By $90 million.

C. By $210 million.

D. By $50 million.

E. By $75 million.

[v]. In a simple frugal economy with no government and no international trade, which one of the following will occur when the economy is at equilibrium Y*?

A. S = C + Id and at the same time, S = Id.

B. Y = S and at the same time, C = Id.

C. C = Y and at the same time S = 0.

D. Id = C.

E. Y = C + Id and at the same time, S = Id.

[vi]. Consider a simple linear frugal governed economy with no international sector and only one non-zero marginal propensity, the marginal propensity to consume (MPC). Assume MPC = 0.5. If Y* rises by $100 billion due to an increase in desired investment spending, the increase in desired investment spending must have been

A. $500 billion.

B. $200 billion.

C. $50 billion.

D. $10 billion.

E. $1 billion.

[vii] Consider an economy completely described by the following two equations:

S = -120 + 0.30Y and Id = 10 +0.10Y. The “paradox of thrift” applied to this particular economy suggests that

A. an exogenous increase in the desire to save will make it so that in equilibrium people actually save less.

B. an exogenous increase in the desire to consume will make it so that in equilibrium people actually consume less.

C. an exogenous increase in the desire to save will make it so that in equilibrium people save the same amount.

D. an exogenous increase in desired investment leads to less saving in equilibrium.

E. an exogenous increase in desired investment leads to less consumption in equilibrium.

[viii]. When the money demand function depends positively on aggregate output/income (as compared to when we assume it does not depend on aggregate output/income at all), we can conclude that

A. expansionary fiscal policy will have more efficacy.

B. expansionary fiscal policy is predicted to decrease interest rates.

C. the efficacy of monetary policy is increased.

D. expansionary fiscal policy will result in some crowding out of private investment.

E. the money multiplier is reduced.

[ix]. Which one of the following is NOT included in what the U.S. government defines as M2?

A. currency in circulation and held by the public.

B. checkable deposits.

C. savings accounts.

D. government bonds held by the public.

E. travelers checks.

[x]. Bob lives in a country with a MONOPOLY commercial bank named Big Bank. The required reserve ratio (rrr) is 5%. Big Bank is always fully loaned-up. Bob finds $100 under his sofa and deposits it into his Big Bank checking account. Bob’s deposit of $100

A. will not change demand deposits at all.

B. will ultimately increase demand deposits by less than or equal to $100.

C. will ultimately increase the money supply by $2,000.

D. has the potential to increase Big Bank’s loans by $2,000.

E. has the potential to increase total demand deposits by $2,000.

[xi]. The transaction motive for holding cash balances ___________ money demand curve as aggregate income changes. The speculative motive for holding cash balances ____________ money demand curve as the interest rate changes.

A. shifts the; shifts the

B. shifts the; causes movements along the same

C. causes movements along the same; shifts the

D. causes movements along the same; causes movements along the same

E. causes movements along the same; has no impact on the

[xii]. Assume an economy and banking “world” like the one assumed in lecture. The required reserve ratio (rrr) is 40%. If the Fed wants to increase the money supply by $600 it should

A. increase the required reserve ratio.

B. sell $240 worth of government securities to the public.

C. buy $240 worth of government securities from the public.

D. buy $600 worth of government securities from the public.

E. buy $359 worth of government securities from the public.

[xiii]. What is the initial round of events (in order) that results when The Fed engages in an open market purchase of securities from the public?

A. Aggregate output decreases, demand for money decreases, the interest rate decreases, planned investment increases, and aggregate output increases.

B. Money supply decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.

C. Money demand decreases, the interest rate increases, planned investment decreases, aggregate output decreases, and money demand decreases.

D. Money supply increases, the interest rate increases, planned investment decreases, aggregate output decreases, and the money demand remains unchanged.

E. Money supply increases, the interest rate decreases, planned investment increases, aggregate desired expenditures increase, and equilibrium output increases.

[xiv]. If the interest rate is high, speculators tend to hold onto

A. bonds instead of money because they expect the interest rate to fall, and when it does, they will be in a position to sell bonds to people at a nice high price.

B. bonds instead of money because the opportunity cost of money is low.

C. money instead of bonds because the brokerage fees and other costs of buying bonds are high when the interest rate is low.

D. money instead of bonds because there is a speculation motive for holding a larger amount of money.

E. cash instead of bonds because they will want to buy bonds in the future.

[xv]. Contractionary monetary policy combined with expansionary fiscal policy is predicted to

A. have uncertain effects on the interest rate and planned investment.

B. drive income and consumption up.

C. drive income and consumption down.

D. drive the interest rate down and planned investment up.

E. drive the interest rate up and planned investment down.

[xvi]. Refer to the money market figure. At an interest rate of 3%, typical households

A. will attempt to increase their holdings of money by selling bonds.

B. are satisfied with the amount of money they are holding.

C. will attempt to increase both their holdings of money and their holdings of bonds.

D. will attempt to reduce their holdings of money by buying bonds.

E. will attempt to consume less.

[xvii]. This multiple choice question is simply a fill in the blank, instead. Suppose an economy that is completely described by the following equations:

[pic]

The investment multiplier for the economy is:

Part II: Make sure you read and do ALL parts of each question. Show as much work as possible. TRY to get started on every question. Show us something. Write legibly and remember to label all graphs and axes in diagrams.

1. Seppo and Vin (among others) are neighbors who live in Grayville, a country with a fractional reserve banking system with a required reserve ratio (rrr) of 25%. Assume there is only one monopoly commercial bank in Grayville, Blackbank. Blackbank always loans up to where its excess reserves = $0. The symbol for Grayville’s currency is $.

The Fed (that is the central bank) in Grayville wants to buy up $500 in government securities from the public. Suppose it buys $200 worth of securities from Seppo and $300 worth of securities from Vin. Suppose the Fed pays both Seppo and Vin by depositing payment into their respective checking accounts at Blackbank, denoted DD-Vin and DD-Seppo. Note DDp refers to ALL of the public’s checking accounts at Blackbank – including Vin’s and Seppo’s.

Questions:

a. Fill in any missing cells (see bold) in the ORIGINAL T-Accounts.

b. Given the information in the top half of the T-Accounts for Grayville, what is the value of the money supply (M1) PRIOR to the Fed’s purchase of the securities from Seppo and Vin? (Note that Seppo and Vin are just two of many people that live in Grayville.)

c. What final impact does the open market operation above have on the money supply (M1) of Grayville assuming Blackbank uses its portfolio of loans to make adjustments to its reserves position? (Note: Assume Seppo and Vin are no longer involved after the initial transaction and that all subsequent transactions are carried out in the commercial banking system.)

d. Fill in all the missing blanks (see bold) in the FINAL T-Accounts illustrated on the previous page as they would appear once the money supply has reached its new final position.

e. How would your answer to part (c) change if it turns out that Vin insists that the Fed pay him for his securities by giving him three new crisp hundred dollars bills signed by Donald Trump? He plans to keep these bills in a vault behind a picture of Adam Smith that hangs in his living room. Note: If you can’t come up with a number answer, at least tell us the direction in which your answer would change and why.

Answer Space:

Answer Space:

2. Suppose that the following set of equations describe ALL the relevant information about the island nation, Itsanice. Itsanice’s currency is called the dollar and its symbol is $.

The Goods and Services Market (Keynesian Cross) can be described by:

Consumption function: C = 20,000 + 0.8Yd (where Yd = disposable income)

Planned Investment function: Id = 3,000 – 4,000r. Current Id = 2,000

Government expenditures: G = 1,000

Taxes: T = 400

Exports: EX = 600

Imports: IM = 400

The money market can be described by:

Required reserve ratio (rrr) = 10% = 0.10

Money Demand function: MD= 1500 – 1,000r

Total Reserves = Required Reserves = 125. Excess Reserves = 0. Currency in circulation = 0.

Other:

The full employment level of national income is YFull employment = 114,800.

Inflation is assumed to be non-existent.

Questions:

a. What is the value of the Money Supply (M1)?

b. Determine the equilibrium level of national income, Y*. Show your work!

c. Illustrate this equilibrium using the 3-panel diagram from class. Make sure you label ALL the values on the horizontal and vertical axes in ALL three panels in your graph.

d. Calculate the multipliers for Gbar and Tbar. Show some work for how you arrived at your particular values.

e. How could the government use its fiscal policy variable Gbar to achieve full employment national income? Be specific with respect to the value and direction of the policy you suggest.

f. How could the government use its fiscal policy variable Tbar to achieve full employment national income? Be specific with respect to the value and direction of the policy you suggest.

g. Compare the policies in (e) and (f) with respect to their impact on Itsanice’s before and after federal budget deficit/surplus situation.

h. Instead of using fiscal policy, how might the Fed use monetary policy to achieve full employment national income? DO NOT FIND AN EXACT NUMBER. Just explain what the Fed would do using a verbal narrative with arrows. Indicate how this monetary policy would “look” in your 3-panel diagram.

PLEASE START ANSWERS ON NEXT PAGE

Answer Space:

Answer Space:

ECON 1120 Wissink S2017 Answers PRELIM 2

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[i] A

By the identity Yd = C + S, we can solve for the saving function: S = Yd – C = Yd – (500 + 0.4Yd) = -500 + 0.6Yd.

[ii] B

Aggregate desired expenditure at Y = $1000 is $1200 (which is C+Id), so not enough was produced to satisfy all of desired expenditure. Thus, there will be unplanned depletions of inventory.

[iii] A

When aggregate output Y is $600 billion, aggregate desired expenditure = C + Id = $580. Since AEd < Y, there will be an unplanned increase in inventories of $20 billion.

[iv] B

The net exogenous change in AEd equals 50 – 20 = $30 million. Using the Keynesian multiplier, we can find the change in income that will result: Y* = 30 * 3 = $90 million.

[v] E

A simple frugal economy with no government or international sector is defined by AEd = C + Id. In equilibrium, Y = AEd, so Y = C + Id. Since Y = C + S is identically true, it follows that C + S = C + Id ( S = Id.

[vi] C

Using the marginal propensity to consume, we can calculate the multiplier on investment: KI = 1/(1-0.5) = 1/0.5 = 2. Since KI = ”Y/ ”I, we can solve for the change in desired investment: ”I = 100/2 = $50 billion.

[vii] A

Graphing the saving and investment functions, it can be seen that, when the saving function shifts upwards, equilibrium savings will decrease.

[viii] D

If the = ΔY/ ΔI, we can solve for the change in desired investment: ΔI = 100/2 = $50 billion.

[ix] A

Graphing the saving and investment functions, it can be seen that, when the saving function shifts upwards, equilibrium savings will decrease.

[x] D

If the money demand function depends positively on aggregate output, expansionary fiscal policy—which increases aggregate output—will result in a higher equilibrium interest rate because money demand will also increase. This will have the effect of lowering desired investment, which is called the crowding out effect.

[xi] D

Government bonds are a type of security and do not qualify as money.

[xii] E

Bob’s deposit of $100 increases by the monopoly bank’s reserves by $100. Using the money multiplier (1 / 0.05 = 20), we see that total demand deposits can increase by, at most, 20 * 100 = $2000.

[xiii] B

Suppose that aggregate income increases. Then, at any given interest rate, consumers will increase their demand for money, which corresponds to a shift in the money demand curve. . The speculative motive for holding cash balances concerns the trade-off between holding money versus interest-bearing securities such as bonds. Suppose that the interest rate increases. This increases the opportunity cost of holding money—bonds now offer a higher rate of return than they did previously—so we would expect consumers to reduce the amount of money they want to hold. This corresponds to a movement along the same money demand curve.

[xiv] C

The money multiplier is 1 / 0.4 = 2.5. Therefore, if the Fed wants to increase money supply by $600, it will have to decrease reserves in the commercial banking system by 600 / 2.5 = $240. It can do so by purchasing $240 worth of government securities to the public.

[xv] E

When the Fed engages in an open market purchase of securities, the first thing that occurs is an increase in money supply through the money creation process in the commercial banking sector. This shifts the money supply curve outwards in the money market, leading to a lower interest rate. This encourages greater desired investment. This will increase aggregate desired expenditure, which means that aggregate output must increase for the economy to return to equilibrium.

[xvi] A

Choice A corresponds to the speculative motive for holding bonds. Recall that, if the interest rate is high, bond price is low: the investor is betting that the price will eventually go up and that, when it does, he will be able to turn a profit.

[xvii] E

Contractionary monetary policy will increase the interest rate and decrease desired investment. Similarly, expansionary fiscal policy will increase the interest rate (increase in aggregate output ( increase in money demand ( higher interest rate), which will depress desired investment.

[xviii] A

At an interest rate of 3%, there will be upward pressure on the interest rate. As the interest rate increases, bond prices are going down, suggesting that typical households are selling bonds and increasing their money holdings.

[xix] KI = 1/(1-c+ct)

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