Economics 101 - Cornell University



Econ 1120-INTRODUCTORY MACROECONOMICS

MAKEUP PRELIM #2-Wissink-Spring 2017 – April 14

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: 18 multiple choice questions @ 3 points each

Part II: 2 problems @ 20 and 26 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 54) =___________________

Q1 (out of 20 points) =_________________

Q2 (out of 26 points) =_________________

TOTAL SCORE: _____________________

Part I: Multiple Choice. Do them ALL.

CIRCLE the letter for your answer.

_____________________________________________

[i]. 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.

[pic]

[ii]. Refer to the table. At an output level of $2,400 billion, there is a tendency for aggregate output(income)

A. to fall.

B. to increase.

C. to remain constant.

D. to either increase or decrease.

E. to increase at an increasing rate.

[iii]. Assume the “Keynesian” AEd multiplier is 2.0. 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. $90 million.

C. $60 million.

D. $50 million.

E. $75 million.

[iv]. Consider a simple linear frugal economy with no government or international sector. Suppose the marginal propensity to consume equals one and subsistence consumption equals $60. If this is the case, then which one of the statements below is TRUE?

A. Y* would have to be zero.

B. Households would save everything and spend nothing.

C. Marginal propensity to save would also equal 1.

D. We cannot determine Y*.

E. The subsistence consumption multiplier would be very small.

[v]. The current Chair of the Board of Governors of the U.S. Federal Reserve System is

A. Ben Bernanke.

B. Alan Krueger.

C. Janet Yellen.

D. Janet Mitchell.

E. Alan Greenspan.

[vi]. Consider a simple frugal economy with no government and no international sector. Assume that only consumption increases when aggregate output(income) increases. In this economy the “paradox of thrift” would be that

A. an exogenous desire to save more would result in the same amount of saving in equilibrium.

B. an exogenous desire to save less would result in the same amount of saving in equilibrium.

C. an exogenous desire to save more would result in less saving in equilibrium.

D. an exogenous desire to save more would result in more saving in equilibrium.

E. an exogenous desire to save less would result in less saving in equilibrium.

[vii]. The Fed’s preferred method to carry out its monetary policy is via

A. changing taxes.

B. changing the discount rate.

C. changing the required reserve ratio on demand deposits of the public.

D. changing government expenditures.

E. engaging in open market operations to change the federal funds rate.

[viii]. Consider a simple linear frugal governed economy with no international sector. Which one of the following statements below is TRUE?

A. Equilibrium will occur where Saving = Actual Investment.

B. Equilibrium will occur where Saving = Desired Investment.

C. Equilibirum will occur where Saving + Taxes = Actual Investment + Government Expenditures.

D. Equilibirum will occur where Saving + Government Expenditures = Taxes + Desired Investment.

E. Equilibirum will occur where Saving + Taxes = Desired Investment + Government Expenditures.

|HSBC BANK |

|Assets |Liabilities and Net Worth |

|Reserves = ___________ |$800 = Demand Deposits of Public |

|Loans = _____________ |$400 = Net Worth |

| | |

[ix]. Refer to the table above for HSBC Bank. The required reserve ratio is 25%. If HSBC has no excess reserves, its loans equal

A. $900.

B. $1,000.

C. $600.

D. $1,800.

E. none of the above.

[x]. Suppose Mistrustville’s required reserve ratio (rrr) is only 1%. Suppose that when people in Mistrustville sell securities to the central bank they insist on being paid in cash. They keep this cash at home under their mattresses, since they do not trust the commercial banks.

As compared to an economy where everyone keeps all their money as demand deposits in commercial banks, the odd behavior of people in Mistrustville will tend to

A. increase the value of the money multiplier.

B. make monetary policy more effective.

C. make monetary policy less effective.

D. make fiscal policy less effective.

E. make fiscal policy more effective.

[xi]. Suppose that at the current interest rate the quantity of money supplied exceeds the quantity of money demanded. Given this information, we know that there will be pressure for

A. the money supply to increase.

B. bond prices to decrease and the interest rate to decrease.

C. bond prices to increase and the interest rate to increase.

D. bond prices to increase and the interest rate to decrease.

E. bond prices to decrease and the interest rate to increase.

[xii]. The Fed wants to INCREASE the money supply. In which answer do both listed options have the potential to increase the money supply?

A. The Fed sells securities to the public & lowers the required reserve ratio.

B. The Fed sells securities to the public & raises the required reserve ratio.

C. The Fed buys securities from the public & raises the required reserve ratio.

D. The Fed buys securities from the public & lowers the required reserve ratio.

E. The Fed buys securities from the public & increases the discount rate.

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

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

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

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

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

E. will attempt to consume less.

[xiv] If the annual market interest rate is 5% and there is no inflation, a bond with a face value of $10,000 and a maturity date in exactly two years is worth _________________ today.

A. $9,523.81

B. $9,070.29

C. $10,526.63

D. $10,000

E. $10,500

[xv]. Expansionary monetary policy combined with contractionary 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 up and planned investment down.

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

[xvi]. 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. travelers checks.

E. government bonds held by the public.

[xvii]. In a “no inflation” model that includes the goods and services market and the money market with money demand that depends on r and Y in the manner discussed in class, which one of the following pairs of events is predicted to unambiguously lead to an increase in the equilibrium interest rate, r*?

A. The Fed purchases government securities from the public and there is a decrease in government expenditures.

B. The Fed decreases the discount rate and it also decreases the required reserve ratio.

C. The Fed decreases the required reserve ratio and there is also an exogenous increase in the level of aggregate desired expenditures via an increase in subsistence consumption.

D. The Fed sells government securities to the public and at the same time there is an increase in government expenditures.

E. The Fed sells government securities to the public and at the same time it decreases the required reserve ratio.

[xviii]. 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 government expenditure 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. Illustrated below is everything you need to know about the T-accounts for the Fed, the consolidated Commercial Banks, and one citizen, Sheeza Investor. The required reserve ratio is 10%. Currency in public circulation is $200. All loan activity in the economy is handled via demand deposits at commercial banks. All banks operate with zero excess reserves.

a. What is the value of the initial money supply, M1?

b. If the Fed decides to sell $12 worth of its securities to Sheeza, by the final position, how much will the money supply have changed and in what direction? Assume that Sheeza pays for the securities with money from her checking account. Assume commercial banks do all their adjusting to meet required reserves by adjusting the amount of loans they hold.

c. What are the final values for the five question marks in the final position T-accounts below?

d. Briefly explain how your answers to (b) change if Sheeza pays the Fed directly with her cash.

|Initial Position |

|Federal Reserve Bank |Commercial Banks |Sheeza Investor |

|Assets |Liabilities+Net Worth |Assets |Liabilities+Net Worth |Assets |Liabilities+Net Worth |

|Securities=$240 |$40=Reserves |Reserves=$40 |$400=DDp |DDSheeza=$15 |$0=Debts |

| |$200=Currency |Loans=$360 | |Securities=$0 |$115=Net Worth |

| | | | |Cash at home=$100 | |

|FINAL Position |

|Federal Reserve Bank |Commercial Banks |Sheeza Investor |

|Assets |Liabilities+Net Worth |Assets |Liabilities+Net Worth |Assets |Liabilities+Net Worth |

|Securities=$228 |$28=Reserves |1) |3) |4) |$0=Debts |

| | | | | | |

| | | | | | |

| | |Reserves=$?? |$??=DDp |DDSheeza=$?? | |

| |$200=Currency |2) | |5) |$115=Net Worth |

| | | | | | |

| | | | | | |

| | |Loans=$?? | |Securities=$?? | |

| | | | |Cash at home=$100 | |

START ANSWERS ON NEXT PAGE

ANSWERS

2. Suppose that the following set of equations describe ALL the relevant information about the island nation, Itsanice.

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

Planned Investment function: Id = 4,000

Government expenditures function: G = 8,000

Tax function: T = 5,000

Export function: EX = 1,000

Import function: IM = 0.3Y (take note that this is only Y and not Yd)

The full employment level of national income is YFull employment = 60,000.

The money market can be safely ignored for now.

Inflation is assumed to be non-existent.

a. Determine the equilibrium level of national income, Y*.

b. Illustrate this macro equilibrium on the “Keynesian Cross” graph.

c. Calculate the multipliers for G, T and Id. Show some work for how you arrived at this particular value.

d. How could the government use fiscal policy to achieve full employment national income? Be specific with respect to the values and directions of the policy you suggest. (Only one suggestion is required.)

Suppose now we recognize that there is a money market and that 1) investment depends on interest in the typical way and 2) money demand depends on interest and aggregate output/income in the usual way. Inflation can still be safely ignored.

e. How will these wrinkles affect the efficacy of the fiscal policy plan you suggested to achieve YFull Employment? SHOW THIS ON AN APPROPRIATE SET OF GRAPHS.

f. How will your fiscal policy plan have to be altered, that is, what would you change and in what way/direction? No numerical calculations are required, just a verbal exposition.

g. How could “The Fed” help the government’s fiscal policy makers out? Explain.

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ANSWERS

ANSWERS

ECON 1120 Wissink S2017 Answers PRELIM 2 MAKEUP

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[i] 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.

[ii] C

When aggregate output equals $2400, AEd = C + Id + G = $2400. Since Y = AEd, the economy is in equilibrium and aggregate output will have a tendency to remain constant.

[iii] C

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 * 2 = $60 million.

[iv] D

If marginal propensity to consume equals 1, the consumption function will be C = 60 + Y. Note that, since the slope of this function is 1, it will be parallel to the 45º helping line. Since the two lines will never intersect in the Keynesian cross diagram, it is impossible determine equilibrium output.

[v] C

Janet Yellen was sworn in as Chair of the Fed Board of Governors on February 3, 2014.

[vi] A

Plotting the saving function (which we can infer would be a positively sloped line, given what we are told about consumption) and desired investment (which is just a horizontal line, since we are told that it does not depend on output), we can see that that an upward shift in the saving function would not change the equilibrium level of saving. Note that B is wrong since it’s all about the DEFINITION of the paradox of thrift. Which is when people want to save MORE, they actually end up depressing the economy and saving the same amount. B is not correct since it’s not in the spirit of the way the paradox has been sold.

[vii] E

Although B, C, and E are all options available to the Federal Reserve, open market operations are the primary way by which it conducts monetary policy.

[viii] E

In a simple linear frugal governed economy with no international sector, it must be case that, if the economy is in equilibrium, leakages equal injections S+T = Id+G. 

[ix] B

From the required reserve ratio and given the assumption that HSBC holds zero excess reserves, the bank will have 800 * 0.25 = $200 in reserves. Since assets = liabilities + net worth, we know that loans = 800 + 400 – 200 = $1000.

[x] C

By not keeping all of their money as demand deposits in commercial banks, the people of Mistrustville reduce the amount of reserves in the banking system. As a result, the banks have fewer reserves to lend out when the central bank engages in expansionary monetary policy by purchasing securities, limiting the money creation effect. Monetary policy is therefore less effective than it would be otherwise.

[xi] D

If quantity of money supplied exceeds quantity of money demanded, there will be pressure on the interest rate to decline. The inverse relationship between bond prices and the interest rate means that bond prices will go up as well.

[xii] D

Buying securities to the public will increase the money supply, as well lowering the reserve requirement ratio.

[xiii] C

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.

[xiv] B

Since PV = FV/(1+r)^T, where FV is the face value of the bond, r is the interest rate, and T is the time until the bond matures, we have: PV = 10000/(1+0.05)^2 = $9070.29.

[xv] E

Expansionary monetary policy will decrease the interest rate and increase desired investment. Similarly, contractionary fiscal policy will decrease the interest rate (decrease in aggregate output ( decrease in money demand ( lower interest rate), which will increase desired investment.

[xvi] E

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

[xvii] D

The Fed selling government securities to the public is a form of contractionary monetary policy, which causes the interest rate to go up. An increase in government expenditures will increase aggregate output, which shifts the money demand curve outward and places upward pressure on the interest rate.

[xviii] 1/(1-c+ct)

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