Name _________________________ Student ID ________________________

Section day and time _________________

Final Exam - Economics 101 (Fall 2009)
You will have 120 minutes to complete this exam. There are 105 points and 7 pages

Multiple Choice: (20 points total, 2 points each) Choose best answer and record in blanks below.

1____ 2____ 3____ 4____ 5____ 6____ 7____ 8____ 9 ____ 10 ____

1) In the long run, the overall level of 5) If US money growth rises 3% and output
production in our economy depends upon: growth rises 2 %, then according to the
a) the supply of labor Quantity Theory and the Fisher relation, the
b) the supply of capital nominal interest rate in the U.S. should
c) technology level a) rise 5%
d) all of the above b) rise 1%
c) not change
2) Which of the following could explain a rise d) fall 1%
in the natural rate of unemployment in the e) fall 5%.
U.S.?
a) a cut in government spending 6) The Phillips Curve says that if fiscal stimulus is
b) a rise in money supply used to lower unemployment below its normal
c) a rise in the minimum wage long-run level, this comes at the cost of
d) a cut in unemployment benefits a) higher output
b) lower output
3) If China has a higher saving rate than the U.S. c) higher inflation
(and the same rates of depreciation and d) lower consumption
population growth, and same production
technology), this implies that in the very long7) Suppose a country has the following Phillips
run China would necessarily have a higher curve:  = e – 2 (u - un). If expectations are
level of ____ than the U.S.: rational , what is the “sacrifice ratio” in terms of
a) GDP per person unemployment (assuming that we are starting at
b) consumption per person the natural rate of unemployment)?
c) both (a) and (b) a) 4
d) neither (a) nor (b) b) 2
c) 0
4) If the economy is experiencing a recession and d) 0.5
interest rates are falling, which of the e) 0.25
following shocks could be causing the
recession, according to the IS-LM model: 8) The “sticky nominal wage” model of
a) rise in government spending aggregate supply implies:
b) fall in money supply a) The real wage tends to fall when GDP rises.
c) rise in exogenous real money demand b) The short-run aggregate supply curve is
d) fall in exogenous investment expenditure upward sloping.
c) A rise in price level lowers the real wage.
d) All of the above.

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9) In the Keynesian Cross model, if government 10) A lesson from the Dynamic DAD-DAS model
spending is raised by $100 million, income is that in order for the Federal Reserve to
must maintain a stable inflation rate, it’s monetary
a) rise by more than $100 million. policy rule setting the nominal interest rate
b) rise by $100 million. must respond:
c) rise by less than $100 million. a) strongly to the output gap.
d) rise, but it is not clear how much b) strongly to inflation.
c) weakly to inflation.
d) weakly to the real interest rate

Problem 1: IS/LM in the Short Run (20 points total)

Suppose the government wishes to stimulate GDP by $1 billion in the short run, and is trying
to decide between using either monetary policy or fiscal policy (in particular, a tax cut).
a) (8 points) Draw a separate IS-LM diagram for each of these policies in the short run; label
the policy above each graph. Be sure to label the axes, the curves, and use arrows showing
the direction the curves shift. Also mark the initial equilibrium as point ‘1’, and the short-run
equilibrium as point ‘2’. Explain each curve shift briefly. (Make the usual IS-LM
assumptions: prices are completely fixed in the short run. Investment is just the usual
function of the interest rate alone; consumption is a function of disposable income alone,
with a constant marginal propensity to consume.)

b) (6 points) Discuss in a few sentences the differences in the effects of the two polices on the
real interest rate and total national saving (sum of private plus government saving). If the
government’s goal were to raise GDP by the $1 billion. amount, while keeping national
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 saving as high as possible (since it is already very low in the U.S.),which policy would be the
better choice? Explain your reasoning in a few sentences.

c) (6 points) Suppose that in this economy, the real money demand behavior were less
responsive to the interest rate than you assumed in parts (a) and (b) above. How would
this change the slopes of the curves?
____: slope of IS curve a) steeper b) flatter c) same d) ambiguous
____: slope of LM curve a) steeper b) flatter c) same d) ambiguous
How would the tax cut discussed above that is designed to raise output the desired $1
billion amount affect the following variables differently than above?
____: interest rate: a) more b) less c) same d) ambiguous
____: investment: a) more b) less c) same d) ambiguous
____: total national saving: a) more b) less c) same d) ambiguous
Does this money demand behavior make the tax cut more or less attractive as a policy
tool for this economy?
____: a) more b) less c) same d) ambiguous

Problem 2: Short Run and Long Run (25 points total)

Suppose we are experiencing a recession due to a shock to the money demand function that
permanently raises real money demand for a given interest rate. Use the IS-LM / AS-AD
tools to analyze the implications in the short run and the long run.
(Make the usual IS-LM assumption: Prices are completely fixed in the short run and
completely flexible in the long run. Assume there is no change in government spending.
Investment is a function only of the interest rate, consumption only a function of disposable
income with a constant marginal propensity to consume, nominal money supply is
exogenous.

a) (10 points) Draw the IS-LM and AS-AD graphs to show the short run and long run
equilibria following this shock. Assume that prices are completely fixed in the short run.
Be sure to label the axes, curves, use arrows to show shifts in curves, and mark the
equilibrium points: 1 for the initial equilibrium, 2 for the short run equilibrium, and 3 for
the long-run equilibrium. Explain in a sentence or two each curve shift.

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b) (6 points) What happens to the following real variables in the short run?
____: real GDP: a) rise b) fall c) no change d) ambiguous
____: real interest rate: a) rise b) fall c) no change d) ambiguous
____: investment: a) rise b) fall c) no change d) ambiguous
____: real money demand a) rise b) fall c) no change d) ambiguous
____: nominal GDP a) rise b) fall c) no change d) ambiguous
____: real money supply a) rise b) fall c) no change d) ambiguous

c) (6 points) Consider the value that each of the variables goes to in the long run -- is this
long-run value the same as the initial level before the shock (point 1 on your graphs), will
it end up higher in the long run than its initial level, will it end up lower, or is this
ambiguous for the given information.
____: real GDP: a) same as initial b) higher c) lower d) ambiguous
____: real interest rate: a) same as initial b) higher c) lower d) ambiguous
____: investment: a) same as initial b) higher c) lower d) ambiguous
____: price level a) same as initial b) higher c) lower d) ambiguous
____: nominal GDP a) same as initial b) higher c) lower d) ambiguous
____: real money supply a) same as initial b) higher c) lower d) ambiguous

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d) (3 points) Will the recession created by this permanent shock be permanent? Discuss in a
couple sentences how the money market responds differently in the long run than in the short
run to this permanent shock.

Problem 3: Neoclassical Model (25 points total)

Suppose the real side of the U.S. macroeconomy is characterized as follows. Note that
consumption depends upon the interest rate here rather than investment.
Production: Y = 10 K1/2 L1/2
Factor supply: K = 100 L = 100
Government: G = 200 T = 200
Consumer behavior: C = 400 + 0.5(Y-T) - 2000r
Investment behavior: I = 200
Suppose the nominal side of the economy is characterized by the following:
Quantity theory of money: MV = PY where V=4
Nominal money supply: M = 500
(Y is real GDP, K capital, L labor, G government purchases, T taxes, C consumption, I
invest-ment, r real interest rate, P price level, M money supply, V velocity.)

a) (12 points) Compute the equilibrium levels of the following variables:

real interest rate, consumption, price level, real wage
Show your work, and be careful about mathematical accuracy.

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b) (5 points) Suppose that there is a cut in government spending. What effect will this have
on the variables listed below? No computations necessary; no explanation required.
____: real GDP: a) rise b) fall c) no change d) ambiguous
____: real interest rate: a) rise b) fall c) no change d) ambiguous
____: consumption: a) rise b) fall c) no change d) ambiguous
____: private saving a) rise b) fall c) no change d) ambiguous
____: national saving a) rise b) fall c) no change d) ambiguous
c) (5 points) Suppose that there is a rise in nominal money supply. What effect will this
have on the variables listed below? No computations necessary; no explanation required.
____: real GDP: a) rise b) fall c) no change d) ambiguous
____: price level a) rise b) fall c) no change d) ambiguous
____: nominal GDP a) rise b) fall c) no change d) ambiguous
____: real wage a) rise b) fall c) no change d) ambiguous
____: nominal wage a) rise b) fall c) no change d) ambiguous
d) (3 points) Does the “classical dichotomy” hold in this economy? Explain what this means.

Problem 4: Solow Growth Model: (15 points total)

Suppose an economy can be characterized by the production function: y = f(k) = 2k0.5, which
already is in per worker terms, where k = K/L. Suppose the depreciation rate is 7%, the saving
rate is 10%, the population growth rate is 3%. Assume there is no technological progress.
a) (9 points) Using the Solow growth model, compute the steady state values of:
- capital per person,
- output per person, and
- the real rental rate on capital.

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b) (6 points) Suppose the country implements a policy that lowers the population growth rate
from 3% to 1%. What would happen to the values of the following:

____: steady state output per person (a) rise (b) fall (c) no change d) ambiguous

____: steady state consumption per person

(a) rise (b) fall (c) no change d) ambiguous
____: steady state real rental rate on capital
(a) rise (b) fall (c) no change d) ambiguous
____: current growth rate in output per person
(a) rise (b) fall (c) no change d) ambiguous
____: steady state growth rate in output per person
(a) rise (b) fall (c) no change d) ambiguous
____: steady state growth rate in total output (not per person)
(a) rise (b) fall (c) no change d) ambiguous

12/8/09