Macro Economics Final Sample 1 Answers

PRINCIPLES OF MACROECONOMICS

FINAL EXAM: Sample #1

Duration - 3 hours

Aids Allowed: Non-programmable calculators only

INSTRUCTIONS:

This examination consists of TWO PARTS

Part I 10 diagrammatic/calculation questions of which you are expected to answer any eight (10 marks each for a total of 80%)

Part II 12 multiple choice questions of which you are expected to answer any ten. (2 marks each for a total of 20%). You must cross out the two multiple choice questions that you do not answer.

Wrong answers will not be deducted from right in grading Part II.

All questions are to be answered in the spaces provided in this question paper bookletDo not remove any pages or add any pages. No additional paper will be supplied. The blank backs of pages may be used for rough work. Show your work where applicable.

Print your name and student number clearly on the front of the exam and on any loose pages.

Student Name: ______________________________________________________ (Family Name) (Given Name)

Student Number: ______________________________

There are 14 pages to the exam.

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Principles of Macroeconomics: Final Exam; Sample #1

PART I: Diagrammatic/CalculationAnswer only 8 of the 10 questions in Part I

Place your answers (and work where necessary) in the space provided.

1. Comparative Advantage

Suppose that one unit of homogeneous resource produces either 20 kiwis or 5 pounds of wool in New Zealand and that a similar resource unit produces either 10 kiwis or 4 pounds of wool in Australia. Assume that these are the only countries and commodities in the world and that there are no economies of scale and no transportation costs.

a) In the space below, determine the country with the comparative advantage in kiwi production and the country with the comparative advantage in wool production. Show your calculations.

Calculate opportunity cost: New Zealand 1K for 1/4W or 1W for 4KAustralia 1K for 0.4W or 1W for 2.5K

Comparative Advantage from lowest opportunity costNew Zealand for K and Australia for W

b) Suppose that New Zealand has 150 units of the resource and Australia has 250 units of the resource. Draw the country's production possibility curve in separate diagrams with kiwis on the vertical axis. (1 mark)

PPC intercepts for at least one country and linear PPCrotation of CPC and new intercepts

c) Suppose that the countries agree to trade at a rate of 3 kiwis for 1 pound of wool. Draw each countries consumption possibility curve (labelled CPC) with trade in your diagrams. (1 mark)

d) Suppose that New Zealand decides to consume 1200 kiwis. Given trade with Australia at the exchange rate of 3 kiwis for 1 pound of wool, what is Australia's consumption of kiwis and wool? (1 mark)

New Zealand consumption of 1200K => trade of 3000-1200 = 1800 kiwis=> Australia trades 600 wool for 1800 kiwis -> consumption: 1800K and 400W

=> Australia trades 600 wool for 1800 kiwis -> consumption: 1800K and 400W

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2. National Accounts (10 marks)

The following information defines Canada's ‘domestic’ accounts in 1995 ($ Billions).Net Income of Unincorporated Businesses (Farm and non-Farm) and Rent 49Wages and Salaries and Supplementary Labour Income 420Depreciation (Capital Consumption Allowances) 106Exports 302Corporate Profits (before Taxes) 75Consumption 463Interest and Miscellaneous Investment Income 50Investment (Fixed) 117Change in Inventories 8Net Investment Income of Non-Residents 24Retained Earnings (Undistributed Corporate Profits) 25Government Spending 193Government Transfer Payments 78Imports 276Corporate Taxes 36Personal Taxes 94Indirect Taxes Less Subsidies 107

Calculate (Show your work) a) Gross Domestic Product as Aggregate Expenditure (2 mark)1 mark: setup with one incorrect number1 mark: AE = 463 + 117 + 8 + 193 + 302 - 276 = 807

b) Net Domestic Income calculated from Aggregate Expenditure (1 mark)1 mark: NDY = 807 – 107 – 106 = 594

c) Net Domestic Income calculated from Factor Incomes (2 marks)1 mark: everything correct except for one number1 mark: correct answer = 420 + 75 + 49 + 50 = 594

d) Personal Income calculated from Net Domestic Income (2 marks)1 mark: everything correct except for one number 1 mark: correct answer = 594 – 36 – 25 + 78 = 611

e) Savings (1 mark)1 mark: = 611 – 94 - 463 = 54

f) Net Domestic Product (1 mark)1 mark= 701 from 807 - 106 or 594 + 107

f) Gross National Product (1 mark)1 mark: = 807 - 24 = 783

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3. Prices Indices (10 marks)

1996 2006Price/unit Quantity Price/unit Quantity

Electricity (KWs) 0.06 1500 0.08 2400Natural Gas (CF) 0.15 2000 0.3 1200

The above table gives data for the price/unit ($)and quantity of Electricity and Natural Gas consumed per month on average by the average family in 1996 and 2006. Assuming that 1996 is the base year, calculate the following values.

a) nominal family consumption in 2006 (1 mark)

1 mark: = 552 from something like 0.08*2400 + 0.3*1200

b) the consumer price index for 2006 to one decimal (3 marks)

1 mark: setup for correct denominator = 0.06*1500 + 0.15*20001 mark: setup for correct numerator = 0.08*1500 + 0.3*20001 mark: correct answer = 184.6 from 100*0.06*2000 + 0.3*1500/0.06*1500 + 0.15*2000 (accept 184 or 185)

c) real consumption in 2006 relative to 1996 according to the consumer price index (1 mark)

1 mark: 299 from something like 552/184.6 (accept something close with a decimal)

d) the total inflation (%) between 1996 and 2006 relative to 1996 using CPI (1 mark)

1 mark: 84.6% (accept 84 or 85%)

e) real consumption in 2006 according to the GDP deflator measure (1 mark)

1 mark: 324 from something like 0.06*2400 + 0.15*1200

f) the GDP deflator for 2006 given 1996 as the base year (3 marks)

1 mark: setup for correct denominator = 0.06*2400 + 0.15*12001 mark: setup for correct numerator = 0.08*2400 + 0.3*12001 mark: correct answer = 170.4 (accept between 170 and 171) from some work

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4. MacroModel (10 marks)

An economy has the following set of macroeconomic equations.

Consumption: C = 580 + 0.8Yd Exports: X = 720Investment: I = 70 + 0.1Y Imports: IM = 150 + 0.1YGovernment Spending G = 460 Net Taxes (Taxes – Transfers) T = -30 + 0.15Y

(note that net fixed taxes are –10 not simply 10)

a) Calculate the Aggregate Expenditure equation. (2 marks)

1 mark: calculate correct constant term = 1,8221 mark: calculate correct induced term = 0.75Yfrom (say) AE = 580 + 0.8(Y – (-30 + 0.15Y) + 70 + 0.1Y + 460 + 720 – (150 + 0.1Y)

= 1,704 + 0.68Y

b) Calculate the value of Equilibrium Income (1 mark)

1 mark: = 5,325 from 1,704/(1-0.32)

c) What is the budget surplus(+)/deficit(-) at equilibrium? (1 mark)1 mark: = +308.75 from –30 + 0.15*5325 – 460

d) What is the change in Inventories at GDP (Y) equal to 5,500? (2 marks)

1 mark: AE = 5,444 from something like 1,704 + 0.68*5500 1 mark: Change in Inv = 5,500 – 5,444 = +56 (must not be negative)

Suppose that there is a recessionary gap of 200.i) What change in government spending will eliminate the recessionary gap? (1 mark)

1 mark: = +64 from 200*0.32 or 200/3.125 or something

ii) What change in fixed taxes will eliminate the recessionary gap of 200? (2 marks)

1 mark: recognition of fixed tax multiplier as –0.8/(1 – 0.68) = 2.5 or any use of 0.8*200 and the multiplier (Don’t worry about the negative sign here)

1 mark: = -80 (must be negative) from some work such as -200/2.5

iii) What change in fixed transfer payments will eliminate the recessionary gap? (1 mark)

1 mark: = +80 (must be positive) with some work such as 200/2.5

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5. Money Supply (10 marks)

Assume that the following conditions hold in Canada's banking system: deposits are all demand deposits, the required reserve ratio for deposits is 12.5% [0.125], there are neither excess reserves nor excess circulation, and banks hold all interest bearing assets as loans. Suppose that the Bank of Canada has an outstanding currency issue of $64 billion; the chartered banks have $2 billion worth of deposits at the bank of Canada; and the currency in circulation (i.e., in the hands of the public) is $37 billion.

a) What is the money supply at equilibrium? (1 mark) 1 mark: = 269 from something like 37 + (64 – 37 + 2)/0.125

b) What is the amount of loans at banks at equilibrium? (1 mark)

1 mark: = 203 from something like 232 – 29 or (64 – 37 + 2)/0.125 - 29

Now calculate the change in reserves and in the money supply at the new equilibrium for each of the following circumstances given the above information.

c) The Bank of Canada sells $US to buy $45 million Canadian in the foreign exchange market and simultaneously sells $13 million in Federal Government bonds to the public. i) the change in reserves is? (1 mark)

1 mark: -58 (m) (must be negative)ii) the change in money supply is? (1 mark)

1 mark: = -58m/0.125 = -$464m (need not be negative if mark lost for wrong sign in i) d) The Federal government finances health expenditure of $450 million by selling bonds worth

$160 million to the Bank of Montreal and increasing taxes by $200 million. i) the change in reserves is? (1 mark)

1 mark: 0 mii) the change in money supply is? (1 mark)

1 mark: = 0 e) Currency in circulation decreases permanently by $120 million due to ATMs.

i) the change in reserves is? (1 mark)1 mark: = +120m (must be positive)

ii) the change in money supply is? (1 mark)1 mark: = +840 from -120 + 120/0.125 (need not be positive if mark lost for wrong sign in i) d) The Bank of Canada writes a check to the Toronto-Dominion bank for $90 million to buy

bonds and switches $35 million in Federal Government deposits at ScotiaBank to the Bank of Canadai) the change in reserves is? (1 mark)

1 mark: +$55 m (from 90 – 35)ii) the change in money supply is? (1 mark)

1 mark: = +440 m from something like 55/0.125

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6. Monetary Policy: Linear Equations (10 marks)

The following equations describe an economyMoney Demand: Md = 0.125Y – 800r Investment: I = 68 – 400rAggregate Expenditure: AE = 360 + I + 0.75YAmounts are in $billions (e.g., 360 = $360 billion)

a) Given Money Supply (Ms) = 154 (billion) and Y/GDP = 1,616 (billion), what is equilibrium r and I? (2 marks)

1 mark: r = 0.06 (6%) from something like r = (0.125(1616) – 154)/8001 mark: I = 44 from I = 68 – 400(0.06)

b) Is Y in equilibrium at 1616? Show your work. (1 mark)

1 mark: Yes since Y = (360 + 44)/(1-0.75) = 1500 (or something similar)

c) Draw the Money Demand/Supply, MEI, and AE/Y diagrams, carefully labeling equilibrium r, I, and Y and the Money intercepts for Money Supply and Demand, the Aggregate Expenditure intercept, and the Investment intercept for Marginal Efficiency of Investment. (3 marks)

1 mark: purely diagrammatic intersection of money demand/supply at 0.06 (0.06), I = 44 from downward sloping MEI, and AE intersecting 45 degree line at 1616

1 mark: two correct of Ms = 154, MEI intercept = 68 1 mark: Md intercept = 202, and AE intercept = 404

d) What is the immediate effect (i.e., not including interest rate effects) on equilibrium GDP of an increase in autonomous government spending of + 20? (1 mark)

1 mark: Y = 1,696 from something like (360 + 20 + 44)/(1 – 0.75)

e) What is the effect on the interest rate and investment of an increase in government spending by +20 if Money Supply remains at 154? Ignore crowding out. (2 marks)

1 mark: r = 0.0725 (7.25%) from 154 = 0.125(1696) – 800r1 mark: I = 39 from something like 68 – 400(0.0725)

f) Is the Y you calculated in d) in equilibrium? Briefly explain.

1 mark: No because the interest rate effect changes Investment and thus Y (Anything that conveys this understanding will do including mention of the crowding out affect)

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7. Money and Spending Equilibrium (10 marks)

Steven Harper intends to reduce the GST sales tax by 1%. If the Conservatives make no other tax or expenditure changes, what effect will this reduction have on the economy if Money Demand is elastic and the Marginal Efficiency of Investment is elastic. Illustrate your understanding by using the appropriate diagrams to analyze the impact of reduction of taxes on aggregate expenditure, GDP, the interest rate, and investment. Be sure to demonstrate ‘crowding out’. Ignore price level and exchange rate effects.Label your axes carefully. Use the subscript ‘o’ for the initial equilibrium and the subscript ‘1’ for the initial effects on the variables and the subscript ‘2’ for the final effect on Y.

r r

M (or M/P) real I

ro

Io

MEI

SMo

DMo

real Y (or GDP)Yo

AEoreal AE

AE1

DM1

I1

r1

AE2

Y2 Y1

1 mark: ro from vertical Money Supply and negatively sloped Money Demand diagram1 mark: Io at ro from negatively sloped MEI1 mark: Yo from positively sloped and something ressembling a 45 degree line1 mark: Both Dm and MEI are relatively flat1 mark: increase AE (to say AE1) due decrease in taxes 1 mark: increase in Y (to Y1 say)1 mark: increase in Money Demand (to MD1 say) to give increase in r (to r1 say)1 mark decrease in Investment (to II say)1 mark: fall in AE relative to AE1 (to AE2 say) but still > Aeo1 mark: final Y (Y2 say) > Yo but < Y1 (Y2 not shown on above graph)

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8. Aggregate Demand and Aggregate Supply Equations (10 marks)

An economy is presently in long-run equilibrium with the following Aggregate Expenditure and Short Run Aggregate Supply equations.AE = 7,600 + 0.6Y – 8P SRAS: Y = 12,000 + 30P

a) What is the Aggregate Demand function? (2 marks)

1 mark: recognition that Y = 7,600 + 0.6Y – 8P (or Y = (7600 – 8P)/(1-0.6)1 mark: Y = 19,000 – 20P

b) What is short-run equilibrium price and Y/GDP? (2 marks)

1 mark: P = 140 from 19,000 – 20P = 12,000 + 30P or something similar1 mark: Y = 16,200 19,000 – 20(140) or 12,000 + 30(140)

c) What is short-run equilibrium price and Y/GDP given a decrease in government spending = -400? (3 marks)

1 mark: AD: Y = 18,000 – 20P from Y = 7200 + 0.6Y – 8P or something similar1 mark: P = 120 from 18,000 – 20P = 12,000 + 30P1 mark: Y = 15,600 from 18,000 – 20(120) or 12,000 + 30(120)

d) If long-run equilibrium GDP = 15,000, what is long-run equilibrium price given the decrease in government spending = -400? (1 mark)

1 mark: P = 150 from 15,000 = 18,000 – 20P

e) Ignore part d). If long-run equilibrium price is 100, what is long-run equilibrium GDP given the decrease in government spending = -400? (1 mark)

1 mark: Y = 16,000 from 18,000 – 20(100)

f) Given your answer from e), what is autonomous expenditure when long-run equilibrium price is 100 given the decrease in government spending = -400? (1 mark)

1 mark: A = 6,400 from something like AE = 7200 – 0.6Y – 8(100)

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9. Aggregate Demand and Aggregate Supply (10 marks)

a) Assume that an economy is initially in short-run Price (Po) and GDP (Yo) equilibrium with considerable unemployment due to a recessionary gap. Draw an Aggregate Demand/Aggregate Supply diagram to show the short-run (Ps, Ys) and long-run (P1, Y1) effects of an increase in government spending that would eliminate the recessionary gap if there was no change in prices. (5 marks)

real Y (or GDP)

P level SRASo

ADs

ADo

PoPs

LRAS

Y*Yo Ys

SRAS1

1 mark: Po and Yo at intersection of AD and SRASo, and vertical LRAS1 mark: increase AD to intersect LRAS (or Y*) > Yo 1 mark: AD must intersect LRAS (or Y*) at Po so that Ps > Po and Ys > Yo but Ys < Y* from intersection of SRASo and AD1 mark: increase SRAS to intersect AD at LRAS (Y*)1 mark: P1 = Po (i.e., no change in price) and Y1 = Yo

b) Suppose that an economy is initially in short-run and long-run Price (Po) and GDP (Yo) equilibrium. Draw an Aggregate Demand/Aggregate Supply diagram to show the short-run (Ps, Ys) and long-run (P1, Y1) effects of a significant technological improvement. Be sure to shift all necessary curves. (5 marks)

P

Po

ADo

SRASoLRASo

AD1

Ys

P1

Y*

SRAS1

Ps

LRAS1

SRAS2

Y*1

1 mark: SRAS shifts to the right1 mark: Ps < Po and Ys > Yo at SRAS1 intersect Ado1 mark: LRAS shifts right (should be, but does not have to be here, beyond beyond Ys)1 mark: P1 < Ps and Y1 > Ys at AD intersect LRAS11 maark: SRAS shifts down to intersect AD at LRAS1

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10. Exchange Rates (10 marks)

The following diagrams represent the original equilibrium position in the market for the Canadian dollar. Show the shift in the demand and/or supply of Canadian dollars and the new equilibrium exchange rate under the following circumstances each considered separately. Assume that the exchange rate is flexible unless otherwise advised.a) A decrease in Canadian imports from the U.S.

(1 marks)

1 mark: Supply decreases

b) Canadian inflation is 5% and U.S. inflation is 2%. (2 marks)

1 mark: Demand decreases1 mark: Supply increases (shifts right)

c) Canadian real GDP increases by 3.5% and US real GDP increases by 1%. (2 marks)

1 mark: Supply increases (shifts right)1 mark: Demand increases but not as much as S so

E depreciates (must have depreciation)

d) Assume a fixed exchange rate for the EC/US. In the diagram, show the immediate impact of an increase in the Canadian money supply on Demand and Supply of the $Canadian. (2 marks)

1 mark: Demand decreases 1 mark: Supply increases (shifts right)

e) What is the equililbrium effect of an increase in the Canadian money supply on EC/US and the interest rate in Canada given the fixed exchange rate? Use your diagram in d) and a draw a Money Demand/Supply diagram in the space below to demonstrate your position. (3 marks)

1 mark: Indicate Qs > Qd at Eo (surplus of $C) in diagram above1 mark: Money D/S diagram with an initial increase in MS and decrease in r1 mark: Money Supply decreases in Money D/s diagram raising r back to original r

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Q$C

S$C

D$C

Eo

$Co

EUS/C

Q$C

S$C

D$C

Eo

$Co

EUS/C

Q$C

S$C

D$C

Eo

$Co

EUS/C

Q$C

S$C

D$C

Eo

$Co

EUS/C


PART II: MULTIPLE CHOICE: DO ALL TEN QUESTIONS Circle the best answer for each question.Each question is worth 2 marks.

1. Which of the following is false for Canadian and US unemployment data for the month of March?a) the unemployment rate in Canada fell to a 32 year lowb) the unemployment rate fell in both Canada and the U.S.c) employment increased in both Canada and the U.S.d) employment growth was greatest in Ontario despite weak manufacturinge) full-time jobs accounted for most of the increase in Canadian employmentf) none of the above

2. Which of the following was the U.S. market’s response to the March employment data?a) bond prices fell on expectation of lower interest rates due to low inflation b) bond prices fell on expectation of higher interest rates to reduce inflationc) bond prices rose on expectation of lower interest rates due to low inflation d) bond prices rose on expectation of higher interest rates to reduce inflatione) none of the above

3. Suppose that all the individuals in an economy have the same Marginal Propensity to Consume (MPC). Suppose further that the government increases income taxes by $100 million to finance a $100 million increase in transfer payments. Which of the following is the most likely effect on the National Accounts?a) Consumption decreases by $100 millionb) Consumption decreases by the MPC*$100 millionc) Consumption doesn’t changed) Consumption increases by the MPC*$100 millione) Consumption increases by $100 millionf) none of the above

4. What is the effect of an increase of the tax rate on Aggregate Expenditure equilibrium? In particular, what is the effect on Autonomous Spending (A), the Marginal Propensity to Spend (MPE), and equilibrium GDP (Y) ceteris paribus?a) decrease in A, decrease in MPE, and decrease in Yb) decrease in A, increase in MPE, and decrease in Yc) decrease in A, increase in MPE, and increase in Yd) no change in A, decrease in MPE, and decrease in Ye) no change in A, increase in MPE, and increase in Yf) increase in A, decrease in MPE, and decrease in Yg) increase in A, decrease in MPE, and increase in Yh) increase in A, increase in MPE, and increase in Yi) none of the above

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5. Suppose that Md = 0.1Y – 1000r is the Money Demand function for an economy and the economy is presently at equilibrium with Y = 2000, Ms (Money Supply) = 150, and the r (interest rate) = 0.05 (5%). What is the change in Money Supply necessary to keep the interest rate unchanged if GDP increases to 2400?a) –50 b) –40 c) –30 d) –20 e) –10 f) 0g) +10 h) +20 i) +30 j) +40 k) +50l) none of the above

6. Suppose that the Marginal Efficiency of Investment shifts out due to increased expansion during business cycle expansion (such as is occuring now). What would be the equilibrium effect of such a increase in the Marginal Efficiency of Investment?a) decrease in Investment, decrease in GDP and decrease in the interest rateb) decrease in Investment, decrease in GDP and increase in the interest ratec) decrease in Investment, increase in GDP and decrease in the interest rated) decrease in Investment, decrease in GDP and increase in the interest ratee) increase in Investment, decrease in GDP and decrease in the interest ratef) increase in Investment, decrease in GDP and increase in the interest rateg) increase in Investment, increase in GDP and decrease in the interest rateh) increase in Investment, increase in GDP and increase in the interest ratei) none of the above

7. Which of the following best explains the recent reluctance of the Bank of Canada to raise interest rates as rapidly as the Federal Reserve Board?a) the Canadian economy grew more slowly than the US economy in the past five yearsb) the Canadian economy is further from potential GDP than the U.S. economyc) fear of inflation is higher in Canada than in the U.S.d) $Canadian has appreciated significantly while the $US has depreciated significantlye) none of the above

8. Suppose that an economy is initially in equilibrium at potential GDP. Which of the following is the long-run equilibrium result of an increase in government spending on Aggregate Expenditure (AE), Aggregate Demand (AD) and Short-run Aggregate Supply (SRAS)?a) AE shifts up (increases), AD shifts right (increases), and SRAS shifts upb) AE shifts up, AD shifts right, and SRAS shifts downc) AE shifts up, AD shifts down, and SRAS Shifts downd) AE doesn’t change, AD shifts right, and SRAS shifts upe) AE doesn’t change, AD doesn’t change, and SRAS doesn’t changef) none of the above

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9. Suppose that an economy is presently at potental (full employment) income. What is short-run and long-run equilibrium effect (relative to initial equilibrium) on the Price level (P) and real GDP (Y) of a significant increase in the price of oil?a) decrease in P and Y in the short-run and decrease in Y in the long-runb) decrease in P and Y in the short-run and no change in Y in the long-runc) decrease in P and increase in Y in the short-run and decrease in Y in the long-rund) decrease in P and increase in Y in the short-run and no change in Y in the long-rune) increase in P and decrease in Y in the short-run and decrease in Y in the long-runf) increase in P and decrease in Y in the short-run and no change in Y in the long-rung) increase in P and increase in Y in the short-run and decrease in Y in the long-h) increase in P and increase in Y in the short-run and no change in Y in the long-runi) none of the above

10. What is the equilibrium effect of an increase in Money Supply on the interest rate, net exports, GDP, and the exchange rate (E) if the exchange rate is flexible?a) no change in interest rate, net exports, GDP, or exchange rate (E) b) no change in interest rate, net exports, and GDP but depreciation of Ec) no change in interest rate but increase in net exports and GDP and depreciation of E d) decrease in interest rate, net exports, GDP, and depreciation of exchange ratee) decrease in interest rate and net exports, increase in GDP, and depreciation of Ef) decrease in interest rate and net exports, increase in GDP, and appreciation of Eg) decrease in interest rate, increase in net exports and GDP, and depreciation of Eh) decrease in interest rate, increase in net exports and GDP, and appreciation of Ei) none of the above

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Macro Economics Final Sample 1 Answers

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