Document 6607536

1
Queens cottege,
ECo
l0l,
2"d
't1
Mid-Term Exam Spring 2014
Last Name (Print)
Phone Number
Language spoken at home
,
First
Year_ Major
Prof. Dohan
Student ID #
College e-mail
Country of birth
Note: for a statement to be tnue, the entire statement must be true, not just part of it.
I. Matching basic vocabulary with concepts (2 pt each)
Select the best answer for the word or tenn in Column
letter
here Column A
A from the answers given in Column B.
(Abbreviations/slmbols u'ere used frequentlv in class & are on "hint sheet".)
Column B.
Put
I
The reason why incorne taxes
reduce the multiplier
A Nonrinal GDP corrected,for price changes by the GDP deflutor
2
Y2 : Ypotential
B taxes on cigarettes, alcohol, perfume, tires, phone service
C Taxes such as properly tax that don't vary v,ith incorne or
D Taxes-(gov't spending + gov't transfer puyrnenls >0
oLrtput
3
Cause of Multiplier effect
n
Causes dernand-pull inflation
5
8
lrrduced investment (mpi x Ya)
Aggregate demand <Yr.
Real GDP
Marginal propensity to save
9
Current definition of investment
l0
Cost of unexpectedly high
6
7
bv businesses
E Iruports, income laxes, unemployment pcrvment
r e c' e iv in g tm
:)
sale.s
lvalue of mtrltiplier
F 4 I I w or k e rs
e n I b e n e fi t s.
G 4ll non-inslitutionalized people ubove ase l6 whont actively seek worlc
H Adiuslment to mtltiplier because taxes are paid partly.from savinp4s.
I Caused hy the spending and respending o.f a prirnary shift in Ydfrom the
hisher incomes earned bv the workers - consltnters
J Nominal interest rates rninus inflation rate
e m p I oyrn
inflation rates
ll
Federal government surplus
t2 Rule of doubling tirne
t3 Automatic stabilizers
t4 Tax multiplier:
15
16
l7
tg
19
20
21
22
23
K
L
The
printe rate ntinus the /bderal./imcls rute
Sqles
-
co,st o.f goods ancl ,services bought
M llhen Y,t >
from other.firms.
Y1,
N Building of nevt plont and equiprnent,, btrilding of nev' residences, and
1l(1-moc + moc*tx')
lhe chunse in itnentorie.s
Crowd ng in of investment
o Equal increases in government spending and taxes raise Y,,*
CroVd ng out of investment
P l{ominal GDP adjusted b1, GDP price deflulor.
Unemployrnent as measllred in ttsa a 70 divicled by grou,th rote per period
Excise taxes, exarnples of
R Hurts creditors and helps debtors if inllation is higher than expected.
real interest rate
S Int,estment ccntsed by increa.secl needJbr capaciQ as output rises
Potential GDP or Yrt
T Firm,y demaneling higher prices.lbr lheir excess inventorlt
Equilibrium only if I,: Io:Sa
U A savingresultingfroru qn A in disposable inconrc
V An increase in the deficit increa.yes interesl rates u,hich leads to a
Interest-sensitive part of
reduclion in private inveslment
investment
\,\ Yd-c:d +Id+Gd+xd- Md
The paradox of thrift
24 Balanced budget multipl ier
25 Value-add by a firm
26 The definition of aggregate
demand
27 Lump sum taxes
x
Businesses order/produce more, same or less depending on Io <,
Id. Iu olv,ctys
Sa in the short run
Y Taxes based on inconrc reduces the multiplier elfect by reducing
Cisposable income earned al every level ofoutput '
:
:,
or >
Z Rapid increases in prices distorts peoples' and producers' purchase
AA
bb
cc
dd
ee
lecision,s lov,ard.s sold, housins. elc.
Aggregate demandJbr all inputs in lhe econonty
Taxes > governtnent spendittg and transfer payments
Demandfor inve,slmenl goocls increases as reql intere,st ratesfall
Level of GDP (called Yt) u,hichfully employs the laborforce
An inc'rease in production leads to an increase in investment as capucity
is reached
ff The econonty will experience unemployment
When everybody tries to sm)e rnore lhey v,ill probably save the same or
tes,s because of the fallacy of convositiott
II. lnflation
(o pts)
We have identified three causes of inflation as measured by an increase in the consumer price
index. They are demand pull (DP). cost push (CP), and increased prices of imports (import price
shock = IPS), no effect NE. There are several scenarios described below that could be associated
with inflation.
1
.
Write in the abbreviation for the appropriate cause of inflation in each of the scenarios givgn below.
_a.Price of crude oil rose sharply in 1973 and 1980 causing an oil price shock which shifted the
aggregate supply curve inward.
_b. lJnions force up wages. then companies raise prices to cover higher costs, so unions force
up prices again etc.
Fed greatly increases the money supply to fight a deep recession & high
The
_c.
unemployment.
Low
interest rates in the US weakens the dollar relative to all other cumencies and the
_e.
prices of foreign goods rise and the demand for US goods rises.
The
demand for goods a services exceeds the capacity of the economy to produce goods a
_f.
services.
Wages rising faster than labor productivity.
Even though we are at full employment the FED greatly increases the money supply to
_9.
_h.
finance a major deficit incurred to finance a major upgrading of the infrastructure.
III. Investment
and Saving(2
pts per question unless noted otherwise)
*. In the long run the desired level of investment in the economy determines the equilibrium level of
saving. But in the short run what determines the actual rate of investment in the economy? (Careful)
a. The profitability of new investment.
b. The need to replace sold inventories and depreciated capital.
_l
rate.
c. The interest
d. The desired rate of savings. which also equals the actual rate of saving.
e. The desired rate of investment
l
of the following affect the desired or planned rate of investment in the economy? Circle one or
more answers. (6 pts) (Careful)
a. The desired rate of saving.
b. The profitability of new investment compared to the interest rate.
c. The depreciation of existing capital.
d. The need for new capacity as the economy expands.
e. The opportunity to lower costs by automating the production process by using new technology.
_2*.Which
_3*.
Choose the complete definition of disposable income from the choices below is
a. GDP - depreciation - "addition to retained earnings" - all taxes + all transfer payments * imports.
b. GDP - depreciation - all taxes r all transfer payments.
c. GDP - depreciation - "addition to retained earnings" - all taxes + all transfer payments.
d. NDP - all taxes + all transfer payment.
e. GDP - taxes * transfer payment.
_4* .
What determines the desired level of savings in an economy?
a. Saving : Personal Saving * Corporate Saving plus Government Saving plus net imports (X-M)
b. Actual Saving: Actual Investment
c. Saving: Personal Saving * Corporate Saving plus Government Saving minus net imporls (X-M)
d. S:Yai-C : personal saving
e. Saving: Personal Saving * Corporate Saving plus Government Saving
3
5.
1S
ptsZt pt each) (For this problem it may be helpful to consult your "cheat sheet" to look for the formula for the multiplier and
exogenous components.) The multiplier is caused by the secondary expansion of demand that results when the
autonomous variables (C, Tx, Tr, l, G, X, M1 as seen in the marginal propensity to consumption from
disposable income (yd) and crowding in of new investment as output rises. The size of the multiplier
however, is also affected by something called "automatic stabilizers" which reduce the impact of a shift in
aggregate demand. Using up t or down .1, arrows or zero for no change. Show w'hat impact each of the
followins events has on the size of the multiplier.
_a.* the marginal propensity to consume falls from: .99 to .9 its normal level.
_b the tax rate "tx" is lower on all income e.g. Tx Tx * /xYa.
_c. the marginal propensity to invest, e.g. the mpi rises from 0.0lYato 0.05Yn.
_d. the marginal propensity to import (mpm) goods fall because American made goods are becoming
less expensive.
govemment decides to build a smafi electric grid.
The
_e.
6. How are these items counted in gross domestic product (GDP)? Put an "X if counted in the Expenditure
approach. E if in Eamings approach, B if appear in both expenditures and earnings approach (yes), DI if only
in disposable income, Not if not included at all. *:>Careful (1 pt each - 18 pts)
_a.
i.
Purchase of paint by the man around the house
b. Purchase ofoaint bv orofessional house painters.
c. Purchase ofa new house at a cheao nrice.
d. Purchase ofa foreclosed house at a cheap price.
_e. The hiring of Transportation Safety Officers by the
government for airporls
_f.
The hiring of a security force by the residents of a
communitv.
_g.
The payment by the government to private f,irms to
build a new smaft electricitv erid.
_h*. Purchase of a new computer by a homeowner to do
Wages paid to a university professor at QC financed by the
state government.
k. Waqes paid to private university prolcssors.
l. Social Securitv Davments paid to orofessors.
m. The total income ffom samblins casinos at Atlantic Citv.
_n. Capital gains on the sale of stock and other securities.
_o.
Capital losses from the sale of gold purchased at $ 1,700 that
was purchased at $2,700.
_ _,p*. Scholarships received by Queens College students for which
no service is surendered in exchange.
_q. Depreciation on private sector equipment and machinery
taxes.
i.
Purchase ofpaper and printer supplies by a student.
_r*.
lnterest paid by the government to households on
government bonds.
IV. Growth
1z pts;
Which policies would lead to a higher per capita GDP growth rate over the next 20 years?
Label as TRUE or FALSE.
Hint: Output per caprta: Q/L: f,(K/L, N/L. HC/L). rr ptcach=7pts)
A.
B.
The rate of population groMh has fallen below the growth rate of CDP.
Increased investment by the government and private indLrstry in research and development of new
technologies.
C. In our depressed economy with widespread unemployment, the FED lowers interest rates to stimulate
investment in new plant and equipment.
D. Granting a dollar for dollar investrnent tax credit against corporate taxes making in essence the cost of
investment zero.
E. China's policy at first of restricting the birth rate to one child per family and now holding it to no more tlran
2 children per family.
F.
In a full employrnent economy, the Fed lowers interest rates to encourage investment and the government
increases taxes on households to discourage consumption to free up real resources to produce investment
goods.
G.
[n an economy with unemployment but has a strong induced investment behavior (crowing in) the
government finally lowers household income taxes permanently.
4
_ A.
V. TRUE = T, FALSE = F. (l pt each, 19)
Even though these questions may look familiar, do not be fooled!
Cutting taxes on the poor (incornes under $20,000/yearlhousehold) will probably have a significant impact
orr
consumption because their marginal propensity to consumer is probably around 0.93.
_8. Increasing taxes on the rich and cutting taxes on the poor ivill probably shift the consumption function upward
because of the differences in the marginal propensiq.to consume.
_C.
_ D.
_ E.
The primary- cost of unemployment to our society is the benefits lost by not having the Iost olltput such as neu'
infrastructure.
Hor"rseholds which conslrme rnore than their disposable income are dissaving, but some
still have an MPS<
0.
At a tirne of high unemployment and stable prices tlre sale of bonds by the federal goventmeltt to stimulate the
econorny will crowd out private investment and leave future generations worse off because of the smaller capital
stock and the larger national debt.
_ F'.
We are still in a recession rvith high unemployment. stable prices and running a large national deficit each
year. A large increase in spending by the Federal governrnent (G) to build infrastructure would actually stirnulate
real private investment ("crowding in" or induced investment) so that future generations could actLralll- be
economically be better off because of the larger private capital stock.
_G. If, the MPC falls from .99 to .90 the slope of the consumption function is flatter and the rnultiplier becomes
smaller.
_ H*. Economists still believe that the economy will be in equilibrium
when desired investment equals desired
savings (la:Sa) which both depend on the interest rate.
_ I*.
Keynes hypothesized that since consumption and saving depended mostly on disposable income rather than on
the interest rate, so that the equilibriLrrn level of income was reached when Ia=Sa We now believe that the
equilibrium level of incorne rvill NOT autornatically go to the full employment level of income. Indeed. it is likely
to be abore or below Yt" r,r ithorrl sorne govenrrnent intervention.
J. As people's wealth fell (net assets) with the collapse of housing prices in 2007, they stafied to save rnore.
_
- K*. Since interest rates on bonds right now are relatively
low compared to historically normal rates, people who
believe that bonds are a good investment for retirement will have to save enough additional money to earn a higher
income to compensate for the lower return on their initial investment.
_ L*. Rapid growth in technology and investment, which increases labor productivity,
makes it more difficLrlt to
growth
reduce unemployment in a slow
economy.
Republicans
M.
of
federal debt creates a burden for future generations and will depress
state
that
the
size
the
_
consumption. Most people when asked if they are burdened by the federal debt rnost people answer "no".
_N. The economy is at full ernployrnent with price stability. The Federal Reserve lou,ers iuterest rates to increase
investrnent in realplant and equipment. If this is the only policy followed, this willcause inflation.
_ O The economy is at less than full employnrent with price stability. The government finances rrore spending on
infrastructure such as roads, a smart grid, and research by issuing bonds. The Fed holds interest rates steady by
expanding the r-noney supply so that no "crow.dit.tg out" occurs. This will leave future generations better off and able
to pay the slightly higher interest costs for servicing the additional bonds.
_ P. C'eteri.s paribzrs, when GDP (Y,) is raised by increased -qovernment spending, desired investment is induced to
rise by the mar-qinal propensitv to invest (mpi*LY,) because of the need for more production capacity and
inventories. We call this crowdlng lz of private investment.
_a.
The Republicans and Democrats. however. rightly say that as interest rates return to their normal higher level
full employrnent. they are concerned that we will have to raise tax rates or cut governmeltt spending on
essential services in order to pay the bond holders the higher interest on tlre now larger public debt. Independents
say thatthe increased productivity and higher incomes generated by this deficit spending will be rnore than
adequate to pay the slight increase in interest payments.
as we reach
_ R. If the GDP price deflator rises frorn 200 to220 (10%) and the nominalGDP rises from $17 trillion to $18
h'illion, then the real GDP has gone dolr,n as measured in constant prices.
_S. To get an accurate measurement of the outpnt of domestic producers. we measure the output of every good
(grain. flour. bread) and service as evaluated at market prices which gives us nominal GDP.
5
Nominal GDP measures the output of all legal final goods & services bought by households. the government,
sold as expofts, or bought as an investrnent -eood by producers that are evaluated at the current market prices.
When we are at full employment on the PPF, then a large increase in the Federal deficit. (Tx - G - Tr > 0),
ccteris paribu's, is likel)' to cause inflation and shortages.
_T
_U.
An increase in disposable income Y6i resulting from a small long-term reduction in weekly payroll taxes
withheld will probably have a higher impact on the consumption function than if we had the same total arnount
sent out to us in otte lump sum per year.
The prirnary purpose of savings by households is to redistribute consumption over time and maybe to give to
their children rather than to earn interest and profit at tlieir current levels.
_V
_W.
PART
VI. MACRO ECONOMIC POLICY (tittte algebra is required)
Itto
credit will be gitten.for just a number!
European economies, still recovering from the world financial crisis, have been suffering higher and higher rates
unemployment as they try to follow the policy urged by Germany's leader Merkel. Assume initially that these
economies are described by the followilig:
of
C:consumption, I:desiredorplannedinvestment,G=plannedgovernmentspending,X:exports.M:ilnports,Tx:taxes,
:
transfer payments, Ya actual GDP, Disposable Income : Ydi Ya-Tx + Tr
Yd : aggregate demand (in lectttre or " aggregate etpendihu e " or ,,l li in text) and is defined as Yd
Ya* is where Ya: Yd where aggregate demand equals actual GDP output.
Tr
:
-
C:C-l. rYdi l:t,G:G.fxITx,Tr-Tr.X-i,andM:M,
:
C+
l + G + X - M,
i
C.l,'G,X, M,Tx,andTrareassumedconstan/
soYd:C+,8fa+l+G+X-M.
Initial Conditions of the Economy in billions of Euros.
Yn = C+|+G+X-M
The equilibrium levelof GDP output is currently:
Yu* =
111000
Full employment level of GDP output
Yfe
=
15,000
You can drarl' strai-uht lines on
the graph using your QC ID or
a credil card
Marqinal propensity to consume
MPC
:
0.8
i. What is the one
2 pis
2 pts
-2.
basic economic problern in this economy?
ol inf'lation b. gron in-e recession & unemplol'ment c. slorv -Erouth
German Chancellor Merkel believes that the large deficits such as in Greece,
Italy and Spain were the cause of their economic problems, so she has been 45"
urging thern to cut government spending bv 400 Euros (austeritv arrproach).
What impact do you predict such a cut will have on equilibrium the GDP (Y"-) on
the European economv. Be sure to specifo sien of the change in Yu*.
a. high rate
3. Using post-Keynesian macro theory, what basic fiscal policy strategy would you
recornmend to achieve full ernployment?
a*. raise or lower Yd (aggregate demand) by the amount of the demand gap
b. cut the deflcit first and then see what else needs to be done.
c. lower the full employment level of incotne
d*. raise or lower Yd (aggregate demand) by the amount of the incon.re gap
e. simply change the equilibrium levelof GDP
2pb
Watch vour signs & sh
uations and calculations
4. Calculate the simple rrrultiplier (show equations)
2 pts
2nfs
correct
sign that gets Yr" :>
5b.Calculate AYo with the conect sign (aggregate demand gap ,\Yd
shifted up or down to achieve economic goals of ,1v,,-.
2 pls
ncome Gap
aYo*
AYo*
-
Yrt -Yax
:
Yo* or Yo*
:> Yr,
the arnount by which aggregate demand Y,1 has to be
Aggregate Denrand Gap So that .\Yd
*M=
\Y".
=
-
On the above graph to the riqht. draw approximately the "Keyesian Cross" (dontt worry about the actual scale or
numbers).
2 pts
2 pts
6a. Mark Yo, on the appropriate place on the Y" axis and draw a vertical line up to 45o Yo line (Use a folded piece of paper as ruler)
6b. Mark Y6", ofl the appropriate place on the Yo axis and draw a vertical line up to 45o Yu line
2pts Ta.Drawthe"original"YacurvesothatitcrossestheYalineatYa.
ltomabove.
6
pts 7b. Draw the "new"
2
Yd cllrve sufficient to close the aggregate demand gap so that it crosses the Y"-lt!C-fi9-!L4bov9-41--Y-
8. Now mark the income or output gap AYn* by drawing an arrow in the correct direction and label it "income gap" with the amount
2,pb
Mark the "demand gap"Ayu by drawing an arrow in the correct direction of desired change of Yd, and label it "demand gap" with
the amount.
2rph:, Q.
The goal: Get Y,* to move from $11,000 to Yo*= $15,000 = Yr".
B. Use Goal Oriented Thinking:
Start from where you want to end up (Yrt of 15,000) and work backwards. (same as ',ou calcttlated up above in 5b)
So Fiscal Policl is easy to figure out but vou must show that vour recommended change reaches the goal.
10. In this situation, how could the administration reach full employment using just government spending so that AG: AYa
[C---l
'--$AG
(+:
:> Ayo*:$
Change in Government Spending: AG
xM
3pi$'
of
increase in G, -
:>
yax
-
cut in G) show increase as J" ilecrease as
+ Ayo- of S _
J
Tax and Transfer Policy (more difficult)
Let's assume that the administration is forced into making (permanent) changes in taxes.
ing taxes affect in order to shift Yd by the desired amount (AY6)
I l. What two economic variables does
2ph
pts
2
4 pl$
So what amount of change in taxes or transfers do you wotlt, (lfor increase and J for decrease) to change AYato make Ya*
"q*
13 How does this Tax (Tx) policy work?
(- l) ->-AYo,
which*MPC of
*pts
by-
Tx bl,
4pts
A
2pb
=>-A
which*MPC oL :>-
14. What change in transfer payments (Tr) would do the same thing?
l'r
+l
h1'
)_
AYai by
$_
:>-AYa *M of
C by
-
-
-
AYo*
:
Yfe?
of
AC by $
15. What would this policy do at first to the deficit in the government budget?
c. Raise
d. Not enough information.
b. Lower it
a. Nothing
it.
16. Changes in investment needed to achieve the same result.
The European central bank decides that it must act now using monetary policy to influence private investment that
responds to the interest rate because it could possibly leave a larger capital stock for the future. They change the
interest rate by changing the money supply (Ms).
The monev supply (Ms) is currentlv 200
Here is how private investment I(i) responds to changes in the interest rate "i" usually.
Ms
100
200
300
I(i)
i
t4% 500
12 800
10 1,000
400
500
600
800
e
8
7
6
I 800
2,200
2,800
3.000
2 pts
2 pt*
2 pts
EI
2 pts
i
2 pti'
2 p*s
2 p1s
: ---__l
How much do we want investment to change and in wh/at direction?
bv %
lncrease Ms from
What do we want to do to the interest rate to achieve our goal of Yfe
lower
How much do we have to cliange the money supply to get the required rate of interest.
to
I will go up by$
Ya*
:
and Ya*
What
:
Yfe
will
happen to investment and Yd
if we change the interest rate that way?
After the rnultiplier effect, what will be the change in Ya*?
7
VII Consumption & Savings Functions, S:I equilibrium, Paradox of thrift
In a simple economy, with no I. C. or Tx or Tr.
2 pts
_1.
Wliich function is the rylg[
A. S-Ya-C
2 pts
_2.What
2 pts
_3.
M. consumption equals C= 500 + .75Ya
savings function that is the twin of the consumption function above?
S:Ya-500
B.
or X &
C. S: -500 +.25Ya D. S: -500 + .75Ya
is the multiplier? It will help you answer the questions below.
What consumption graph below best plots this C-function.
A
B
D
C
Ya
Ya
c
Ya
.75Y
GDP
2400
Output
4. At what output Ievel Ya- will the people be spending exactly as much as is being
A. +.75Y
GDP
Output
B.
s00
c.
2000 D.2400
produced at Ya
E. 2500
5.Show your calculations to the right.
$aving-lnvestment Graphs (Not to scale)
Saving
A
[=+200
$
Sa=+400
''''l;=+200
.75Y
Sa=-500
Ya
Ya
S,r=o
So=-500
2000
l ioo
sa=o
Sa=-500
Sa=-500
_6.
Based on your choice above. or a calculation. which savine-investment $aph best representsthe savings function
conesponding to (or derived liom) the consumption problem in the above problem l. Think about which graph
rept"esents lhe aclual sat ings function, such that Sd - 0 at the outpul level v,here C equals Ya. Remember that
v,here the consumption.fitnc:tictn intersects the 45 degree Ya line, consumption exactly equals outprt and that level
of output is colled the "breakeven point". The slopes of these qnphs are reprsentationat & not r@listic.
So
= 0 and I.r =0. Calcr-rlate & enter on left. Show your calculation down below.