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MIT 14 02 - Quiz 1

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14.02 Principles of MacroeconomicsSpring 05Quiz 1Thursday March 3, 20057:30 pm - 9 pmPlease answer the following questions. Write your answers di-rectly on the quiz. There are 6 True/False questions, followed by2 long questions. The last part of the second long question is foran extra credit of 7 points, but the rest of the quiz adds up to 100points. There is a blank page at the end of the quiz to be used forscratch paper. Good luck!NAME:MIT ID NUMBER:TA:CLASS TIME:EMAIL:(Table is for corrector use only.)1 2 3 4 TotalI. T/FII. LQ 1III. LQ 2Total1I. True/ False (30 points)Answer each as TRUE or FALSE (note - there is no uncertainoption), providing a few sentences of explanation for your choice.Each question counts for 5 points.1. The growth rate of real GDP is a better measure of economic growththan the growth rate of nominal GDP.2. Consider a proportional income tax T = tY . Changing the proportionalincome tax rate will only a¤ect the autonomous spending, but not the multiplier.23. In equilibrium in the …nancial market with the presence of banks, thesupply of money is a fraction (< 1) of the supply of high powered money.4. In an open market operation where the central bank increases moneysupply by buying bonds, the price of bonds will fall.35. According to the s tandard IS-LM framework, if investment becomes moreresponsive to interest rates, the equilibrium interest rate is also more responsiveto a monetary expansion.6. In the standard labor market model, the real wage is always determinedby the degree of competition among …rms and the marginal product of labor.4II. Long question - IS-LM (35 points)Suppose the goods market is described as follows :Goods MarketGoods Demand: Z = C + I + GConsumption: C = a + b (Y  T ), where a and b are positive constantsInvestment: I = e  fi, where e and f are positive constantsGovernment Exp.: G = G0, where G0is a constantTax: T = hYAssume 0 < b < 1; 0 < h < 1.1. Derive the IS relation. (5 points)5Suppose the money market (with private banks) is described as follows :LetHsPbe the supply of real central bank money. The overall real moneydemand isMdP= uY  vi.Assume that people hold a …xed proportion  of their mone y in currency,and the rest of it in checkable de posits.Private banks are required to h old  of their total checkable deposits inreserve.2. Denote the demand for real central bank money asHdP. ExpressHdPinterms of parameters (, ,u,v), output (Y ) and interest rate (i). (5 points)63. Draw the demand and supply for real central bank money in a (H=P; i)space. (5 points)4. Derive the LM relation using the conditions for the central bank moneymarket to be in equilibrium. Does a change in the required reserve ratio a¤ectthe sensitivity of output to interest rates along the LM curve? (5 points)75. After several bank runs, the central bank decides to increase the requiredreserve ratio from  to 0> . How does this policy a¤ect the equilibrium outputand interest rate? Show your results graphically in a (Y; i) space. Explain whyincreasing the required reserve ratio has such an impact on the equilibriumoutput and interest rate. (5 points)86. Suppose now that the government wants to increase output in the shortrun. Discuss the e¤ectiveness of …scal versus monetary policy if the overallmoney demand is very sensitive to interest rates; and investment is very insen-sitive to interest rates. Use a graph in your explanation. (5 points)97. Suppose now that the government decides to decrease the tax rate h by ahalf. Does monetary policy become more e¤ective now? Write a few sentencesto explain. (5 points)10III. Long question - The Labor Market (35 points)Consider an economy with the following speci…cs : The wage setting curveis given by W=P =   u (where the constant  denotes any variable whoseincrease would increase the real wage, and u is the unemployment rate). Theproduction function is Y = AN (where N is employed labor and A is laborproductivity), and …rms price at a markup of  over marginal costs.1. Suppose the economy is in labor market equilibrium, with an unemploy-ment rate equal to the natural rate. It has a non-institutional civilian popu-lation of 80 million and a number unemployed (they are all looking for a job)equal to 3.2 million. Also consider the following values for the parameters : = 1;  = 10=3;  = 20%; A = 1(a) Determine the equilibrium rate of unemployment (3 points)(b) Determine the participation rate (3 points)(c) Determine the natural level of output (3 points)112. For the case where Y = AN, with A > 1(a) Write down the price setting equation. (3 points)(b) Does the equilibrium real wage increase or decrease (relative to thecase where A = 1)? Provide some intuition for your answer. (4 points)(c) Does the natural rate of unemployment increase or decrease (relativeto the case where A = 1)? Provide some intuition for your answer. (4 points)123. For each of the following, describe what happens to the natural rate ofunemployment(a) An increase in the legislated minimum wage (5 points)(b) A decrease in unemployment bene…ts (5 points)(c) An increase in anti-trust legislation (5 points)134. Extra credit : Any model which predicts that steady increases in pro-ductivity lead to steady decreases in the unemployment rate over time is incontradiction with the facts. There must be something wrong with the mo del.Discuss. (7 points)14Scratch


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