Econ 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 1 of 7Name:Section No.:SSN:GSI:Economics 102Introduction to MacroeconomicsProf. Alan DeardorffFinal Exam - AnswersForm 1April 27, 1998Part 1: Multiple Choice (60 points, 2 each)1. c2. d3. b4. d5. d6. d7. d8. d9. a10. a11. e12. b13. e14. e15. b16. e17. d18. c19. e20. c21. d22. a23. b24. b25. e26. b27. d28. c29. b30. dEcon 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 2 of 7Part II: Short Answer (38 points)1. (14 points) In this question you will analyze the long run effects of a change ininternational capital flows, assuming that there is no net effect on real output.è There is a decrease in foreign demand for U.S. financial assets at any real interestrate.a. (6 points) In the space provided below illustrate the effects of this event using thediagrams of Mankiw’s Open Economy Model (including determination of the realinterest rate and the real exchange rate). Make sure that you clearly label all axes,all curves, and the direction of change for all variables.b. LFNFINFI1NFI2DLF2DLF1NFI1NFI2NXErrSLFEcon 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 3 of 7(8 points) Give the direction of change for each of the following variables:i. real interest rate _____ii. real exchange rate _____iii. national savings _____iv. private savings _____v. domestic investment _____vi. net foreign investment _____vii. net exports _____viii. consumption _____increaseincreaseincreaseincreaseincreasedecreasedecreasedecrease (depreciate)Econ 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 4 of 72. (14 points) For this question you will analyze the effects of a macroeconomic policychange using the AS/AD diagram in the short and long run, and also the short runMS/MD diagram. Assume for the sake of this question that the change in macropolicy does not lead to any changes in the factors of productivity in the long run.Also, assume that the economy starts in long run equilibrium.èThe government reduces purchases of goods.a. (3 points) Illustrate the short run effects of this policy in an AS/AD diagram.Briefly (one sentence or less) explain why you shifted the curve(s) that you did.b. (4 points) Based on the changes you found in part (a), show the effects of thispolicy in the short run diagram of money supply and demand. Again explainbriefly why you shifted the curve(s) that you did. How does this policy effect thereal interest rate in the short run?SRASLRASAD1AD2PYFall in government purchases reducesaggregate demand for any price leveland shifts the AD curve to the left.$rMSMD1MD2Fall in price (P) and fall in income (Y)above both cause less money to bedemanded at any interest rate, shiftingthe money demand curve to the left.Econ 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 5 of 7c. (3 points) Redraw your diagram from part (a) in the space below. Then illustratethe long run change(s) that will occur. Briefly explain.d. (4 points) Comparing the old long run equilibrium (before the change ingovernment purchases) to the new long run equilibrium, how have the followingvariables changed:i. The Real interest rate _____ii. Domestic Investment _____iii. Net Exports _____iv. Consumption _____LRASAD2PAD1SRAS1SRAS3YExpected (perceived) prices andwages fall, shifting the SRAScurve down. P therefore fallsfurther, while Y moves back up(the broken arrows).decreaseincreaseincreaseincreaseEcon 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 6 of 73. In this question you will analyze the effects of certain policy changes using the Phillipscurve diagram on the next page. The economy starts in long run equilibrium prior tothese changes, at the point labeled S on the short-run Phillips curve PhC0 withexpected rate of inflation Eπ0 and unemployment equal to the natural rate, uN.Assume that expected inflation is fixed in the short run, that it adjusts toward actualinflation over time, and that it equals actual inflation in the long run.èThe Congress enacts a tax cut, in the hope of pleasing voters prior to a Congressionalelection.a. (4 points) Illustrate the effects of this tax cut in the diagram, assuming that theFed does not initially respond with any change in monetary policy. First, in thediagram on the next page, label as PhCA the short-run Phillips curve appropriateto this new situation, and label as A a point on it where the economy might beafter the tax cut. Then indicate, by circling the answers below, what happens tothe unemployment rate and the rate of inflation.The unemployment rate: rises falls stays the same [circle one]The rate of inflation: rises falls stays the same [circle one]b. (2 points) Now show what happens next, as expected inflation adjusts toward thenew actual rate of inflation that you found in part (a). Continue to assume nochange in monetary policy. Again, identify the new short-run Phillips curve asPhCB and mark a point B on it where the economy could be.c. (2 points) Finally, show what will happen to the economy in the long run, if theFed now does the best it can to fight inflation while not allowing theunemployment rate to move above its natural rate. Identify as PhCC a short-runPhillips curve that might prevail in the long run, and a point C that represents thelong-run combination of unemployment and inflation that will be approached.d. (2 points) Based on your analysis, comparing now to the rates that prevailedbefore these policies were begun, what effects has the tax cut (and accompanyingmonetary policies) had on unemployment and inflation in the long run?The unemployment rate: rises falls stays the same [circle one]The rate of inflation: rises falls stays the same [circle one]Econ 102 Alan DeardorffWinter Term 1998 Final Exam - AnswersPage 7 of 7PhC0 = PhCASEπ0uNπuPhCBPhCCABCEπBPoint B must be at a higher uthan A, but it could be at alower π, if PhCB has shiftedless. Point C must be atuN, but it could beanywhere above EπB.This answer is based on my own interpretation of this question, which is different, it turnsout, from what many of you were told by the GSIs. I apologize for my ambiguouswording. Grading will be flexible.I had intended that part (c) follow part (b), not substitute for it (that is, the Fed goes intoaction only after expectations of inflation have begun to increase). Part (b) was meant torefer to a second short-run equilibrium, after expectations have adjusted somewhat, but nota new long-run