Econ 352 Fall 2009Midterm (Form 1)Instructor: Kanda NaknoiOctober 7, 2009Time: 12:00-13:15Part OneInstruction: Answer 4 out of 5 following questions. Depict appropriate diagrams asrequired.1. (10 points) Assume that the marginal propensity to consume is 90 percent. Explainthe effects of a reduction in income tax on private saving, public saving and nationalsaving. Will the household saving rate rise? Why?2. (10 points) Suppose the Fed purchased the treasury bills (i.e. short-term U.S. gov-ernment bonds) from commercial banks in its open-market operation with a planto reverse this transaction in 3 months. How will this operation influence moneysupply, nominal interest rate and inflation? Explain your answer using a diagram.3. (10 points) In response to an economic slowdown, China has implemented a fiscalstimulus package since last fall. Explain the impact of China’s fiscal stimulus onthe world real interest rate using a diagram. Does your answer depend on whetheryou consider China a large-open economy or a small-open economy? If yes, How?4. (10 points) In response to an economic slowdown, China has implemented a fiscalstimulus package since last fall. Discuss the effects of China’s fiscal stimulus onChina’s real and nominal exchange rates. Illustrate an appropriate diagram.5. (10 points) Use a diagram to illustrate the impact of a removal of minimum wageslaw on the labor market. Will the natural rate of unemployment fall into zero?Why?1Part TwoInstruction: In the answer sheet, mark the test form as ”01.” Answer whether the followingstatements are true or false. If you answer true, mark ”A” in the answer sheet. Mark”B” otherwise. Note that you must use pencil no. 2. (1 point each)1. Both GDP deflator and consumer price index reflect changes in prices of importgoods.2. Both GDP deflator and consumer price index reflect changes in prices of exportgoods.3. The sum of public saving and private saving of a closed economy is equal to itsdomestic investment.4. The sum of public saving and private saving of an open economy is equal to itsdomestic investment.5. In a closed economy, an increase in the government consumption reduces the nationalsaving.6. In an open economy, an increase in the government consumption reduces the nationalsaving.7. When the value of imports is larger than that of exports, that country is a borrower.8. When the national saving is larger than the domestic investment, that country is aborrower.9. The U.S. currently has twin deficits. Hence, the U.S. receives capital flows from therest of the world.10. Population growth increases demand for the real money balance, all else equal.11. A purchase of domestic government bonds by the central bank increases moneysupply.12. A purchase of foreign government bonds by the central bank increases money supply.13. In the absence of output growth, the long-run rate of inflation is the same as thelong-run growth rate of money supply.14. In the presence of output growth, the long-run rate of inflation is the same as thelong-run growth rate of money supply.15. Deflation raises the real cost of borrowing and hurts borrowers.216. Deflation raises the real cost of borrowing and hurts lenders.17. When the real exchange rate appreciates, the net export rises.18. The purchasing power parity predicts that a currency of a high-inflation economywill appreciate in the long run.19. Real exchange rate appreciation increases the purchasing power of dollars spent ondomestic goods relative to that spent on foreign goods.20. An income tax cut in a small-open economy creates real exchange rate appreciation.21. An income tax cut in a large-open economy creates real exchange rate appreciation.22. An income tax cut in a small-open economy creates nominal exchange rate appre-ciation.23. An income tax cut in a large-open economy creates nominal exchange rate appreci-ation.24. An income tax cut in a small-open economy raises the real interest rate.25. An income tax cut in a large-open economy raises the real interest rate.26. In theory, country with high rate of population growth has higher level of naturalrate of unemployment.27. A fall in the job separation rate reduces the natural rate of unemployment, all elseequal.28. A fall in the job finding rate reduces the natural rate of unemployment, all elseequal.29. The efficiency wages theory argues that high wages can attract high-quality workers,hence real wage rigidity can be an optimal outcome.30. Labor union contracts can create real wage