Midterm II 75 minutes Econ 1102 30 Principles of Macroeconomics Justin Barnette November 14 2007 Name On the following pages please show all of your work If you need more space use the back of the page Clearly state the location of your work answers Clearly highlight circle solutions Fully label all graphs Read each question carefully and be sure to answer all parts of every question When in doubt write the formula for the solution The formula alone is worth half the points for each part of the question There should be 10 pages including this cover sheet 1 Question 1 20 points Match the following terms with the correct definition number from the last page of the exam You can go ahead and tear off the last page of the exam Asset Money Barter Moral Hazard Budget Deficit National Debt Central Bank Net Worth Crowding Out Open Market Operations Fiscal Policy Phillips Curve Indexing Rational Expectations Liquidity Run on a Bank M1 Structural Budget Deficit Monetary Policy Velocity 2 Question 2 4 points Consider the hypothetical country Sunland Suppose that the government expenditures in Sunland are fixed at 1000 The taxes are of the form T 200 0 25Y and transfers are such that TR 500 a Given that the level of GDP is 8000 what can you say about the government s budget Does it have a surplus deficit b What is the magnitude of the surplus or deficit Question 3 6 points Suppose you have the following initial information for an economy Assume that the deficit grows at 3 per year Complete the following Year Real GDP 2004 100 2005 102 2006 104 2007 106 Debt s Deficit s 50 25 Question 4 12 points 3 Suppose that the following information describes an economy C 200 0 6DI T 400 0 25Y I 800 G 500 X 900 IM 800 a Calculate disposable income net taxes and the real equilibrium GDP on the demand side b Economists believe that potential GDP is 2000 Suppose they decide to decrease G in order to cure the inflationary gap By how much should they decrease G so that there will be no gap at all 4 Question 5 6 points a If the Federal Reserve Bank increases the amount of reserves by 100 billion what happens to the money supply in the US if the required reserve ratio is 20 b What happens to money supply if the required reserve ratio is 10 Question 6 8 points Suppose you have the following information for an economy Complete the following Year Real GDP Price Level M1 2004 500 100 2005 550 104 2006 560 2007 125 Velocity 5000 8 6000 14 6000 14 5 Question 7 20 points a Draw the market for money and the market for an economy with the equilibrium in each picture clearly labeled Be sure to label the axes correctly b Depict a situation in which the central bank increases interest rates c What happens to the money demand curve d Show how this affects the aggregate demand curve above e What happens to GDP f What happens to the price level 6 g What happens to unemployment How does this compare to the inflation Did the central bank sacrifice one for the other Is there a trade off between inflation and unemployment h What kind of fiscal policy is necessary to reduce unemployment Question 8 10 points a The Dinky Bank received a deposit of 80 billion this week Suppose this fictional bank loans all of its excess reserves to the UMN for football stadium funding If the U receives 65 billion from Dinky Bank what is the reserve ratio b Depict this deposit and loan situation using a balance sheet T account If you are unsure of part a draw a general balance sheet for credit 7 Question 9 14 points a What are the tools of expansionary fiscal policy b If the government follows an expansionary fiscal policy what happens to interest rates Prove your result I want the order in which everything happens along with the specifics on what is happening 8 Bonus 3 Points Consider an economy growing at 3 per year If the money supply and the velocity stay constant will this economy experience inflation or deflation If so what is the rate of inflation deflation Bonus 5 Points Suppose banks in Panama hold 500 billion in required reserves Since Panama uses US dollars as its currency the central bank cannot print more money or increase reserves with the click of a mouse like the Federal Reserve If the required reserve ratio is 25 how can Panama increase the money supply by 500 billion dollars Bonus 2 Points There is a series of jokes regarding Chuck Norris online A few include Chuck Norris does not sleep He waits When the Boogeyman goes to sleep every night he checks his closet for Chuck Norris Chuck Norris doesn t read books He stares them down until he gets the information he wants Chuck Norris doesn t borrow at the discount rate he lends at the discount rate Why do economists think the last one is funny because economists are lame is not credit worthy Start by defining the discount rate 9 demonstrates higher inflation rates are associated with lower unemployment 1 rates when deficit spending by the government forces private investment spending to 2 contract 3 the value of all assets minus the value of all liabilities the sum of all coins and paper money in circulation plus certain checkable 4 deposit balances at banks and savings institutions 5 the standard object used in exchanging goods and services the number of times per year that an average dollar is spent on goods and 6 services 7 the minimum amount of reserves in cash or the equivalent required by law the hypothetical deficit we would have under current fiscal policies if the 8 economy were operating near full employment 9 the government s plan for spending and taxation 10 the federal government s total indebtedness at a moment in time 11 the Fed s purchase or sale of government securities the amount by which the government s receipts exceed its expenditures during a 12 specified period of time usually a year the amount by which the government s expenditures exceed its receipts during a 13 specified period of time usually a year 14 refers to the ease with which an asset can be converted into cash provisions in a law or a contract whereby monetary payments are automatically 15 adjusted whenever a specified price index changes 16 occurs when many depositors withdraw cash from their accounts all at once 17 money that is decreed as such by the government 18 liquid assets that are close substitutes for money forecasts that while not necessarily correct are the best that can be made 19 given the available data 20 an item of value that an individual or firm owns actions that the Federal Reserve