Economics 302 First Midterm Spring 2005 April 11 2005 INSTRUCTIONS You will be given two bluebooks for this exam In using the bluebooks WRITE ONLY on the RIGHT HAND SIDE of the page 1 Put your name UW ID number and discussion section on each of the two bluebooks 2 Write Identification Questions on the cover of one bluebook 3 In this bluebook answer the four Identification Questions 4 In this same bluebook also answer the First Essay 5 Write Short Responses on the cover of the second bluebook 6 In this second bluebook answer the four Short Responses 7 In this second bluebook answer the Second Essay 8 Also in this second bluebook answer the Problem DISCUSSION SECTIONS Richard Dunn Section 319 318 315 316 317 Day Thursday Thursday Friday Friday Friday Time 1 20 3 30 8 50 12 05 1 20 Location 58 Bascom 6116 Social Sciences 6322 Social Sciences 4322 Social Sciences 6322 Social Sciences Time 8 50 11 00 11 00 3 30 9 55 Location 55 Bascom 58 Bascom 123 Ingraham 6322 Social Science 374 Van Hise Micah Hughes Section 301 302 303 304 305 Day Thursday Thursday Friday Thursday Friday Regrade Policy After the return of graded exams there will be a one week period in which students may request a regrade of a particular question If such a request is made the ENTIRE question will be subject to review and potential grade revision During the course of this re evaluation the question s grade may increase decrease or remain the same 1 USE YOUR FIRST BLUEBOOK FOR IDENTIFICATIONS AND SHORT RESPONSES I Identifications 15 minutes total time and 5 points each In your FIRST BLUEBOOK identify and briefly explain the importance of each of the following terms 1 Golden Rule Level of Saving 2 Stabilization Policy 3 Monetary Transmission Mechanism 4 Stagflation II Short Responses 15 minutes total time and 5 points each In your SECOND BLUEBOOK discuss each of the following statements Explain your answer in a paragraph in the space provided Do not exceed the space allowed 1 BRIEFLY explain the relationship between the Loanable Funds Market and the IS Curve 2 BRIEFLY explain the relationship between the Market for Real Money Balances and the LM curve 3 In a Solow Growth Model the steady state level of capital is constant Is this statement true or false Explain your answer and if it is false how could you change the statement to make it true 4 Suppose animal spirits cause consumption to be lower at every level of income Describe TWO policy actions that could restore the economy to the original level of output in the short run Be sure to illustrate both the consumption shock and the result of the proscribed action with a graph Use separate graphs for the two policy actions 2 USE YOUR SECOND BLUEBOOK FOR ESSAYS AND THE PROBLEM III Essays 30 minutes total time 20 points per essay Remember in the essay To use standard English and complete sentences To organize your answer That the grade will depend not only on content but also on organization expression of thought and clarity To include well labeled graphs or examples if they will help to illustrate your answer To include appropriate mathematical statements if they will help to illustrate your answer In your FIRST BLUEBOOK answer the following essay question Essay 1 IS LM and AD AS Answer the following question using the Keynesian Model of a closed economy Suppose the Federal government would like to increase output in the short run and will engage in expansionary fiscal policy The President contacts you the Chair of the Federal Reserve and asks you to take action to keep interest rates close to where they currently are You heed the President s request a 5 points What action s do you take b 5 points Illustrate and explain the movements of the IS and LM curves c 5 points Illustrate and explain the movement of the aggregate demand curve in both the short run and in the long run assuming no further actions are taken d 5 points What potential long term effect should you warn the President about In your SECOND BLUEBOOK answer the following essay question Essay 1 Solow Growth The following question asks you to compare two steady states and describe the path of the economy in moving from the initial steady state to a new steady state All answers can be found by using the capital accumulation equation appropriate to the Solow model described below and the national income accounts identity for a closed economy with no government spending The country of Kelly exhibits long run growth that is exactly described by a Solow Growth Model In Kelly physical capital needs to be purchased one year in advance the capital investment that takes place in 2005 does not enter the capital stock until 2006 and thus firms cannot change their capital stock once a year begins Capital depreciates at an annual rate of d The population of Kelly grows at an annual rate of n while the level of technology is constant The economy is a closed economy with the following investment function for each individual i r 10 20r where r is the real interest rate 3 a 5 points Suppose in 2005 Kelly is at a steady state but the marginal propensity to save is less than the golden rule level of savings Define what a steady state requires and describe what happens to consumption per person investment per person and TOTAL capital in the economy when the economy is in a steady state b 5 points At the beginning of 2006 the marginal propensity to save increases to the golden rule level Describe what happens to consumption per person investment per person output per person and the interest rate in 2006 Hint Recall the rules governing when capital that is purchased can actually be used For the following part of this question you will find it useful to include graphs to illustrate what happens to the path of each of these variables over time e g you could graph consumption per person over time indicating in your graph the impact of the changes outlined in the question In using a graph to help illustrate your answer be specific with regard to the labeling of different time periods on the graph Only partial credit will be given if you do not explain why the graph looks as it does EX c 2004 2005 2006 2007 2 year c 6 points Eventually Kelly establishes a new steady state in response to the change in the marginal propensity to save given in part b Compare consumption per person investment per person and the interest rate in this new steady state to the steady state that existed in 2005 d 4 points Explain why citizens in a country