Midterm II 75 minutes Econ 1102 29 Principles of Macroeconomics Ceyhun Elgin April 4 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 where your work answer are Clearly highlight circle solutions Calculators are NOT allowed You may leave answers as fractions Fully label all graphs Read each question carefully and be sure to answer all parts of every question There should be 12 pages including the cover sheet 1 Question 1 15 points Define the following 5 terms a Equation of Exchange b Velocity of Money c Expansionary Fiscal Policy d M2 e Crowding Out 2 Question 2 15 points Consider the following economy Consumption C 25 0 75 Y T Investment I 3 0 25i Government spending G 12 Taxes T 20 Money supply M S 80 Money demand M D Y i P where i is interest rate in percentages C is consumption Y is nominal GDP I is investment G is government expenditures T is taxes MS is money supply and MD is money demand a Assuming that the price level is P 2 find the equilibrium real output interest rate consumption and investment 3 b Now assume that the government increases spending so that G 17 Answer part a again c What would be the change in the equilibrium output in part b in the simple model without the money market Hint Think about the expenditure multiplier Compare this to the change in output in part b and explain why there is a difference 4 Question 3 12 points Remember the discussion about the shape of the AS Aggregate Supply curve Using this graphically prove that Expansionary fiscal policy is a good tool to increase real GDP without increasing prices much Is this claim always true What should the shape of the AS curve look like for this claim to be true 5 Question 4 14 points Suppose that the following information is given for an economy C 100 0 8DI T 100 0 0625y TR 100 I 100 G 200 X 800 M 300 a Calculate the equilibrium real GDP on the demand side b Calculate the usual multiplier with taxes c Suppose G decreases by 100 What is the new equilibrium real GDP on the demand side 6 d Calculate the tax multiplier e Assume that nothing has changed since part a Government economists believe the potential GDP is 3000 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 7 Question 5 12 points Consider the hypothetical country Sunland Suppose that the government expenditures in Sunland are fixed at 1350 The taxes are of the form T 100 0 13Y and transfers are such that TR 50 a Given that the level of GDP is 9000 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 8 Question 6 12 points Consider the real liquidity preference model i e the diagram with real money demand and real money supply curves In that model graphically show what happens if the monetary authority increases the nominal money supply M Does the real interest rate change If so how How do we call this situation 9 Question 7 10 points What are the national income and product accounts for the economy the input output matrix of which is given below Agriculture Manufacture Consumption Investment Exports Total 2 6 3 6 8 10 2 4 5 4 Imports 4 Tariff Revenue 2 5 1 9 3 Labor Compensation Returns to Capital Total 3 10 13 3 5 8 20 30 Agriculture Manufacturing 18 10 6 9 20 30 Question 8 10 points a What are the tools of the contractionary fiscal policy b Prove that if the government follows a contractionary fiscal policy then interest rates go down 11 Bonus Question 10 points Choose one of the questions to answer If you answer both you will receive ZERO points a Name two benefits and two costs of dollarization from Miguel s guest lecture b How many types of inflation did Simge tell you in the guest lecture In which category do you think the US inflation rate is 12