Macroeconomics for E&BE Sample Final Exam 1 PDF

UNIVERISITY OF GRONINGEN FACULTY OF ECONOMICS AND BUSINESS Macroeconomics for E&BE EBP812B05 Sample Final Exam 1 Part I – Multiple Choice (20 points) Please answer this part by marking your answer on the multiple choice response she...

UNIVERISITY OF GRONINGEN FACULTY OF ECONOMICS AND BUSINESS Macroeconomics for E&BE EBP812B05 Sample Final Exam 1 Part I – Multiple Choice (20 points) Please answer this part by marking your answer on the multiple choice response sheet. No credit will be given to answers in this booklet. 1) Suppose a country has 100 million people, of whom 50 million are working age. Of these 50 million, 20 million have jobs. Of the remainder: 10 million are actively searching for jobs; 10 million would like jobs but are not searching; and 10 million do not want jobs at all. How many people are out of the labour force? A) 10 million B) 20 million C) 30 million D) 70 million Answer: B 2) If the proportion of unemployed leaving unemployment increases, then a reduction in the unemployment rate will A) increase in the separation rate. B) reduce in the nominal wage. C) reduce the duration that one is unemployed. D) None of the above. Answer: C 3) Efficiency wage theory suggests that A) workers will be paid less than their reservation wage. B) productivity might drop if the wage rate is too low. C) the government do not set tax rates so high that people will prefer not to work. D) unskilled workers will have a lower turnover rate than skilled workers. Answer: B 4) In the wage setting relation W = PeF(u,z), the variable z does NOT include which of the following variables? A) The minimum wage. B) Unemployment benefits. C) The extent to which firms set prices as markup over their marginal cost. D) All of the above Answer: C Use the following information for questions 5 and 6. Assume that the Phillips curve equation is represented by the following equation: πt − πt-1 = (m + z) − αut. 5) The natural rate of unemployment un will be equal to A) m + z. B) m + z − α. C) α(m + z). D) (m + z)/α. Answer: D 6) Assume that the unemployment rate u has been greater than the natural rate of unemployment un for a number of years, and will remain above the natural rate of unemployment in the future. Given this information, we know that A) the rate of inflation will approximately be equal to zero. B) the rate of inflation should neither increase nor decrease. C) the rate of inflation should steadily increase over time. D) the rate of inflation should steadily decrease over time. Answer: D 7) A relationship based on Okun’s law, suggests that when the unemployment rate is above the natural rate , A) inflation is higher than expected. B) inflation is lower than expected. C) output is below potential. D) output is above potential. Answer: C Use the following information for questions 8 and 9. Suppose output is at its potential level, and the government is running a fiscal deficit. Now, the government decides to reduce it by increasing taxes. 8) In the short run A) the IS curve shifts to the left. B) output decreases. C) inflation is decreasing. D) All of the above. Answer: D 9) As fiscal consolidation takes place, the central bank, in order to restore output to its potential level, should A) decrease the policy rate. B) increase the policy rate. C) increase the inflation rate. D) decrease money supply. Answer: A 10) Of the following, the most often used measure of changing living standards is A) the growth rate of nominal GDP. B) the growth rate of real GDP. C) the growth rate of nominal GDP per capita. D) the growth rate of real GDP per capita. Answer: D 11) Assume that the production function with inputs capital K and labour N has constant returns to scale. If both capital and labor increase by 2%, output (Y) will A) not change. B) increase by less than 2%. C) increase by 2%. D) increase by 4%. Answer: C 12) When the economy is in a steady state, we know with certainty that in the absence of population growth and technological progress A) investment per worker exceeds depreciation per worker. B) output per worker is constant. C) consumption per worker is maximized. D) the economy is dynamically efficient. Answer: B Use the following information for questions 13 and 14. Suppose two countries are identical in every way with the following exception: Economy A has a higher saving rate s than economy B. 13) Given this information, we know with certainty that A) steady-state consumption per worker in A is lower than in B. B) steady-state consumption per worker in A and B are equal. C) steady-state consumption per worker in A is higher than in B. D) None of the above is true with certainty. Answer: D 14) Given this information, we know with certainty that in the steady state A) the growth rate of output per effective worker in A is higher than in B. B) the growth rate of output per worker in A is higher than in B. C) the growth rate of output in A is higher than in B. D) None of the above. Answer: D 15) Which of the following will cause an increase in output per effective worker? A) An increase in the saving rate. B) An increase in population growth. C) An increase in the rate of depreciation. D) An increase in the rate of technological progress. Answer: A Use the following information for question 16. The production function is given by Y = K1/3(AN) 2/3. Furthermore, 1. the rate of depreciation is 5% per year, 2. the population growth rate is 2% per year, and 3. the growth rate of technology is 3% per year. 4. the saving rate is 40%. 16) Required investment is a fraction x of the stock of capital per effective worker, where x is, A) 0.02 B) 0.03 C) 0.05 D) 0.10 Answer: D 17) In the context of the AK-model of endogenous growth is correct, a lower rate of growth of output per worker in the long run could occur as a result of which of the following? A) A lower rate of saving. B) A lower rate of depreciation. C) Answers A and B are correct. D) Answers A and B are both not correct. Answer: A 18) The level of Research and Development (R&D) spending depends on A) how spending on R&D translates in new ideas. B) how spending on R&D translates in new products. C) the extent to which firms benefit from results of their own R&D. D) All of the above. Answer: D The final questions are about the guest lecture delivered by prof. Klaas Knot on Friday January 11, 2019. 19) What is the objective of monetary policy in the euro area? A) Full employment. B) Price stability. C) Financial stability. D) A combination of A, B and C. Answer: B 20) When a Central Bank is giving forward guidance, it attempts to A) influence the term premium on government bonds. B) influence the risk premium on government bonds. C) influence expectations about long term interest rates. D) All of the above. Answer: C Part II – The IS-LM-PC model (15 points) Consider the following equations that characterize the goods and money market of an economy: Consumption: 𝐶 = 500 + 0.5(𝑌 – 𝑇) Investment: 𝐼 = 200 + 0.1𝑌 – 5000𝑟 Government spending: 𝐺 = 400 Taxes: 𝑇 = 400 Nominal interest rate: 𝑖 = 0.05 Actual inflation rate: π = 0.03 a) Derive the relation between output 𝑌 and the real interest rate 𝑟 that describes the equilibrium in the goods market (the IS curve). (2 points) From the equilibrium condition Y = C + I + G, we find = 2250 − 12500𝑟. (1 point for the equilibrium condition, and 1 point for the correct relation; expressing r as a function of Y is also correct: 𝑟 = 0.18 − 0.00008𝑌). b) Derive the LM curve (assuming the expected inflation rate equals the actual inflation rate), and calculate the short-run equilibrium level of output. (2 points) LM: 𝑟 = 𝑖 − 𝜋 ! = 0.02 𝑌 ∗ = 2250 − 12500 × 0.02 = 2000 (1 point for the real interest rate, and 1 point for Y.) The Phillips curve is 𝜋# − 𝜋#! = 0.0001 (𝑌# – 𝑌$ ). Expectations are formed adaptively according to 𝜋#! = 𝜋#%& , and last period’s inflation rate is 𝜋#%& = 0.01. c) Calculate the natural level of output using the value for Y obtained in question b). (If you did not find the equilibrium output level in question b), assume that the short-run equilibrium value of 𝑌 is 2500.) (2 points) Skipping the time index: 𝜋 − 𝜋%& = 0.0001(𝑌 − 𝑌$ ) 0.03 − 0.01 = 0.0001(2000 − 𝑌$ ) 𝑌$ = 1800 (If Y = 2500 was used, then the natural level of output equals 2300.) (1 point for filling in the numbers in the Phillips curve, and 1 point for the natural level of output.) d) Draw the IS-LM-PC model. Indicate both the short- and medium-run equilibria in the graph. Explain how the economy moves from the short-run to the medium-run. Notes: No further calculations are required, and label the axes and lines in the graph correctly. (5 points) Graph: The standard IS-LM-PC graph, the short-run equilibrium should be to the right of the medium-run equilibrium. Explanation: The central bank will increase the real interest rate (by increasing 𝑖) to prevent run-away inflation. The increase in the interest rate reduces investment, and thereby reduces output to the natural level. (2 points for the correct graph, 1 point for indicating both equilibria, 1 point for the increase of r, and 1 point for how Y adjusts; Subtract 1 point if curves/axes/equilibria are not properly labelled; If Y = 2500 was used, qualitatively the answer is the same.) The next two questions are about the IS-LM-PC model in general, and not about the specific scenario described above. e) True or False: The government can increase the natural level of output by increasing government spending and taxes by the same amount. Motivate your answer. (2 points) False, in the medium-run output returns to the natural level (1 point), neither government spending nor taxes affect the natural output level (1 point). f) True or False: A permanent increase in the oil price increases the natural interest rate. Motivate your answer. (2 points) True, an increase in the oil price increases the mark-up and shifts the PS-curve downwards, increasing the natural rate of unemployment (1 point). This reduces the natural level of output, but does not shift the IS-curve. It follows that the lower natural level of output must correspond to a higher natural interest rate (1 point). Part III – The Solow growth model (15 points) Consider the version of the Solow model of economic growth with population growth and technological progress. Let the aggregate production function be: 𝑌 = 𝐾 '/) (𝐴𝑁)&/). In addition, the saving rate is 𝑠 = 0.8 and the depreciation rate is 𝛿 = 0.10. Suppose furthermore for the first question that A and N are constant at a value of 1, i.e. 𝐴 = 1, 𝑁 = 1, with 𝑔* = 0 and 𝑔+ = 0. a) Rewrite the production function, using the information that 𝐴 = 𝑁 = 1, show the steady- state condition, and calculate the steady-state values of capital and output. (2 points) 𝑌 = 𝐾 '/) 𝑠𝑌 = 𝛿𝐾 0.8𝐾 '/) = 0.1𝐾 𝐾 ∗ = 8) = 512 𝑌 ∗ = 512'/) = 64 (0.5 point for the production function, 0.5 point for the steady-state condition, 2x0.5 point for each steady state value; writing the production function and the steady-state condition in effective worker terms is also correct.) Now suppose A and N are no longer constant and equal to 1. Moreover, the rate of technological progress is 𝑔* = 0.04 and the population growth rate is 𝑔+ = 0.06. b) Rewrite the production function in per effective worker terms, and show the steady-state condition. Subsequently calculate the steady-state values of capital, output, consumption, saving, and required investment, all in terms of effective workers. (4 points) , - '/) *+ = @*+A , - 𝑠 *+ = (𝛿 + 𝑔* + 𝑔+ ) *+ ! - " - 0.8 @*+ A = 0.2 *+ - ∗..0 ) @*+ A = @..'A = 4) = 64 , ∗ @*+ A = 64'/) = 16 1 , *+ = (1 − 𝑠) *+ = 0.2 × 16 = 3.2 2 , *+ = 𝑠 *+ = 0.8 × 16 = 12.8 3 - *+ = (𝛿 + 𝑔* + 𝑔+ ) *+ = 0.2 × 64 = 12.8 (0.5 point for the production function, 1 point for the steady-state condition, 5x0.5 point for each steady state value. Writing the production function and the steady-state condition in effective worker terms is also correct.) The golden-rule saving rate equals 2/3. Suppose that now the actual saving rate is reduced to the golden rule saving rate. This implies that over time the economy will transition to a new steady state. c) Explain how the economy transitions from the old to the new steady state. Draw the diagram of the Solow-model, and indicate both the old and the new steady states. Notes: No further calculations are required, and label the axes and lines in the graph correctly. (2 points) When the saving rate falls, required investment will now exceed actual investment. By implication, the capital stock in effective worker terms will start to shrink until a new, lower, steady state is reached. Standard Solow model graph. The saving rate drops, so the saving curve also shifts down. The new steady state should be drawn to the left of the old steady state. (1 point for the graph with both steady states, and 1 point for a lower saving rate resulting in a the lower steady state; Subtract 1 point if any labels are missing.) d) Explain what happens to consumption per effective worker when the saving rate is decreased to the golden rule saving rate. Distinguish in your answer between (1) what happens immediately after the saving rate is changed, (2) what happens once the new steady state is reached, and (3) what happens during the transition from the old to the new steady state. (Note that no further calculations are necessary.) (3 points) The saving rate was 0.8 and falls to the golden-rule saving rate of 2/3. (1) Immediately after reducing the saving rate consumption per effective worker rises, as a greater share of income per effective worker may be consumed and the capital stock per effective worker has not yet adjusted. (2) In the new steady state consumption per effective worker is higher than it was before (by definition of the golden rule). (3) During the transition the consumption per effective worker level falls from the high level obtained directly after reducing 𝑠 to the new steady-state value, but always remains above the old level of consumption per effective worker. (1 point for each element in the answer.) The last two questions are about the Solow model with population growth and technological progress in general (i.e. not based on the specific values used in the previous exercises). e) True or False: In the steady state, output per worker and capital per worker grow at the same rate. Motivate your answer. (2 points) True, both grow at the rate of technological progress, 𝑔*. (2 points) (1 point if only one variable increases at rate 𝑔*.) f) True or False: An increase in the rate of technological progress, gA, increases the total amount of depreciation (in per effective worker terms) in the steady state. Motivate your answer. (2 points) False, the increase in 𝑔* reduces output per effective worker in the steady state (1 point), by - implication the amount of depreciation 𝛿 *+ is also lower (1 point)