UNIVERSITY
Department YORK of Economics
ECON1010N: Principles of Macroeconomics
Midterm #3: March 25, 2011
Duration 1 Hour
Aids Allowed: Non-programmable calculators only
Time Allowed: 1 Hour
The total marks in this test are 50. The test is divided into two parts:
Part I - Problem format - is worth 40 marks (40 of the total mark of 50)
Part II Explanations (5 marks) and Multiple choice (5 marks) (10 of the total mark of 50)
Show your work where applicable.
Please use pen instead of pencil.
Print your name and student number clearly on the front of the exam and on any loose pages.
Name:
(Family Name)
Student #:
.
(Given Name)
.
There are 6 pages to the exam.
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ECON1010N : Midterm Test #3, March 25, 2011
Name: ______________________
Part I: Place your answers (and work where necessary) in the space provided.
Clearly label all axes, curves, and points.
1.
Monetary Policy (10 marks)
Suppose that the Bank of Canada decreases the money supply to slow down the Canadian
economy to prevent inflation. In the space below, use Money Demand/Supply, MEI, and
AE/Y diagrams to demonstrate the impact of a decrease in money supply on interest rate,
investment, and GDP equilibrium. Ignore Crowding Out. Label your axes carefully. Use
the subscript o to represent the original equilibrium and 1 to represent subsequent
changes. In particular,
a) Draw AE/Y, Money D/S, and MEI diagrams showing an initial equilibrium before the
monetary policy. Use the subscript o for initial curves and equilibria. (5 marks)
b) Now show the effect of the Bank of Canadas monetary policy on the interest rate,
investment, and equilibrium GDP using the subscript 1. (5 marks)
r
SM1
r
SM0
r1
r0
r1
r0
MEI
DM
Mo
real AE
I1 Io
AE0
AE1
M (or M/P)
M
real I
real Y (or GDP)
Y1 Yo
1 mark: vertical M (or S ) and negatively sloped MDo with r on the vertical and M on the
horizontal
1 mark: ro at intersection of M (or SM) and negatively sloped MDo
1 mark: downward sloping MEI in diagram with r on vertical and I on horizontal axis
1 mark: Io from negatively sloped MEI at ro
1 mark: Yo from intersection of AEo and 45 degree line
1 mark: Decrease in Money Supply (SM1) Take off 2 marks if they get this wrong(i.e., dont give
the next mark) and then see if they are consistent with this change
1 mark: increase in interest rate (r1) from intersection of new SM and MDo (no mark for
decrease in interest rate even if it is consistent with an increase in money supply)
1 mark: Decrease in I (I1) (or increase if they increased money supply)
1 mark: shift down of AE to AE1 (or shift up if they increased money supply)
1 mark: Fall of Y (Y1) (or s hift up if they increased money supply)
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ECON1010N : Midterm Test #3, March 25, 2011
2.
Name: ______________________
Spending and Monetary Equilibrium: Fiscal Policy (10 marks)
Use an AE/Y, Md/Ms, and MEI diagram to show the impact on equilibrium income, the
interest rate, and investment of an increase in government spending. Be sure to
demonstrate crowding out.
Label your axes carefully and use different subscripts to distinguish between the original
equilibrium (o) and subsequent changes.
Mo
r
r
Md1
r1
ro
Mdo
I1 Io AE1
AE2
AE
M/P
AE
Yo
I
Y1 Y/GDP
1 mark: initial equilibrium ro at intersection of vertical Ms and downward sloping Md
1 mark: initial equilibrium Io from downward sloping MEI at ro
1 mark: initial equilibrium Yo from intersection of positively sloped AEo and 450 line
1 mark: an initial increase in AE (AE1 say)
1 mark: increase in equilibrium Y to Y1 (say) > Yo at AE1 intersect the 45 degree line
1 mark: an increase in Money Demand
1 mark: an increase in r to r1 > ro at MD1 interesect Ms(Mo)
1 mark: I1 < Io from negatively sloped MEI at r1
1 mark: a fall back of AE between AEo and AE1
1 mark: Y (not shown) between Yo and Y1 from 45 degree line and the middle AE
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ECON1010N : Midterm Test #3, March 25, 2011
3.
Name: ______________________
Monetary Demand and Supply Equations (10 marks)
Suppose that the following equations describe an economy (r is in decimal form).
Money Demand: MD = 0.08Y 900r Aggregate Expenditure: AE = 461 + I + 0.8Y
Marginal Efficiency of Investment:
I = 75 1200r
a) What is the equilibrium interest rate is if GDP (Y) = 2500 and Money Supply (MS) = 173?
(2 marks)
1 mark: setup: something like 173 = 0.08*2500 900 r
1 mark: correct answer, r = 0.03 (3%)
b) What is equilibrium Investment given your calculation of the interest rate? (1 mark)
1 mark: I =39 from 75 1200*0.03
c) Is this economy in equilibrium? Explain (2 marks; all for the explanation)
1 mark: Y = 2500 from Y = 461 + 39 + 0.8Y
1 mark: something like the initial Y (or Y determining demand for money and hence interest
rate) is the Y determined by the interest rate
d) What government policy (fiscal or monetary) would result in an increase in equilibrium
GDP and an increase in the equilibrium interest rate? Briefly explain (no diagram) the steps
that bring about this combination. (2 marks)
1 mark fiscal policy
1 mark: increase in G (or decrease in taxes) increases Y, which increases interest rate through
the demand for many
e) What government policy (fiscal or monetary) would result in a decrease in equilibrium GDP
and an increase in the equilibrium interest rate? Briefly explain (no diagram) the steps that
bring about combination. this (3 marks)
1 mark: monetary
1 mark: decrease in money supply increases interest rate
1 mark: increase in interest rate decreases Investment and GDP
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ECON1010N : Midterm Test #3, March 25, 2011
4.
Name: ______________________
Aggregate Demand (10 marks)
Suppose that the equation for Aggregate Expenditure with a price variable is
AE = 1200 + 0.6Y 10P
a) What is the Aggregate expenditure equation if P = 60? (1 mark)
1 mark: AE = 600 + 0.6Y (from something like AE = 1200 + 0.6Y 10*60)
b) What is equilibrium Y if P = 60? (1 mark)
1 mark: Y = 1500 from something like Y = 600/(1 0.6)
c) What is the Aggregate Demand equation if AE = 1200 + 0.6Y 10P? (2 marks)
1 mark: recognition that Y = 1200 + 0.6Y 10P
1 mark: Y = 3,000 25P from something like Y = (1200 10P)/(1 0.6)
d) What is Aggregate Demand if Government Spending increases by 80? (1 mark)
1 mark: Y = 3200 25P from either Y = (1280 10P)/(1 0.6) or 3000 + 2.5*80 + 0.6Y
e) Draw the original AE (AEo) and AD (Ado) and new AE (AEs) and new Aggregate
Demand (ADs) with the correct intercepts in the diagrams below . Indicate equilibrium Yo
and Y1 in the upper diagram. (5 marks)
2400
2200
2000
1800
1600
1400
1200
1000
800
600
400
200
0
0
000000000000000000000000
10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240
120
110
100
SRAS
90
80
70
60
50
40
30
20
10
0
0
000000000000000000000000
10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240
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ECON1010N : Midterm Test #3, March 25, 2011
Name: ______________________
1 mark: A linear AE intersecting a 450 line in upper diagram (doesnt matter where)
1 mark: This AEo has vertical intercept = 600 intersecting 450 line at 1500
1 mark: linear downward sloping ADo in bottom diagram that goes through Y = 1500 and P =
60 (i.e., intersecting SRAS at these points)
1 mark: Shift up of AE (dont worry about amount) to intersect 450 line at some Y
1 mark: AD shifts to right passing through P = 60 at the Y1 determined in AE/Y equilibrium
(i.e., AD must shift directly right so that it is Y1 from above at P = 60)
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ECON1010N : Midterm Test #3, March 25, 2011
Name: ______________________
IIa: Explanations (5 marks)
Give a brief explanation of each of the following.
a)
What is the meaning of ceteris paribus? (1 mark)
1 mark: other things equal (or something conveying the idea of holding everything else constant)
b) What is the Transactions Demand for Money? (1 mark)
1 mark: the demand for money for purchasing commodities or assets (demand for money to buy
things but not simple demand for money for transactions)
c) What is the Speculative Demand for Money?
1 mark: demand for money as an inverse function of the interest rate (or demand for money due
to uncertainty of markets)
d) What is the meaning of neutrality of money for classical economists?
1 mark: money has no effect on the real variables in society
e) What are open market operations? (1 mark)
1 mark: Central Bank (BofC) buys and sells securities (or bonds (and foreign exchange) in
financial markets (in open markets)
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ECON1010N : Midterm Test #3, March 25, 2011
Name: ______________________
Part IIb: Multiple Choice: Circle the best answer
Each question is worth 1 mark. No marks deducted for wrong answers.
1.
Which of the following will not increase the equilibrium interest rate?
a) Bank of Canada sales of government bonds to the general public
b) An increase in currency in circulation held by the general public
c) An increase the required (target) reserve ratio
d) Switching Federal deposits from the Bank of Canada to the chartered banks
e) An increase in equilibrium GDP
f) None of the above
2.
What is the present value (to the nearest whole number) of a return of $1200 payable at the
end of 2 years if the interest rate is 6%?
a) $1050 b) $1068 c) $1071 d) $1088 e) $1344 f) $1348 g) None of the above
3.
An decrease in equilibrium GDP ceteris paribus will
a) Decrease the transactions demand for money and decrease the interest rate
b) Decrease the transactions demand for money and increase the interest rate
b) Decrease the speculative demand for money and decrease the interest rate
c) Decrease the speculative demand for money and increase the interest rate
d) Decrease the money supply and decrease the interest rate
e) Decrease the money supply and increase the interest rate
f) None of the above
3.
Which of the following will increase real Investment if real Investment is only a function of
the interest rate ceteris paribus?
a) Decrease in the Demand for Money b) Increase in equilibrium GDP
c) Decrease in the Supply of Money
d) Increase in the Marginal Efficiency of
Investment
e) Increase in Aggregate Expenditure f) None of the above
5.
What happened to the Canadian Unemployment (UE) Rate in February, 2011?
a) The UE rate fell because Participation fell less than Employment fell
b) The UE rate fell because Participation rose more than Employment rose
c) The UE rate rose because Participation fell more than Employment fell
d) The UE rate rose because Particpation rose less than Employment rose
e) The UE rate didnt change because Participation rose as much as Employment fell
f) The UE rate didnt change because Participation fell as much as Employment rose
g) None of the above
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