Unformatted text preview: Econ 3080-002 Exam 3 Name___________________________________ Circle the 2 short answer questions you want graded: 1 2 3 Instructions: You have 50 minutes to complete the exam. There are 7 multiple choice questions worth 4 pts each for 28 total and 3 short answer questions (of which you must complete 2) worth 72 pts total. Complete the multiple choice on the scantron provided. You may use a calculator but no cell phone calculators. Please keep your eyes on your own test. You must turn in both the scantron and your test booklet with your short answers. Good luck. Multiple Choice Questions: 1) Use the data below to answer the following questions. Suppose a country using the United States system of unemployment statistics has 400 million people, of whom 300 million are working age. Of these 300 million, 180 million have jobs. Of the remainder: 30 million are actively searching for jobs; 20 million would like jobs but are not searching; and 70 million do not want jobs at all. The unemployment rate is approximately:
a. b. c. d. e. 8% 10% 14% 27% 40% 2) The US economy in the 1970s was characterized by a. Low unemployment and low inflation b. High unemployment and low inflation c. Low unemployment and high inflation d. High unemployment and high inflation 3) a. b. c. d. a. b. c. 4) d. All of the above 5) a. b. c. d.
6) Decreased from 11.1% to 5.26% Increased from 5.0% to 10.0% Increased from 5.26% to 11.1% a. b. c. d. a. b. c. d. e. 7) Short Answer. Pick two questions and write your answers on the extra pages provided. For full credit, please show all of your work for your calculations. Additionally, on the front page of the exam circle the numbers of the two questions you want graded.
1) (36 pts) Use the information below to answer the following questions: C = 800 + .6 YD I = 800 G = 1000 T = 600 YD=Y-T a) (8 pts) Solve for the equilibrium level of GDP. Y=C+I+G Y=800+.6(Y-600)+800+1000 Y= 2240+.6Y .4Y=2240 Y=(1/.4)*2240=2.5*2240 Y*=5600 b) (7 pts) Graph the equilibrium. Be sure to clearly label you axes, curves, and equilibrium point. c) (7 pts) The government, concerned with a possible recession, chooses to cut taxes for the year in order to increase GDP by 500. By how much do they need to cut taxes to achieve this goal? The taxation multiplier is c1/(1-c1)=-.6/.4=-1.5. Thus to increase GDP by 500, a decrease in taxes of $333.33 will achieve this goal. d) (7 pts) In a few sentences, or in short hand linking the important variables, explain the process by which reducing taxes increases GDP. TY d CY
A decrease in taxes increases disposable income which in turn increases consumption. Consumption is a component of GDP and thus increases GDP. This increase in GDP increases disposable income further, starting the multiplier effect. e) (7 pts) Finally, if you could change one variable in the model to make the tax cuts more effective, what variable would it be, which direction would you change it, and why? Changing the marginal propensity to consume to be larger will make the multiplier larger and make the change in fiscal policy more effective. 2) (36 pts) Use the information below to answer the following questions: C=c0+c1*YD T=G YD=Y-T G and I are exogenous. For this question you will be examining the effects of keeping the budget balanced (G=T). a) (9 pts) Solve for the equilibrium level of GDP in terms of I, G, c0, and c1 (Note you can replace T with G because they are equal). Y=C+I+G Y=c0+c1(Y-T)+I+G Y=c0+c1(Y-G)+I+G Y=c0+c1*Y-c1*G+I+G (1-c1)Y=c0+I+(1-c1)G Y*=[1/(1-c1)][c0+I+(1-c1)G]=(c0+I)/(1-c1)+G (9 pts) If both taxes and government increase by $1, how much does equilibrium GDP increase? Increasing G and T by $1 will lead to a $1 increase in Y*. This can be seen two ways. First, in the solution above for equilibrium GDP, increasing G by $1 increase Y by $1. Alternatively, we can use the government spending and taxation multipliers and sum the results of these changes. A $1 increase in G will lead to an increase of 1/(1-c1) in Y. A $1 increase in T will lead to a c1/(1-c1) decline in Y. Netting these changes give us a change in Y of 1/(1-c1) c1/(1-c1) = (1-c1)/(1-c1) = $1. (9 pts) In a few sentences, or in short hand linking the important variables, explain the process by which increasing taxes and government spending changes GDP. b) c) T of $1 Y d of $1 C by c1 G of $1Y of $1 Y d of $1C of c1 No net change in Yd or C An increase in taxes decreases disposable income which in turn decreases consumption by the marginal propensity to consume. An increase in government spending increases GDP and thus disposable income which in turn increases consumption by the marginal propensity to consume. As a result, consumption is unchanged. d) (9 pts) Does the size of this change depend on the marginal propensity to consume? Why or why now? No, the size of the change in GDP is one for one regardless of the size of the marginal propensity to consume because the effect of an increase in taxes on consumption is exactly offset by the effect of the change of government spending on consumption. 3) (36 pts) Use the IS-LM framework to answer the following questions: a) (9 pts) Recently the Federal Reserve lowered the federal funds interest rate to 3%. Draw the effect of this on an IS-LM graph. b) (9 pts) In a few sentences, or in short hand linking the important variables, explain the process by which the Fed lowers the interest rate and its effect on other important variables. Ms shift LM right Y, i C d YY I iI so Investment unabigously increases. c) (9 pts) Shortly afterward, congress passed a tax rebate program effectively reducing taxes for the year. On a new graph, show the net effect of both the Fed reduction in interest rates and the tax rebates. d) (9 pts) In a few sentences, or in short hand linking the important variables, discuss the effect of the tax rebate on the other important variables and the net effect of both the rebate and the interest rate cut on these variables. Tax Rebate Effects: TY d CYI
A decrease in taxes increases disposable income which in turn increases consumption. Consumption is a component of GDP and thus increases GDP. This increase in GDP increases disposable income further, starting the multiplier effect. It also increases Investment which increases GDP further via a multiplier effect. Y with M/P held constant must I since M/P=Y L(i). i I so the end effect on investment is ambiguous.
Taken together with the previous Fed rate cut the interest rate change is ambiguous but GDP will have increased. Disposable income and consumption will have increases but the effect on Investment, while likely positive cannot be determined without knowing that the interest rate didn't increase. ...
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