Economics 1 - Spring 2006 - Train - Final Answers

Economics 1 - Spring 2006 - Train - Final Answers -...

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Department of Economics Professor Kenneth Train University of California, Berkeley Spring 2006 ECONOMICS 1 FINAL EXAMINATION May 12, 2006 INSTRUCTIONS 1. Please fill in the information below: Your Name: __SUGGESTED SOLUTIONS ____________________ Your SID #: ______________________________________________ GSI’s Name: ______________________________________________ Section Day/Time: _________________________________________ 2. The exam ends at 8 pm. 3. If you finish after 7:45, please remain in your seat so that you do not disturb others. 4. When time is called, stop writing and pass your exam to the aisle. Please stay in your seat until all of the exams are collected. 5. There are a total of 180 points, 8 questions, and 14 pages, including this cover sheet. Points for each question are in parentheses. 6. Answer the questions in the space provided. (NO BLUE BOOKS.) If you need extra room to answer questions, use the backs of the pages. 7. Calculators are not permitted. Do not turn the page until you are told to begin the exam.
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Page 2 of 14 Question 1: (40 points) True, False, Uncertain: Decide whether the following are true, false, or uncertain. Your grade is determined by your explanation; an answer without an explanation receives no credit. a) (10 points) When there is a negative externality associated with producing a good, a competitive market will choose to produce at a level where the total private surplus is not maximized. False. Regardless of whether there are externalities or not, a competitive market will produce where total private surplus is maximized. It is total social surplus that is not maximized by a competitive market in the presence of an externality. b) (10 points) The aggregate demand curve is downward sloping because a rise in prices leads to a fall in interest rates. False. As prices rise, people need more money to conduct their transactions, leading to an increase in money demand. The increase in money demand causes a rise in the interest rate. This rise in the interest rate causes both investment and consumption to fall, setting off a multiplier effect that leads to a fall in output that is larger than the original fall in investment and consumption. Thus, the aggregate demand curve is downward sloping because there an increase in prices leads to rise in interest rates and a fall in output.
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Page 3 of 14 c) (10 points) The effect of contractionary monetary policy on output is smaller in an open economy than in a closed economy. STUDENTS GET FULL POINTS FOR EITHER OF THE FOLLOWING TWO ANSWERS ANSWER 1: False. Contractionary monetary policy is a rise in the interest rate. In a closed economy, a rise in the interest rate causes both investment and consumption to fall, setting off a multiplier effect that lowers output. In an open economy, the rise in the interest rate also causes the domestic currency to appreciate, making exports more expensive to foreigners and imports less expensive to domestic buyers. Net exports thus fall, so that the fall in planned aggregate expenditure is larger.
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Economics 1 - Spring 2006 - Train - Final Answers -...

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