Final06 - Professor McClelland Economics 102 FINAL EXAM...

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Unformatted text preview: December 11, 2006 Professor McClelland Economics 102 FINAL EXAM PLEASE NOTE: The exam has 4 parts. Each of the 4 parts is of equal value. Total time: 2 hours. Answer the last part (Part D) on the sheet provided. For each of the other 3 parts (A through C), PLEASE USE A SEPARATE EXAM BOOK FOR EACH PART; i.e., submit a total of 3 exam books. 011 the outside of each book please put (a) your name, (b) your TA’s name, and (c) the question (A,B, or C) being answered. PART A (30 minutes) The dollar dropped sharply against other major currencies on foreign exchange markets. ...Lurking behind the dollar’s depreciation is the rising probability, in the View of some economists and currency investors, that a slowing American economy will force the Federal Reserve to begin cutting borrowing costs [interest rates] next year. (1) If American interest rates fall as British interest rates rise (the latter a forecast in the article quoted above), what will be the impact on the value of the American dollar in foreign exchange markets? Use supply-andwdemand analysis to explain your answer, including (after the change in interest rates indicated) which curve or curves will shift, in which direction (left or right), and why. (2) (a) What will be the impact of this change in the value of the US. dollar (your answer to (1)) on American exports and imports? (b) Will this change in exports and imports (your answer to (a)) be good or bad for the American economy? Explain your answer. (0) What will be the impact of this change in exports and imports on American investment spending? Again, explain your answer. OVER (1) (2) (3) PART B (30 minutes) The Myth of a Natural Jobless Rate The Federal Reserve has again voted to leave interest rates alone, despite a continuing recovery and low unemployment. So it’s time to bury the idea of a natural rate of unemployment. The claim, you will recall, is that bringing unemployment below its “natural rate” is both futile and dangerous: futile, because the economy is doing the best it can; dangerous because an overheated economy triggers acceleratinginflation that is hard to reverse. Until recently, most believers in the natural rate hypothesis placed it in the vicinity of 4.5%. Lately, the actual jobless rate has hovered slightly below 4.5% and inflation has not increased. Explain the relationship between (a) structural unemployment and (b) the natural rate of unemployment. LIST 4 developments that (in theory) could lead to a reduction in structural unemployment. Assume that prices suddenly start to rise sharply, and the Federal Reserve wants to combat this inflationary threat. (a) Will the Fed buy or sell bonds? Without using geometry, explain why the resulting open market operations (your answer to (a)) will cause a change in the interest rate. (Assume the economy has only one interest rate.) Under what circumstances would this change in the interest rate (your answer to (b)) have little observed effect on the level of desired investment spending? OVER PART C (30 minutes) Justify, qualify, or repudiate each of the following statements. (1) “The US. is experiencing a sluggish economic recovery while suffering from a gigantic Federal deficit. The solution to both problems is to raise taxes.” ' (2) “A consumer boycott of seal furs will not help save the seals. The only effect of a consumer boycott will be to lower the price of seal furs, and that, in turn, will increase demand.” (3) “Economists claim (a) it is good for an economy if consumers spend more, and (b) it is good for an economy if households save more. At least one of those claims must be wrong.” (Hint: discussed in Handout #11.) OVER ...
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