Midterm2answers S2006

Midterm2answers S2006 - Department of Economics University...

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Department of Economics Professor Kenneth Train University of California, Berkeley Spring 2006 ECONOMICS 1 SECOND MIDTERM EXAMINATION April 19, 2006 INSTRUCTIONS 1. Please fill in the information below: Your Name: ___ SUGGESTED SOLUTIONS ____________________ Your SID #: ___ NOT FOR DISTRIBUTION _____________________ GSI’s Name: ______________________________________________ Section Day/Time: _________________________________________ 2. The exam ends at 11:57 am. 3. If you finish early, 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 100 points, 6 questions, and 9 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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Question 1: (20 points, 10 minutes) 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) Expansionary monetary policy increases both aggregate output and the interest rate. False. Expansionary monetary policy increases aggregate output through lowering the interest rate. To conduct expansionary policy, the monetary authority increases the money supply, which forces interest rates to fall to induce the market to hold the increased money supply. The lower interest rate lowers the return on savings, so consumers consume more and save less. The lower interest rate also lowers the cost of borrowing, so firms invest more. Both the increase in consumption and the increase in investment start off a multiplier effect and lead to increased aggregate output. b) (10 points) Suppose a person’s von Neumann-Morgenstern utility function exhibits diminishing marginal utility of income. This person is willing to pay some amount to reduce uncertainty about his/her income. True. Consider the example at right. This utility function exhibits diminishing marginal utility; utility increases as income increases, but at a decreasing rate. This person prefers a certain income of y to a gamble over y L and y H where the two outcomes have equal probability (that is, a gamble with an expected value equal to y). This person is risk-averse. He or she would be willing to pay up to the difference between y and y C in order avoid the gamble over y L and y H and therefore reduce uncertainty about his or her income. utility
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Midterm2answers S2006 - Department of Economics University...

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