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ECM B06: Midterm Exam 
SOLUTIONS
Professor Jack Parkinson
Q1.
(20 marks)
 Solution
PART A:
LR Output
•
Y = 2(2,500)
0.50
(2,500)
0.50
= 2(50)(50)
= 5,000
(2 marks)
Real interest rate
•
Y = C + I + G
•
5,000 = 1,200 + 0.30(5,000 – 1,500) + 1,500 – 50r
+ 1,500
•
50r =250
•
r = (250/50) = 5.00 (percent)
(2 marks)
Government spending on goods and services (net) =
G
= .3xY =
1,500
Taxes =
T = 1,500
= G
Consumption
•
C
= 1,200 + 0.30(YT)
= 2,250
(2 marks)
Investment
•
I
= 1,500 – 50r
= 1,250
(1 mark)
Private Saving =
S
PVT
= Y – T – C
= 1,250
(1 mark)
Government saving =
S
GOVT
= T – G
= 0
(1 mark)
National saving =
S
NAT
= S
PVT
+ S
GOVT
= Y – C – G
= 1,250
(1 mark)
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Solution (continued)
PART B:
LR Output
•
Y = 2(2,500)
0.50
(2,500)
0.50
= 2(50)(50)
= 5,000
(1 mark)
Real interest rate
•
Y = C + I + G
•
5,000 = 1,200 + 0.30(5,000 – 1,500)
+
1,650
– 50r
+ 1,500
•
50r =400
•
r = (400/50) = 8.00 (percent)
(2 marks)
Government spending on goods and services (net) =
G
= 30%xY =
1,500
Taxes =
T = 1,500
= G
Consumption
•
C
= 1,200 + 0.30(YT)
= 2,250
(1 mark)
Investment
•
I
= 1,650 – 50r
= 1,250
(1 mark)
Private Saving =
S
PVT
= Y – T – C
= 1,250
(1 mark)
Government saving =
S
GOVT
= T – G
= 0
(1 mark)
National saving =
S
NAT
= S
PVT
+ S
GOVT
= Y – C – G
= 1,250
(1 mark)
r
S
NAT
9%
B
Graph: 2 points
•
subtract 1 pt if supply of loanable funds curve in NOT vertical
•
subtract 1 pt if wrong curve shift
5%
A
I
1
(r)
I
0
(r)
1,250
S, I
2
Q2.
(15 marks)
 Solution
A)
M∙V = P∙Y
M
= the nominal money supply (the aggregate nominal quantity of money supplied)
V
= the income velocity of money (the speed at which the nominal money supply circulates
each year to pay for nominal GDP)
P
= the nominal price level = GDP deflator = average price level for domestic output
Y
= real GDP = aggregate real output
(1 mark for each term – 4 marks)
M & P are
nominal
variables (i.e. they are measured in current prices)
(1 mark)
V & Y are
real
variables (i.e. they are not
measured in current prices)
(1 mark)
B)
In the LR when V & Y are both constant (fixed) M & P move together oneto
one.
Initially in LR equilibrium we have
Y
P
V
M
⋅
=
⋅
0
0
, later this becomes
Y
P
V
M
⋅
=
⋅
0
0
5
5
If the central bank raises the money supply to 5 times its previous level then:
1) P will also be raised to 5 times its previous level;
2) nominal GDP (P∙Y) will be raised to 5 times its previous level; and
3) real GDP (Y) will remain the same (i.e. it is unaffected by this money supply change).
1 mark for point 3) )
C)
If
M∙V = P∙Y
holds in the very LR then over time it holds in rates of changes:
∆
+
∆
=
∆
+
∆
Y
Y
P
P
V
V
M
M
, so
∆
+
=
∆
Y
Y
M
M
π
%
5
.
3
%
8
+
=
=
∆
M
M
year
per
%
5
.
4
=
(2 marks)
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This note was uploaded on 06/19/2010 for the course ECON ECMB06 taught by Professor Parkinson during the Spring '10 term at University of Toronto Toronto.
 Spring '10
 PARKINSON

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