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F2010_MT2_Problems_VersionA

# F2010_MT2_Problems_VersionA - ECO 320L Fall 2010 Professor...

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ECO 320L Fall 2010 Professor Beatrix Paal Midterm 2 name: 10/29/2010 6 problems, 82 regular + 7 extra credit points 1. Use the following to answer questions a-e: (_____ of 14 points) In an economy money demand is described by the function 0.02 (,) Y LYi i The current money supply is \$2100, and current income is 420 units of goods. The real interest rate, as determined by the equilibrium of the goods market, is 4%, and is expected to stay at this level in the future as well. The central bank is planning to expand the money supply at the constant rate σ = 10% per year. For parts a)-d) of this question, assume that the economy is not expected to grow in the future. a. (_____ of 3 points) Calculate the inflation rate that a rational consumer should expect to see. Calculate the (approximate) nominal interest rate. b. (_____ of 2 points) Prove that real money demand is 60 units of goods. (Show your derivation in detail.) c. (_____ of 2 points) Calculate the current price level. d. (_____ of 2 points extra credit) Calculate the income velocity of money demand. Version A Page 1

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e. (_____ of 5 points extra credit) Assume now, that the economy is identical to the initial one, except that income is expected to grow at a rate 2% per year. Recalculate expected inflation, the nominal interest rate, money demand, the price level and velocity. Version A Page 2
2. (_____ of 16 points) Assume that labor supply is NOT interest elastic . For each of the following shocks, select whether the shock could be a source of output fluctuations, and indicate whether output would increase or decrease in response to it. Use the sketch of the general equilibrium graph to show how the shock would affect the IS/FE/LM curves (include both the exogenous and the endogenous shifts). Label the curves, show which one shifts and how, and mark the new general equilibrium point. Assume throughout that prices adjust quickly and Ricardian equivalence holds. Version A Page 3 rise fall a) (4 points) Optimistic expectations about the future causing investment demand to rise  r Y b) (4 points) Increase in current TFP r Y c) (4 points) Current tax cut financed by borrowing without any plan to change current or future government expenditures (NOT ELIGIBLE for next question) r Y d) (4 points) Increase in current money supply which also signals an increase in future money growth (NOT ELIGIBLE for next question) r Y Will output respond? Yes No

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3. Use the following to answer questions a-e: (_____ of 21 points) Choose ONE of the shocks from the previous question EXCEPT if the shock description says it is not eligible to be chosen for the next question. Assume now that labor supply is interest elastic .
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F2010_MT2_Problems_VersionA - ECO 320L Fall 2010 Professor...

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