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Unformatted text preview: 1 EC140 Final Exam, April 12, 2010: Answers
PART A: Multiple Choice
28.E PART B: Short Answer Questions
Please see the following pages. Page
Question 1 (10 Marks)
P SHORT-RUN EFFECTS LONG-RUN EFFECTS
AS0 AS0 E2 P2
P0 E0 AD1 AD1
E0 P0 AD0 AD0 Y Y
Y0 = Y* Y1 Y0 = Y* = Y2 a) In the diagram on the LEFT above show the SHORT-RUN effects on the economy of an
increase in desired investment spending. Identify the new short-run equilibrium as E1 and
label the new short-run equilibrium levels of real GDP and price level as Y1 and P1. [2
b) In the diagram on the RIGHT above show the LONG-RUN effects on the economy of this
increase in desired investment spending. (Assume no change in potential output.) Identify the
new long-run equilibrium as E2 and label the new long-run equilibrium values of real GDP and
price level as Y2 and P2. (You may find it useful to redraw the short-run equilibrium from part
a) and then show the new long-run equilibrium.)
c) Briefly explain what happens during the adjustment process from the short-run equilibrium
to the long-run equilibrium and why it happens in that way.
In the short run at point E1, Y1 >Y* (an inflationary gap).
wages (and other factor prices)
unit costs at all levels of Y
firms raise output prices ( P) in response to unit costs AS curve shifts up
AE (as C & NX )
movement up AD1 Y
Y=Y* at E2.
d) In part b) we asked you to assume no change in potential output. However, in the long
run, this increase in desired investment, other things being equal, can be expected to lead
/DECREASE in potential output (circle one)
because ____Capital stock increases ( I K ) ___________ [1 mark] 3
Question 2 [10 marks]
MS = M1
Interest rate i1 MS = M0
E0 i0 MD Quantity of Money
a) Suppose the Bank of Canada adopts a contractionary monetary policy. On the diagram
above show the effects of this policy (assuming, initially, no change in real GDP or price
level.) Identify the new monetary equilibrium as point E1 and use the subscript “1” to
identify any new curves or variable values.
b) If this a CLOSED economy, which type or category of aggregate spending will be
affected by this monetary policy change? How and why will it be affected? Explain.
Desired investment spending (I) is affected. Investment spending decreases (I )
because an increase in the level of (real) interest rates raises the cost of financing
investment spending (whether that financing uses borrowed funds or retained
c) Assume now that this is an OPEN economy operating with flexible exchange rates. In
the diagram below show the effects of a contractionary domestic monetary policy on the
foreign exchange market (assuming no changes in foreign monetary policy.) Identify the
new foreign exchange market equilibrium as point E1 and use the subscript “1” to identify
any new curves or variable values.
e0 E0 E1 e1 S1 D1 D0
Quantity of foreign
exchange d) Briefly explain how and why the change in the exchange rate shown in the diagram
above affects aggregate expenditure on Canadian goods and services.
A decrease in e from e0 to e1 is a decrease in the C$ price of one unit of foreign
currency or an appreciation of the C$. The result is an increase in the relative
price of Canadian-produced goods which lowers exports ( X0) and raises
imports ( m
IM) and thus decreases net exports ( NX). A fall in net exports
reduces aggregate expenditure on Canadian goods ( NX
Question 3 [10 marks]
(AE) Y=AE E1 AE1
AE0 E0 Y (billions) 0
(billions) Y0= 400 Y*= 600 200
50 B1 0
Y0 =400 Y*= 600 800 Y (billions)
B0 a) The current value of the actual budget deficit is $___100______ billion.[1 mark]
b) The current value of the cyclically-adjusted budget deficit is $__50__ billion. [1
c) Suppose that the government of this economy wished to exactly eliminate the
current output gap by changing the level of its purchases of good and services (G)
while leaving the tax rate (t) constant. If the marginal propensity to spend (z) in this
economy has a value of 0.6, then:
G would have to INCREASE by $_80_________________ billion. /DECREASE (circle one) [1 mark]
[2 marks] [CONTINUED OVER] 5
d) On the diagrams above show the effects of the change in government purchases
identified in your answer to part c). Identify the new equilibrium as point E1 and use the
subscript “1” to denote any new curves or variable values.
e) Between E0 and E1 total tax revenue (T) has
INCREASED /DECREASED (circle one) by $_50__________________ billion THE END [1 mark] [1 mark] ...
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This note was uploaded on 08/10/2011 for the course BUS 121 taught by Professor L during the Spring '10 term at Wilfred Laurier University .
- Spring '10