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Unformatted text preview: Name: Section:
T.A. Name:
180.101 ELEMENTS OF MACROECONOMTCS
Fall, 2011 First Term Examination Prof. Louis J. Maccini
Time Allotment for the Exam: 60 Minutes
Total Points on the Exam: 180 Points
Answer Key
INSTRUCTIONS (a) At the top of this page, write your name, section number and TA name. You will get
a bonus of 5 points if both the section number and TA name are completed correctly. (b) The exam contains five pages. Writing is permitted on both sides of each page.
Answer each question on the side of the page speciﬁed. There will be instructions on
where to place answers to questions on each side of each page. Answers that are placed
on the wrong page or the wrong side of a page will not be graded. QUESTIONS
NB: You may answer Question 1 on both sides of this page. Question 1. (Total: 20 Points) Answer the questions below regarding the following
events in US. economic history: (a) (10 Points) The Great Moderation: Over what period of time did the Great
Moderation occur? Why is the period referred to as the Great Moderation? (b) (10 Points) The Great Recession: What is the ofﬁcial period of time over which
the Great Recession occurred? Why is the period referred to as the Great Recession? NB: You may continue your answer to Question lon this side of this page. Answer to Question 1: (a) The Great Moderation: The Great Moderation occurred roughly from the mideighties
to the mid2000’s. The period is referred to as the Great Moderation because the growth
rate of real GDP was much less volatile over this period than it had been over the prior 40 years. (b) The Great Recession: The ofﬁcial dates of the Great Recession are from January, 2008
through June, 2009, or from the ISI quarter, 2008 through the 2nd quarter, 2009. It is
referred to as the Great Recession because real GDP exhibited its sharpest decline (of
approximately 5%) in the last 60 years. NB: You may answer Question 2 on both sides of this page. Question 2. (Total: 40 Points). Consider a small economy with only three producers in
a particular year: Sunni, Cubbi, and Grannni. Sunni gathers sixty bushels of Wild gummi
berries, which sell for ten copper coins each. She sells ﬁfty bushels to Grammi and ten
bushels to Tummi, who likes to consume gummi berries. Cubbi scoops mud from the
riverbank to make two hundred clay jars, which sell for five copper coins each. He sells
one hundred clay jars to Grammi and sells the remainder to households in the village who
use them as ﬂower pots. Grammi makes one hundred jars of gummy berry juice, which
she sells for twenty copper coins each to people in the village. Compute GDP for this economy according to each of the following approaches: (a) (20 Points) The Value Added Approach: Show the details of your calculations as
well as total GDP. (b) (20 Points) The Expenditure Approach: Show the details of your calculations as well
as total GDP. In this case, indicate which of the components are consumption and which
are investment. Answer to Question 2:
Denote cc = copper coins. Then, (a) GDP by the Value Added Approach is calculated by summing the value added at
each stage of production. Value Added is sales, assuming all production is sold, minus
intermediate purchases. Value Added for each producer is as follows: Sunni: Sales = 60 bushels of gummy berries at 1000 = 60000. Of these, 50
bushels were sold to Grammi and 10 bushels were sold to Tummi. Intermediate
Purchases == 0. Value Added = 60000. Cubbi: Sales = 200 clay jars valued at 50c per jar = 100000. Of these, 100 clay
jars were sold to Grammi at 500 = 50000. And 100 jars were sold to households
in the village at 500 per jar = 50000. Intermediate Purchases = 0. Value Added =
100000. Grammi: Value of Production = 100 jars of gummy berry juice at 2000 = 200000.
All 200 jars were sold to people in the village. Intermediate Purchases = 50
bushels of gummy berries at 1000 = 50000 plus 100 clay jars at 500 = 50000;
Total Intermediate Purchases = 100000. Value Added = 200000 — 100000 =
100000. Total Value Added = 60000 + 100000 + 100000 = 260000 NB: You may continue your answer to Question 2on this side of this page. (b) GDP by the Expenditure Approach: GDP by the Expenditure Approach is computed
by summing expenditures on ﬁnal output in the form of consumption and investment. Consumption: Expenditures on ﬁnal output or ﬁnal sales to consumers include:
Sales by Sunni of 10 bushels of gummy berries to Tummi at 1000 = 10000
Sales by Cubbi of 100 clay jars to households in the village at
500 = 50000
Sales by Grammi of 100 jars of gummy berry juice to people in the
village at 2000 = 200000
Total Consumption = 10000 +50000 + 200000 = 260000 Investment: Expenditures on ﬁnal output to business ﬁrms is Investment: None Total GDPExpenditure Approach = Consumption + Investment
= 260000 + 0 = 260000 NB: You must answer Question 3a on this side of this page alone. Question 3. (Total: 80 Points) Consider a closed economy operating under slack
economic conditions with no government. An economist writes a report that estimates
that the marginal propensity to consume for households in the economy is 2/3. His
estimates also indicate that autonomous consumption spending by households is $3 00
billion, and that autonomous investment spending by business ﬁrms is $500 billion. Question 3—21. (20 Points) Write down a model that captures the essential features of this
economy. Explain brieﬂy each of the relationships of the model. Model Y=E
E=C+I
C=300+(2/3)Y
1:500 Explanation (i) The ﬁrst equation is the equilibrium condition which requires aggregate
planned spending to equal aggregate income or output in equilibrium. (ii) The second equation is a deﬁnition of aggregate planned expenditure, which
is the sum of consumption and investment in a closed economy with no
government. (iii) The third equation is the consumption function where $300 billion is the level
of autonomous consumption spending and 2/ 3 is the marginal propensity to
consume. (iv) The last equation is the investment function which states that investment is
entirely autonomous at $500 billion NB: You must answer Question 31) on this side of this page alone. Question 3—b. (20 Points) In his report, the economist claims that the current
equilibrium level of real income in this economy is $2400 billion. Evaluate the
economist’s claim by calculating the true equilibrium. Show your work. Construct a
diagram that pictures the determination of the equilibrium level of real income, being
sure to label all curves and axes appropriately, and explain carefully why it is an
equilibrium. Calculations Y =——[E+T] =———[300+500]= 3 x [800] = 2400 The economist is correct. The equilibrium level of real income is $2400 billion. Graph
To construct a diagram, the Expenditure Schedule is calculated as E = C + I = 300 + (2/3)Y + 500 = 800 + (2/3)Y and the Equilibrium Schedule is Y = E. The level of real income of $2400 billion is an
equilibrium because, at that level of real income, aggregate planned expenditure of $2400 billion (C + I = 800 + 1600 = 2400) equals aggregate real output of $2400 L g billion. NB: You may answer Question 3c on both sides of this page. Question 3—c. (40 Points) In his report, the economist estimates that the standard of
living of the society would improve if the equilibrium level of real income were $2550
billion. He undertakes a survey of the society and discovers that both households and
business ﬁrms have become optimistic about the future. The survey indicates that
households plan to increase their autonomous consumption spending by $50 billion, and
that business ﬁrms plan to increase autonomous investment spending by $100 billion.
This is a total increase in autonomous spending of $150 billion. The economist thus
claims that the planned increase in autonomous spending will exactly achieve the
increase in real income that is needed to achieve the desired level of real income of $2550
billion. Is the claim of the eConomist correct? If so, explain carefully why. If not, explain
carefully why not, and calculate the correct new equilibrium level of real income. In either case, show your calculations and provide a detailed explanation of why the claim
of the economist is correct or incorrect. Calculations: The claim is not correct. To see why mathematically, one approach is to use multipliers whichal'e AY l 1 —::——:——:3
3 __l_’_:_1_=___1_.:3
3 Hence, AY=3 xAE=3 x($50 billion) = $150 billion
AY=3 x AT=3 x($100 billion) = $300 billion Total AY = $150 billion + $300 billion =$450 billion NB: You may continue your answer to Question 3con this side of this page. Hence, an increase in autonomous consumption spending of $50 billion will increase
real output and thus real income by $150 billion. And an increase in autonomous
investment spending of $100 billion will increase real output and thus real income by
$300 billion. This results in a total increase in real output and thus real income of $450
billion. Given that the original equilibrium level of real income was $2400 billion, and
that the desired level of real income is $2550 billion, the increase in autonomous
consumption spending and autonomous investment spending of a total of $150 billion
will result in an overall increase in real income by $450 billion. That is, the new
equilibrium level of real income would be $2850 billion. This overshoots the desired
level of real income of $2550. An alternative calculation is to calculate the new equilibrium level of real income, Y M ,
at the higher level of autonomous consumption spending of $350 billion and the higher
level of autonomous investment spending of $600 billion. That is, w 1 z 2 1
Y =1—_—I;[C+]]=1—:—2—[350+600]=3[950]= 2850 3 which again shows that the new equilibrium level of real income of $2850 billion is
higher than the desired level of real income which is $2550. 2850
vol) Mo
by: Explanation: The effect on real income is larger than the increase in autonomous
consumption spending and the increase in autonomous investment spending because
the increase in autonomous consumption spending plus the increase in autonomous
investment spending leads to an increase in induced consumption spending. This can
be explained through the stages of the multiplier process: Primary Stage: Captures the effect of the increase in autonomous consumption
spending plus the increase in autonomous investment spending. The increase in
autonomous consumption expenditure of $50 billion plus the increase in autonomous
investment spending of $100 billion causes an increase in aggregate planned
expenditure of $150 billion, which causes business ﬁrms to increase output by $150
billion and thereby pay out $150 billion more income in wages, salaries, proﬁts, etc.
Hence an increase in autonomous consumption spending plus the increase in
autonomous investment spending by a total of $150 billion causes an increase in
income of $150 billion in the primary stage. Secondary Stages: Captures the effects of the increase in induced consumption
spending. The increase in income of $150 billion in the primary stage causes
households to further increase consumption expenditures due to the consumption
function. This is due to the induced increase in consumption spending that arises from
the increase in income in the primary stage. Since consumption depends on income
with a marginal propensity to consume of (2/3), the increase in income in the primary
stage will increase consumption expenditures in the secondary stages. This further
raises aggregate expenditures, which causes business ﬁrms to increase output and thus
income further, etc. NB: You may answer Question 4 on both sides of this page. Question 4. (40 Points). “When conditions on the SupplySide of the economy are
‘tight’, even small increases in prices bring forth substantial increases in the supply of
output”. True, false, or uncertain. Use a carefully drawn diagram to illustrate your
results, and explain your answer carefully and in detail in intuitive economic terms. Explanation The statement is false. When Aggregate Supply Conditions are “tight”, the aggregate
supply curve is very steep. Hence, in this case, even very large increases in prices bring
forth small increases in the supply of output. The intuition is that, under “tight” supply
conditions, unemployment is very low (loss; than 3%) and excess capacity is very low
(under 10%). Hence, business ﬁrms cannot easily increase output by hiring more
workers, working them more hours, utilizing capital more intensely, etc. Thus, even very
large increases in prices generate small increases in the supply of output. 7X3 .
l (F...
Q7 NB: You may continue your answer to Question 4—on this side of this page. ...
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This note was uploaded on 01/12/2012 for the course ECON AS.180.101 taught by Professor Maccini during the Fall '08 term at Johns Hopkins.
 Fall '08
 Maccini
 Macroeconomics

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