Midterm II_answers - ECON 202 Macroeconomic Theory Fall...

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Unformatted text preview: ECON 202 Macroeconomic Theory Fall 2011 MIDTERM II Tuesday, 13 December 2011 17:40-19:40 Please answer the following questions. Write your answers Clearly on the midterm. You can achieve a total 100 points. There are 6 short questions followed by three long questions. You should read all of the questions first. There is a blank page attached at the end of the midterm to be used as scratch paper. GOOD LUCK! NAB/IE .............................................................. . . NUMBER ..../E?+.N.SLO.E§....L€.TJ ............................ .. (This table is for the instructor use only: Short Questions SHORT QUESTIONS (15 points, 2.5 points each) Please state whether the following two statements are TRUE or FALSE with a short explanation (3 or 4 lines). True,I false answer 1 pointI correct explanation 1.5 points. 1) In the medium run, a permanent increase in the nominal money growth of, say 10%, is reflected in a 10% incr e in the inflation rate, leaving the output level and investments constant.( UE FALSE) .... 9‘} nae) NWn-P\ m.w.. yen—aha m>2\8t.....m....m §.mmu>L “er-sf “Squat-$31 .... m1\\...r-.Q¥.....Q..L..¢f?...fi~.\\4.w m MW” 0 e different from the natura TRUE ALSE) 3+...c..n¢.§...-.-..¢L.has ~40) ............................................. .. ..... ............... 3) Suppose that E (nominal exchange rate, 1TL=E$) increases by 4%, This will result in a real appreciation if and o 'f price level in the domestic country increases more than 4%. (TRUE ALS ..... we.3....era..........o.s.2f...as...a.osmosis.................... P t w u u s u - n n n u n a u . a u u o . o - n . - a o . I n a u . o - n u - I q . I n . o u n o . I n s n - I u o u - o n . o - o u . o u a. a n I u I u - I - o - . n n n a - a - u o - n o - o u . o- 4) Suppose there is a reduction 'n taxes. The reduction in taxes W11 increase in domestic output, import ' bigger the higher the margina propensity to 5) Assuming the inflatio ° nominal appreciation wi the Marshall Lerner condition. (TRUE ALSE Marcher...L¢:nyr....3..£.f....s=).h|.?9:& ............................... .. ..... P ‘5 “kc-At 1 “40¢; a 6) .- er afixed exchange rate regime, the central bank must keep 153*. ( ALSE) groanjnfi-uhfi“ para-o (943301 ..... ....... .. .v. .. Wiltw) 5(l*\.+.1€x.. WW a: s eh? H.w.as.-a 4-K F Era-v5 _ “'9”? .... ..'i..§..s..$.\-.F.' .......................... .. LONG QUESTION I: IS-LM and AS—AD (35 points) Consider an economy characterized by the following relationships: Goods Market: Y=C(Y-T)+I(Y,i)+G Financial Markets: M/P=Y*L(i) Wage Setting: W=Pe*F(u,z) Price Setting: P=(l+m)*W Production Technology: Y=N Constant Size of Labor Force: L All variables and functions are defined as they were in lectures and the textbook. Aggregate Supply (AS) relationship relates the price level in the economy to the expected price level, the level of firm competition (m), labor market conditions (2), and the output level in the economy. a) Solve for the output level as a function of unemployment and express your AS equation in terms of Y (and not u). Do not write down AS equation from your memory show your work! (5 points) F35 is clarinet) Eh“ Low war-wet Heat Liszt/1:5... P;?€ (\kP)K\ru¢—a+?=) 1 L, 3;: P" “W Mum—~13“) 1135 .P"—\ .— \M3 K\ ca+usjsze§§r b) In no more t an three sentence in why the AS curve captures the notion that “high economic activity puts upwards pressure on prices”. In particular, describe the channels through which an increase in output leads-to an increase in the price level. ' (5 pomts) ¢ F. : macho-fl - a fin? w‘rfmmd t W“,- egoggs PL? kaO-A he)“ gar hang *‘ Cm thw (\’L) 9-D M ven three policy changes. For each, you are to On the next page, you are gi dium—run dynamics of the economy. To get fiill describe the short-run and me credit, you must provide: In the top-left graph, a clear accounting of the shifting AS and/or AD curves. Use the bottom—left graph to show how the underlying IS and LM curves are moving. In each graph, the drawn curves represent the initial equilibrium. “1”, and medium-rim movements with a Label short-run movements these equilibriums with a “2”. Include the following axis or curve labels (Yn is the natural rate of output): Pena Yo- ‘fun» in Short—Run Equilibrium: ASI,AD1. IS]. LM 1. Pi. Pei. Y1. Y‘H. ii ADz. lSz. LMz. P2. P62. Y2. Ynz, i2 initial Equilibrium: ASg, ADD. ISO. LMo. Pu. I Medium-Run Equilibrium: A82. IS-LM graph to show how this model’s short-run If appropriate, use the om the fixed-price model studied in the first section of response is different fr this course. Please also mention how we move from short run equilibrium to medium run equilibrium! c) The government cuts taxes. Show the changes in the graphs below (2.5 points). Explain what happens to investment, consumption, price level, output and interest rate inathe Short-Run and Mediuni Run. (2.5 points) AS—AD _-..-__— _-_;_..—_— level d) The central bank decreases the money supply and government increases vernrnent urchases simultaneousl . the defense expenditures (go 9 1 3: Show the changes in the graphs below (5 points). Explain what happens to investment, consumption, price level, output level e Short—Run and Medium Run. (5 points) and interest rate in th AS—AD as ASS-amij *‘V‘* 4"“ S‘nura- .36 At) «=- ‘H-Q 12.55% =0 HS .1, ‘3 4-34 5.“ on HA! ("ko ‘m 9) O ru"" “’6‘ 954. 9-1-8: sir-=9 H“ ’m. Kacey: (. 4“) $5“ me. fl ":1" 9' "E i ‘1 5°“ e) The overnment increases the unem lo ent benefits. Show the changes in the graphs below (5 points). Explain what happens to investment, consumption, price level, output level and interest rate in the Short-Run and Medium Run. (5 points) «=- ‘51, $\ AS-AD P‘ P Ase 3.? -— + :. pt 9N3) 9% __ __ a )w .. U:- ?\ -— ‘9‘; P 9 El .95“ I L ‘4‘ Va x Y ESZ- “'— 6‘ \ 7‘)? ?? tad-A 9°"! 1 IS—L 0) JR.) K,é u \R 1 w ‘4 fl PL..— Iao :3' Q *5 (“RAF 1': u LONG QUESTION 11: OPEN ECONOMY (30 points, 5 points each) 1) We know from the exchange rate market that 1TL=0.5£. (Turkey is the domestic country and UK is the foreign country here) Price level in Turkey:100, Price level in UK=200. What is the real exchange rate? What does it suggest intuitively? (5 points) a ? (Pin 2 .1. vr‘u '5 0‘: ‘9“ 3“." u!) 2) What is the interest parity condition? Let’s assume that the interest rate in Turkey is initially 5% and interest rate in UK is 7%. Does the foreign exchange market expect the Turkish Lira to appreciate or depreciate? Mention the exact amount of appreciation] depreciation. (5 points) fiche-n on Tar-Eng b...» in TL «I; “NI-n a; UV- ‘9“) :n T‘— . - I» k\ rug) 1': \\+H-‘) 5‘. (Sq-u w... \~ urfldnh a. 47 s I“ W- t...» m 4r w Consider the following Open economy: C = 650 I = 100 G = 50 IM = Y8 + 305 IF =L—205 2 Y* = 100 (For simplicity I assume C,'G and I areexogen 3) A) What is the domestic demand for goods in the domestic cou points) . B) What is the demand for domestically produced goods, Z? (This will depend on Y, Y* and real exchange rate) (2.5 points) ' AW c «vi-*6 9 3‘39 9" _ ‘5‘- ‘f Y a- 4) Derive the equilibrium output level, setting the exchange rate-=l(g =1) (5 points) Gflu“ a) ‘I :2- $1.... 1.. -w :5" . ' age 5- 1-" ' " ups s1: (3 decreases from 1 to 0.5) on the domestic country. Using hs show the effects of this depreciation on goods market orts. (LABEL THE AXIS AND LINES) (5 points) 5) What is the effect of depreciation by 50% equilibrium output level and trade balance in two separate grap equilibrium and net exp 2 ‘Olg Y :3 51° “bi-V!" flow «u: g: 1‘: M“ u. r Vac-J ‘- o N!- : ‘l‘o -\fr:_ N‘fi g \ = a 7.9 ’$. ‘3. 'L = 6’ F1, an". I}. I- a— H90 " 3a: - ‘ v N” u. 1: -vg-,c)-uar ~¥ 1 .I 30 -— - as: 6) Explain the fixed exchange rate system Why would a country decrde to peg its currency to a foreign currency“? What would happen 1f government expenditures suddenly increase as a result of an unexpected earthquake? (5 points) Under Fitd meme HR Jd-iW“ 39-4 {LN-J exam" 9.“ L a“. "anew poflcg 3”" " \t W fish 93M . 01-3” bu“ "“k'r" “ s. nan-\an We.” 9"“ ‘3 thus-33w“ w a “,1:- _ ~ 3‘ r.“ u‘ V W" W" “" art-c 0-“, \c ~03 “ “I.” V, gm M QM. (pans-etc: “"" 3 Fucrfinb 9. *- wH-r'lh AIMMW "-" ‘ a," 94mm. - cow-rib ‘P H—e WU" . * ‘1. 1 tr“ poi? “" u" a ‘4: LONG QUESTION III: PHILIPS CURVE (20 points) Suppose the Phillips curve is given by TI: = 1T: + 0-2 — 5'”: where 7‘3 = 975?; ent in this economy? (5 points) R: defined OJ PPQU. efllgn\l ’rK _1. What is the natural rate of unemploym ’rH WW 2. For now assume that 9:0. (What does that mean?) Suppose that the government decides to lower unemployment to 3% and keep it there forever. What is the rate of inflation for t=100? Is this realistic? Why? (7 points) Sing; 9 :9 t Thazo (This man‘s Art-oa- -H'£ oft/*5”? ?o)’r tn&\o¥§€y‘ (Lonar'd *‘VG’ rods”: «H sou-rt a.) \9-3" a funwk‘k gala-MAP”) ,9); ya). 'E‘vfasaeaa. .. fix 5 D a, . \rxfihfiné“ ~“l bg 5 r). W , “CV-“s a M . 8-0::th filth-id ‘,\&\fi "‘1 Sun - 3’} wo;\$ \I-t ’7’? m ‘h 3. Assume that only for the first three periods (t=1, t=2, and t=3) people form ‘ 8 their expectations using 9=O. After the third period, from t=4 on, they start n I using 9:1 forever. Also, the government still wants to keep unemployment at . E 3%. What is the rate of inflation for t = 4, 5, and 6? What is the expected rate Q 3 5-. I" of inflation for t=4, 5, and 6? Is this setup more realistic? Why? (8 points) ._— ’D‘e s- tinger-Eon 9°93 -I e- ‘\F\ JrH Cacao-mg Kgc-or-c flea": Pr’ru \LJC\ 15 ' - \Mx ‘ "(V-{ts “\5 ‘ " Rs \o-o \v (Ll-4" ' gill—95 003 f" L I ) Iva-j 5"!» €400 ($3 5 0.0? h e .5 Th“ 35 a “QR (zenith-1c sore. G u :0 \ é‘k‘u ’3 0“) Lace—I‘m expcc-hfima dirt P P z 06"“ C: o.\ 1 m “Yo-Ref u g " ‘ s. qfékowfion ctrcc'hhm: 9" °\""°7’ C 0 \g * \uak’iral' nun-HA \ng-Komun BONUS QUESTIONS: (3 points) (No partial points) e double digit numbers, what could be the 1) Inflation in Turkey reached th the monetary policy in reasons of it? Does the inflation problem affect Turkey? (1.5 point) Afi't—cr mob?“ €¢°“°~‘“C csfiscs (wry Co-Jn’rrlcs 2)"de in Q‘fieonfimaj WM fiscg‘t Qpficigs fl mJ-‘Vfia I“ can Cog, "‘ 5i\, refit. . " " GA. Q5u°\\j wkflbfim lain the Central Bank of Turkey’s interventions to the foreign exchange markets from August 2011. What are the reasons of these interventions? What are the results of these interventions on the exchange ' rything else kept fixed) (1.5 point) '\ “WW'I‘QOH3 \t 2) Exp rv-‘Iv'f Ari-ON Bo flow-i!" “Cir-wt) Tw; rum: 0& ‘3 9. 42.00.93; ins» on‘ tree t V“ _ UK “N 1 hr WW M TL, my (Etna-ltd Scratch Paper ...
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This note was uploaded on 03/22/2012 for the course ECONOMICS 202 taught by Professor Pinarderingure during the Spring '12 term at Middle East Technical University.

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Midterm II_answers - ECON 202 Macroeconomic Theory Fall...

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