Student Name: Student Number: ECON 2HH3 - Sections C01 and C02 Marc-André Letendre and Bidyut Kumar Talukdar DAY CLASS ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m DURATION OF EXAMINATION: 3 Hours MCMASTER UNIVERSITY FINAL EXAMINATION APRIL, 2010 THIS EXAMINATION PAPER INCLUDES 9 PAGES AND 18 QUESTIONS. YOU ARE RESPONSIBLE FOR ENSURING THAT YOUR COPY OF THE PAPER IS COMPLETE. PLEASE BRING ANY DISCREPANCY TO THE ATTENTION OF YOUR INVIGILATOR. Special Instructions: Write your name and student number at the top of this page. Write all your answers in the exam booklets provided. is Total number of points: 74 Th Pay attention to the points allocated to each question and budget your time accord- ingly. sh Answer all questions. Use of Casio FX-991 calculator only is allowed. You will find a list of formulas at the end of this exam paper. Continued on Page 2 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 2 Questions from Chapters 1, 2 and 3 1. (1 point) Indicate whether the following statement is true or false. You do not need to justify your answer. Write your answer in your EXAM BOOKLET. Inflation is ultimately determined by the rate of growth in money supply. 2. (1 point) Indicate whether the following statement is true or false. You do not need to ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m justify your answer. Write your answer in your EXAM BOOKLET. An intermediate good is used as an input to produce a final good. 3. (1 point) Indicate whether the following statement is true or false. You do not need to justify your answer. Write your answer in your EXAM BOOKLET. Business cycle activity is represented graphically as deviations of real GDP from its trend. 4. (1 point) Fill-in the blank. Write your answer in your EXAM BOOKLET. The approach to measuring GDP sums the value added to all the goods and services produced in an economy over a particular time. 5. (1 point) Are deviations from trend in Canadian employment a lagging, leading or coincident variable? You do not need to justify your answer. Write your answer in Th is your EXAM BOOKLET. 6. (3 points) Consider the following information about an economy: sh • Working-age population: 30 millions people • Unemployment: 5 millions people • Labour force: 20 millions people (a) Calculate the number of people employed. (b) Calculate the unemployment rate. (c) Calculate the labour force participation rate. Continued on Page 3 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 3 Questions from Chapters 4 and 5: One-Period Model of the Macroeconomy 7. (3 points) Briefly explain why hours worked by the representative consumer might increase, decrease or stay the same when the real wage increases in our one-period model. Organize your answer around the income and substitution effects of a change in the real wage rate. No graphs necessary to earn full marks. 8. (2 points) Can the government run a deficit in the one-period model? Briefly explain ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m why or why not. 9. (1.5 points) Consider our one-period model where the representative firm chooses labour input N to maximize profits π = zK 0.5 N 0.5 − wN . Use calculus to derive the optimality condition implied by the firm’s profit maximization exercise. 10. (1.5 points) Consider our one-period model where the representative firm’s labour demand function is given by w = 1 2 ( K N )1 2 . Calculate the amount of labour demanded by the firm when w = 5 and K = 200. 11. (4 points) Consider our one-period model of the macroeconomy. Recall that in this framework we find the competitive equilibrium outcome by maximizing the consumer’s utility subject to the constraint imposed by the economy’s production possibilities is frontier (in other words we solve a benevolent social planner’s problem). Suppose that Th the government reduces its spending (that is, G decreases). (a) (3 points) Use a graph (consumption on the vertical axis and leisure on the horizontal axis) to find out how equilibrium consumption and leisure are affected by sh the decrease in G. (b) (1 point) Does output increase, decrease, or stay unchanged? Provide a brief explanation. Continued on Page 4 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 4 Question from Chapter 8: A Two-Period Model: The Consumption-Savings Decision and Credit Markets 12. (10 points) Consider a consumer who receives endowment income y and y ′ in the current and future periods, respectively. However, there is a credit market imperfection because of limited commitment. As in the setup with collateralizable wealth we examined in this chapter, suppose each consumer has a component of wealth (e.g. housing) which has value pH in the future period, cannot be sold in the current period, and can be pledged as collateral against loans. Suppose also that the government requires period. ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m each consumer to pay a lump-sum tax t in the current period and a tax t′ in the future The collateral constraint is given by c≤y−t+ pH 1+r (a) (2 points) On a graph, represent the constraint faced by the consumer when maximizing utility. Future consumption on the vertical axis and current consumption on the horizontal axis. (b) (5 points) Now suppose that the government reduces t and increases t′ so that the government present-value budget constraint continues to hold. Use a graph to explain the effects on an individual consumer’s consumption in the present and the future? Assume that the collateral constraint holds with equality (binding) before and after the change in taxes. (c) (3 points) Does Ricardian equivalence hold in this economy? Explain why or Th is why not. Questions from Chapter 9: A Real Intertemporal Model with Investment sh 13. (3 points) As we saw in class, in a model with asymmetric information and where there are good and bad borrowers we end up with a borrowing rate that is greater than the lending rate. Let rB denote the rate at which a firm borrows and let x denote the spread between borrowing and lending rates. Therefore, rB = r + x where r is the rate a bank gets when it is lending. Explain why a firm that is a “good” borrower will end up investing less when a financial crisis increases the fraction of “bad” borrowers. Continued on Page 5 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 5 14. (10 points) Consider two economists who disagree about the main factor driving the current economic recovery in Canada. Economist A’s theory is the following. Since empirical evidence seems to show that a rising stock market precedes increases in total factor productivity (TFP) and that the Canadian stock market is doing well, he thinks that it is an expected increase in TFP (which corresponds to an expected increase in Z ′ in our model) that is the main factor currently increasing real GDP. ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m Economist B’s theory is that the temporary government stimulus (reflected by an increase in G in our model) is the main factor currently increasing real GDP. (a) (3 points) Focus your discussion on the goods market in the current period (include a graph) to explain why economist A’s theory is consistent with our real intertemporal model. Provide an explanation for each curve shift. (b) (5 points) Focus your discussion on the goods market in the current period (include a graph) to explain why economist B’s theory is consistent with our real intertemporal model. Provide an explanation for each curve shift. If you find that both the output supply and output demand curves shift, assume that the shift in the output demand curve is greater. (c) (2 points) Explain how you could attempt to find out which of the two economists seems to be correct using data on aggregate investment. That is, how could you tell which of the two economists seems to be correct if you knew whether there is sh Th is an increase or a decrease in investment in Canada right now. Continued on Page 6 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 6 Questions from Chapter 10: A Monetary Intertemporal Model 15. (2 points) Briefly explain whether doubling the money supply has any effect on real output in the monetary intertemporal model studied in class. 16. (8 points) The Bank of Canada is evaluating the possibility of switching from inflation targeting to some form of price-level targeting. For the purpose of our analysis, let’s suppose that the Bank of Canada’s ultimate goal is to keep the price level constant ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m and that it uses interest rate targeting to try achieving that ultimate goal. That is, it behaves in such a way to keep the nominal interest rate (denoted R in our model) constant. Recall that the nominal interest rate, the real interest rate (r) and the inflation rate (i) are related through the approximate Fisher equation R = r + i. The Bank of Canada needs to know the effectiveness of an interest rate targeting policy in delivering a constant price level. To do so, it needs you to answer the following questions in the context of the monetary intertemporal model we studied in class. (a) (3 points) Consider the case of a temporary increase in money demand resulting from a reduction in the supply of credit card balances. Suppose that the shock shifting the money demand leaves the real interest rate r constant. Explain whether an interest rate targeting policy would deliver a constant price level when such a shock hits the economy. A graph of the money market in the current period is not necessary to get full marks. (b) (3 points) Now consider the case of a temporary decrease in total factor pro- is ductivity (perhaps because of a temporary run up in energy prices). As seen in Th class (you are not asked to show this) the equilibrium effects of such a temporary decrease in total factor productivity is to increase the real interest rate r and to decrease real output Y . Explain whether an interest rate targeting policy would sh deliver a constant price level when such a shock hits the economy. A graph of the money market in the current period is not necessary to get full marks. (c) (2 points) What would you report to the Bank of Canada regarding the effectiveness of an interest rate targeting policy in delivering a constant price level? Continued on Page 7 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 7 17. (5 points) Examples of recent large scale natural disasters are numerous, unfortunately. Our real intertemporal model predicts that a natural disaster that destroys part of the capital stock leads to an increase in the real interest rate (you are not asked to show this). Focussing your discussion on the labour market in the current period (include a graph), try to determine what is the effect of such a natural disaster on employment. Question from Chapter 11: Market Clearing Models of the Business Cycle 18. (16 points) In the market-clearing business cycle model, suppose there is a persistent ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m decrease in total factor productivity, so that there are decreases in Z and Z ′ , current and future total factor productivity, respectively. Answer the following two questions with the aid of diagrams for the labour market, the goods market, and the money market in the current period. (a) (12 points) What are the effects on output (Y ), employment (N ), consumption (C), real wage (w), real interest rate (r), and the price level (P ) of this negative productivity shock? Explain your answer clearly and explain each curve shift. If you find that there is ambiguity about the net effect on the real interest rate, assume that the net effect is an increase in r. Also, assume that the effect of a change in the real interest rate on the labour supply curve is small. (b) (4 points) Are the movements in N , C, w and P consistent with the key business sh Th is cycle facts? Why or why not? Continued on Page 8 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 8 Formulas Chapter 2: Income-expenditure identity: Y = C + I + G + N X. Private disposable income Y d = Y + N F P + T R − IN T − T . Private sector saving S p = Y d − C. Government saving S g = T − T R − IN T − G. Government deficit D = −S g . National saving S = S p + sg . ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m Chapter 4: time constraint ℓ + N s = h. Budget constraint: C = wN s + π − T . Consumer optimality condition M RSℓ,C = w. Production function Y = zF (K, N ). Firm’s profit function π = zF (K, N d ) − wN d and profit maximizing condition M PN = w. Chapter 5: Government budget constraint: G + T . Production possibilities frontier: C = zF (K, h − ℓ) − G. Optimality condition: M RSℓ,C = M RTℓ,C = M PN Chapter 8: Consumer’s budget constraints: c + s = y − t, c′ = y ′ − t′ + (1 + r)s, and c + c′ /(1 + r) = we where wealth is we = (y − t) + (y ′ − t′ )/(1 + r). Consumer optimality condition M RSC,C ′ = 1+r. Government budget constraints: G = T +B, G′ +(1+r)B = T ′ , and G + G′ /(1 + r) = T + T ′ /(1 + r). Credit market equilibrium condition: S p = B. Chapter 9: Consumer’s budget constraints: C + S p = w(h − ℓ) + π − T , C ′ = w′ (h − ℓ′ ) + π ′ − T ′ + (1 + r)S p , and sh Th is C′ w′ (h − ℓ′ ) + π ′ − T ′ = w(h − ℓ) + π − T + . 1+r 1+r Consumer’s optimality conditions: w(1 + r) 1 + r = M RSC,C ′ w = M RSℓ,C w′ = M RSℓ′ ,C ′ = M RSℓ,ℓ′ w′ Firm’s production function Y = zF (K, N ) and Y ′ = z ′ F (K ′ , N ′ ). Capital accumulation C+ equation K ′ = (1 − d)K + I. Firm’s profits and objective functions: π = Y − wn − I π′ . 1+r and 1 = (M PK′ + 1 − d)/(1 + r) which reduces to π ′ = Y ′ − w′ N ′ + (1 − d)K ′ Firm’s optimality conditions: w = M PN V =π+ M Pk′ − d = r. Government budget constraint: G + G′ /(1 + r) = T + T ′ /(1 + r) Continued on Page 9 https://www.coursehero.com/file/9975735/final2hhw10/ Economics 2HH3 - Examination Page 9 Chapter 10: Approximated Fisher equation: r = R − i. Inflation rate: i = (P ′ − P )/P . Firms and consumers transaction constraint: P (C + I + T ) + B d = M − + B − (1 + R− ) + P X d Firms and consumers budget constraint: P (C + I + T ) + B d + M d + P qX d = M − + B − (1 + R− ) + P Y Money demand equation: M d = P Y − P (1 + q)X d . Money demand function: M d = P L(Y, R) or M d = P L(Y, r + i) where i = (P ′ − P )/P . Government budget constraint ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m P G + (1 + R− )B − = P T + B + M − M − . Cobb-Douglas production function: Y = ZK α N 1−α where 0 < α < 1. Kα Nα M PK′ = αZ ′ sh Th is M PN = (1 − α)Z THE END https://www.coursehero.com/file/9975735/final2hhw10/ Powered by TCPDF (www.tcpdf.org) N ′1−α K ′1−α
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