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1 Economics 32, Sec. 1 Menzie D. Cinn Fall 21 Social Sciences 7418 Universiy of Wisconsin-Madison Final Examinaion Ansers Tis exam is 8 minues long, and is or 8 poins. ou are given 88 minues o complee i. ar I is muliple coice, ar II is a sor anser. Te poins are allocaed in proporion o e ime you sould spend on eac problem. ar I and ar II, Q1 goes ino bluebook A; ar II, Q2 and Q3 goes ino bluebook B. BEGIN BLUEBOOK A BEGIN BLUEBOOK A BEGIN BLUEBOOK A AT I: Muliple Coice [4 minues oal, 2.5 poins eac]. Do NOT explain. (16 problems 1. Suppose e Fed decides o resric e rae of gro of e money supply in e Unied Saes. ou sould expec o see a an iniial increase in e value of e dollar a is diminised somea over e long run. b an iniial increase in e value of e dollar a is samped by a second round depreciaion. c an iniial increase in e value of e dollar a coninues unil e Fed canges policy again. d an iniial decline in e value of e dollar a is offse somea over e long run. e an iniial decline in e value of e dollar a coninues unil e Fed canges policy again. 2. Wi markup pricing and muliyear conracs saggered across ree-year inervals, a moneary policy canno influence real GD even if expecaions are raional. b moneary policy canno influence real GD even if ages are oerise flexible. c moneary policy can influence real GD even if expecaions are raional. d moneary policy canno influence real unemploymen even if ages are oerise flexible. e none of e above. 3. Wic of e folloing is a source of gro in poenial GD? a Gro in e labor force b Gro in e capial sock c Gro in labor produciviy d All of e above e None of e above 4. Te income ax sysem of e Unied Saes can discourage invesmen. Tis endency, oever, can be offse by e simulaive effecs of a increasing e ax credi percenage a firms can subrac from eir ax liabiliies. b alloing ineres paymens o be deduced from income before ax liabiliy is compued. c alloing depreciaion o be deduced more quickly from income before ax liabiliy is compued. d loering e real rae of ineres roug macroeconomic policy. e all of e above. 5. urcasing poer pariy does no old up as ell in e sor run as i does in e long run because a prices are fixed in e sor run and e resuling inflexibiliy is ard o describe eoreically. b subsiuion among similar goods is nearly impossible en an inernaional ransacion is involved. c goods arbirage is no an insananeous, cosless process. d is conclusions are dran from price sabiliy, a long-erm penomenon. e all of e above.

2 6. Housing invesmen is more sensiive o ineres raes an business invesmen because a e price of ousing rends up over ime. b e rae of pysical depreciaion is greaer for ouses. c e rae of pysical depreciaion is greaer for business invesmen. d all of e above. e bo a and c. 7. Suppose a e desired capial sock is alays equal o ree imes oal oupu for any year. In a case, e acceleraor principle implies a invesmen sould alays a equal some consan muliple greaer an 3 imes e annual cange in GD o accommodae depreciaion. b be precisely equal o ree imes e annual cange in GD regardless of e rae of depreciaion. c equal some consan muliple less an ree imes e annual cange in GD o accommodae depreciaion. d be proporional o e annual cange in GD, bu e informaion provided is insufficien o compue e muliple exacly. e none of e above. 8. For e purposes of inegraing forard-looking business invesmen decisions ino a model of macroeconomic beavior, capial employmen decisions proceed along a leas o dimensions. Te mos imporan of ese consideraions are a o muc capial sock o mainain and o muc o depreciae. b o muc capial sock o mainain and o quickly o acieve a sock by a flo of invesmen expendiure. c o muc capial o ren and o muc o purcase. d o muc of e capial a is rened sould be depreciaed and o muc sould be sen back. e o fas o expand e capial sock of a groing division and o fas o conrac e capial sock of a failing division. 9. If poin A represens an economy s iniial posiion aay from equilibrium a poin E, ic of e panels of e figure belo displays a recovery rajecory from a maerials price sock a produced unexpeced inflaion? a A b B c C d D e none of e panels 2

3 1. Given e moneary policy rule, r.5 ˆ π.5( π π 3 and assuming ˆ and π, le inflaion increase by 2 percenage poins. By o muc ould e Fed π increase ineres raes? a 6 percenage poins b 2 percenage poins c 3 percenage poins d 5 percenage poins e Less an 2 percenage poins 11. Assume an expecaions augmened illips curve olds, and expeced inflaion equals lagged inflaion. Ten a e unemploymen rae mus exceed e naural rae if acual GD falls sor of is poenial. b e unemploymen rae is independen of any acceleraed inflaion caused by ouside price socks. c e unemploymen rae mus fall sor of e naural rae if acual GD exceeds is poenial. d any aemp o keep acual GD above is poenial mus produce acceleraing raes of inflaion. e unemploymen can be mainained a e naural rae even given acceleraing inflaion. 12. urcasing poer pariy does no old up as ell in e sor run as i does in e long run because a prices are fixed in e sor run and e resuling inflexibiliy is ard o describe eoreically. b is conclusions are dran from price sabiliy, a long-erm penomenon. c subsiuion among similar goods is nearly impossible en an inernaional ransacion is involved. d goods arbirage is no an insananeous, cosless process. e all of e above. 13. Le expeced inflaion in e Unied Saes be 5 percen i a nominal rae of ineres equal o 1 percen; le corresponding inflaionary expecaions abroad equal 1 percen i a nominal ineres rae of 12 percen. According o ineres rae pariy, a people mus expec e dollar o appreciae by 3 percen. b people mus expec e dollar o appreciae by 5 percen. c people mus expec e dollar o appreciae by 3 percen. d people mus expec e dollar o appreciae by 5 percen. e expecaions abou e fuure sreng of e dollar mus sill be undeermined. 14. Wic of e folloing is an assumpion of e informaion-based model of supply developed by Lucas? a rices and ages are assumed o be flexible. b eople are no fully informed abou a is going on in e economy. c A posiive correlaion beeen supply price and quaniy is assumed for firms individual supply curves. d All of e above are accurae. e None of e above is accurae. 15. Given e Lucas formulaion of supply ere i represens e oupu of some firm i, i i ( i i represens a firm s price, represens an overall price index, and i is e i firm s poenial oupu, e parameer is a posiive because prices are sicky going don. b negaive because e lack of pricing informaion is posiively correlaed i oupu. c posiive because, en e relaive price of eir produc rises, firms increase eir oupu. d negaive because firms implici demand curves are assumed o be negaively sloped. e none of e above. 3

4 16. Wic of e folloing is an assumpion of e informaion-based model of supply developed by Lucas? a rices and ages are assumed o be flexible. b eople are no fully informed abou a is going on in e economy. c A posiive correlaion beeen supply price and quaniy is assumed for firms individual supply curves. d All of e above are accurae. e None of e above is accurae. AT II: Sor Anser (4 minues oal 1. (2 minues Suppose equilibrium income is given by: ~ ( d nv μ ( d nv M [ α A m, ] ~ 1 ere α 1- b(1- m(d nvk/ A a bta e d GO g nq Noe a in is model, E q v and T TA, C a bta b(1 1.1 (4 minues So grapically a appens if res-of-orld income exogenously rises from, o,1 (call is. Label axes and curve sifs carefully, soing o far e curve(s sifs in. LM M, 1 b(1 m d nv 1 IS A IS A 1, W,, W, 1 4

5 (4 minues Work ou algebraically e cange US income So your ork! Hin: use oal differenials. Take e oal differenial of e expression for equilibrium income. 1- b(1- m(d nvk/ 1 ere M d nv d nv m A α μ α ~ ] ( ( [ ~ Since noing else canges, e M A μ. Tis means e cange in income is given by: m α ~ 1.3. (4 minues Work ou algebraically e cange in US ineres rae. So your ork! Hin: k M μ 1 Take e oal differenial: k M 1 μ Subsiue in e anser from 1.2: m k α ~ 1.4. (4 minues Work ou algebraically a e cange in e real excange rae. So your ork! Te real excange rae equaion is given by: v q E Take e oal differenial: v q E Subsiuing in e anser from 1.3: m k v E α ~ 1.5. (4 minues So e cange in ne expors (or e rade balance. Hin: e original level of ne expors is given by: W E n m m g X, Is e cange posiive or negaive? Take e oal differenial:

6 E X g m m n W Subsiue in for eac componen: k X m ~ α m m nv ~ αm Te impac of iger impors ino e res-of-e-orld (US expors is posiive, bu iger income increases impors and ence reduces ne expors. In addiion, iger real ineres raes in e US induce dollar appreciaion, and furer expendiure sicing aay from US goods, so a e don kno a appens o ne expors. END BLUEBOOK A END BLUEBOOK A END BLUEBOOK A Exam coninues BEGIN BLUEBOOK B BEGIN BLUEBOOK B BEGIN BLUEBOOK B 2. (15 minues oal Suppose e ave an economy ere e cenral bank follos a Taylor rule: r ˆ π β δ ( π π And e macroeconomic policy rule is given by: ˆ δ ( π π β σ Were e IS curve is given by: σˆ 2.1 (5 minues Explain a appens if e cenral bank decreases e arge inflaion rae from.4 o.2, using graps. Assume e acion akes place in period 2. ou can assume price adjusmen akes e form: π π f ˆ 1 1 Z Be sure o label e curve sifs clearly. 6

7 π.4.2 M M1. ^ 2.2 (5 minues Ignore your anser o 2.1. Explain using a grap a appens o e curve(s if e cenral bank responds only o e inflaion gap, and does no pay aenion o e oupu gap. Explain e economic inuiion beind your anser. Te Taylor rule becomes: r π δ π π ( Te macroeconomic policy curve en canges from: ˆ δ ( π π β σ To: ˆ δ ( π π σ 7

8 π.4 M1 M. ˆ Te M curve becomes flaer, ic means a reducions in e arge inflaion rae ould induce muc larger negaive oupu gaps; and increases in e arge inflaion rae ould induce larger posiive oupu gaps. 2.3 (5 minues Compare e impac of an oil sock in e case ere e Taylor rule is convenionally defined, and en i is defined as in 2.2. A grap or graps ill be useful. 8

9 π.4 M1 M. ˆ IT ˆT Ŷ Wi e sandard Taylor rule, oupu gap falls o Ŷ argeing, oupu gap falls o a all e oupu gap in is rule. IT ˆ T, and evenually reurns o. Wi solely inflaion, ic is a larger negaive because e cenral bank does no eig 3. (5 minues Suppose using a gro accouning equaion, e labor sare of oal income is 2/3, and e capial sare is 1/3, en so ic oucome ill ave a bigger effec on GD gro: eier 1 percenage acceleraion in labor force gro, a 2 percenage poin acceleraion in capial sock accumulaion, or a 2/3 percenage poin acceleraion in TF gro. So your ork! Te gro equaion is given by / A / A (2 / 3( N / N (1/ 3( K / K For a one percenage poin acceleraion in labor force gro: / (2 / 3 ( N / N (2 / 3 (.1.67 For a one percenage poin acceleraion in capial sock gro: / (1/ 3 ( K / K (1/ 3(.2.67 For a one percenage poin acceleraion in capial sock gro: / A / A.67 So eac opion yields e same gro rae. END BLUEBOOK B END BLUEBOOK B END BLUEBOOK B Exam Ends /e32finala_f