Eco 304L: Introduction to Macroeconomics
Spring 2000
Professor Harry Cleaver

Third (and Last!) Test

Part I: The Aggregate Supply & Demand Macro Model

Section A: Multiple choice questions (3 points each for a total of 12 points)
(Answer all, more than one correct answer possible, but not always.)

1. Which of the following changes would cause the aggregate supply curve to shift to the right (or down)?

2. In the Batavian economy unemployment has been falling, but the price level has increased by very little.  The most likely explanation for this is that

3. In 1974 and again in 1978 the world economy was subjected to the shock of dramatic increases in the price of oil. Using aggregate supply and demand model and your knowledge of the social situation at the time to analyse the effects of these shocks you might expect the following:

4. A deepening trade deficit would have which of the following effects:
the continuing flood of cheap imports would hold down the costs of production and thus accelerate any tendency of the aggregate supply curve to rise

Section B: Essays
(Answer one of the following for 12 points.)

6. a) Explain, using words and graphs, the derivation of an aggregate demand (AD) curve. b) Show and explain the impact on the AD curve (and hence on output Y) of a general rise in the expected rate of return on investment.  c) Which elements of the early Reagan economic program were designed to bring about such a rise?

7. a) Explain why the aggregate supply (AS) curve can not be understood as the sum of individual firms' supply curves.  b) Having excluded this understanding, what is the rationale for the AS curve?  c) Finally, using a graph and words explain the usual rationale for the usually postulated shape of the AS curve.

Part II: Policy Problem w/model
(Answer the indicated questions for 40 points.)

Dealing with the Trade Deficit

Your candidate has asked you to evaluate some policy changes others have suggested that would reduce the trade deficit and mollify potential (labor) voters. These are:

Your candidate wants to know which of these will reduce the trade deficit the most?

To answer this query you have available to you the following elements to build a macroeconomic model:

A consumption function: C = 789.225 + .75Yd - 50P (Yd = Y - T, and P = the price level)

A tax function: T = -170.15 + .216Y

An investment function: I = 986.76 + .1Y - 50i - 40P (i = interest rate, P = the price level)

A money demand function: i = 82.978  - .07Md (where Md = money demand)

An import function: M = 328.26 + .1Y

An aggregate supply function: P = 1.07516 + .0001Y

You also know that government expenditures are expected to = $1,628.7 billion, exports are expected to = $996.3 billion, and the Fed is expected to hold the money supply at $1,125.4 billion.

Solve one of the following (questions 8, 9 or 10, preferably 8 because you get the most points that way):

8. Using these elements find the currently expected equilibrium levels of Y, prices and interest rates by deriving an aggregate demand function and combining it with the aggregate supply function.  (20 points)

9. If you have not learned how to do this, you can earn partial credit by assuming a price level of 2.0, deriving IS and LM curves and combining them to find the equilibrium level of income and interest rates.  (15 points)  (Note: there is a peculiarity about the LM function in this model: it is horizontal.)

10. If you have not learned how to do either of the above you can still earn partial credit by assuming a price level of 2.0 and by using the Keynesian cross approach to solve for the equilibrium level of income and interest rates.  (10 points)

Answer all the following: (11-15)

11. Once you have solved for the equilibrium income (which is approximately $9,248.4 billion [the actual US level in 1999] and the price level (2.0) and the interest rate (4.2 percent), calculate the trade balance to determine the size of the trade deficit.  (5 points)

Using whatever you need from what you have discovered so far, calculate by how much each of the suggested policy changes would reduce the trade deficit:

12. Increasing the marginal tax rate from .216 to .3  (4 points)

13. Decreasing government expenditures by 100 (4 points)

14. Reducing the money supply by 100 (4 points)

15. Assuming that the sole policy goal is the reduction of the trade deficit which would you therefore recommend?  If this was not the only goal, if, for example, your candidate was also concerned with issues of unemployment, which policy might you recommend?  (3 points)

Part IV: Supply-side Economics and Monetarism
(Answer 1 of the following questions for 12 points.)

16. Explain the rationale for juxtaposing "supply-side" economics to Keynesian "demand-side" economics.  Then discuss in what ways I have argued that this title is misleading and how "supply-side" economics can be better understood in terms of an attempt to redistribute income and power.  Which of Reagan's policies make more sense in this light and which, if any, do not?

17. In practice the Reagan "supply-side" policies were combined with a contraction in the money supply.  In what sense were those tight money policies "monetarist"?  Using aggregate supply and demand analysis (graphs and words only) explain what was hoped for with this combination of policies and what actually happened.

Part V: The International Debt Crisis
(Answer 1 of the following questions for 12 points.)

18. In the 1980s a central phenomenon in world finance and in the history of development in the Third World was the onset of an international debt crisis which, in some ways, is still with us.  a) Discuss some of the factors involved in the massive accumulation of debt in some countries in the 1970s.  b) Explain how changes in American economic policies triggered the onset of the crisis.

19. a) Discuss at least three of the options available to countries faced with the inability to repay their international debt in the early 1980s.  b) Which of these options was generally chosen and why didn't it resolve the crisis in short order?  In other words, what factors have been involved to prolong the crisis -to some extent right down to the present?

Part VI: The Peso Crisis
(Answer 1 of the following questions for 12 points.)

20. Discuss the combination and interaction of political and economic problems and policies that led to the collapse of the peso in December 1994.  What was going on in Mexican society, in its financial markets and within the policy circles of its government?  And how did these things mix to produce a crisis?

21. Discuss the Mexican and US governments' early 1995 responses to the Peso Crisis.  Describe what was done, and why, and the ways in which those actions were complementary or contradictory --on both economic and political planes?  Explain too the effects of the policies, on macroeconomic variables and on various groups of people.