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)?
- a sudden, exogenous increase in the cost of a basic good like
oil
- a deterioration in the capital stock due to inadequate public
investment
- productivity raising technological changes brought on by government
subsidies to research and development
- a post-war expulsion of women from waged jobs to make room
for returning soldiers
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
- the Batavian economy is well below
capacity and is operating on the flat portion of its AS curve.
- the monetary authority in Batavia
has been reducing the money supply to keep interest rates high.
- all wages in the Batavian economy
are set by explicit contracts that last for a minimum of a year.
- the Batavian economy is very close
to capacity and is operating on the steep portion of its AS curve.
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:
- the sudden flood of petrodollars into world financial markets would
drive down interest rates, stimulating investment and growth
- the increase in the price of oil would raise production costs and
shift the aggregate supply curve upwards which would tend to raise price
levels and reduce the level of economic activity.
- the ability of workers to force up money wages in the face of rising
prices would shift the aggregate demand curve to right putting further
upward pressure on the price level
- all of the above
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
- the growing deficit would push the aggregate demand curve to the
left lowering, ceteris paribus, the equilibrium level of economic activity
- worker anger over cheap imports would stir unrest raising production
costs and shifting the aggregate supply curve upward, creating inflationary
pressures.
- worker delight in cheap imports and the consequent rise in real
wages will limit wage demands and keep the aggregate supply curve from
shifting up.
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:
- One suggestion is to increase the marginal tax rate.
- Another is to decrease government expenditures.
- A final is to reduce the money supply.
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.