ECO3152B: MACROECONOMIC THEORY III
FINAL EXAM
SECTION 1 (40 points) Each question has an equal weight of 2 points. Choose the one
alternative that best completes the statement or answers the question.
1) If consumers expect a tax cut to be temporary,
A) consumption remains unchanged.
B) the increase in consumption will be much larger than for a permanent tax cut.
C) the decrease in consumption will be much smaller than for a permanent tax cut.
D) the overall effects are much larger than for a permanent tax cut.
E) the increase in consumption will be much smaller than for a permanent tax cut.
2) Asymmetric information in the credit market means that
A) the bank cannot distinguish bad borrowers from good borrowers.
B) the bank cannot prevent consumers from defaulting on their loans.
C) the default rate on loans is excessively high.
D) borrowers can borrow from financial institutions other than banks.
E) consumers can only borrow from banks.
3) In a pay-as-you-go social security system, everyone can be made better off only if
A) the population growth rate exceeds the real interest rate.
B) the real interest rate remains higher than the population growth rate.
C) the number of old households exceeds the number of young households.
D) the interest rate for borrowers is sufficiently below that of lenders.
E) it is preceded by a fully funded system.
4) In a fully-funded social security program
A) the young pay for the benefits of the old.
B) the young are forced to save for their own retirement.
C) the young have to buy bonds for the old.
D) the young are forced to save for the retirement of the old.
5) Consumer choice theory predicts that, with identical consumers,fully-funded social security
A) always makes all generations worse off.
B) makes some generations better off, and cannot make any generation worse off.
C) may make some generations worse off and cannot make any generation better off.
D) maybe Pareto improving.
E) can potentially reduce welfare.
6) In the monetary intertemporal model, changing the money supply Ms
A) has real consequences.
B) affects the price level.
C) has no impact on prices or inflation.
D) is used to create economic growth in the short run.
E) affects output directly.
7) In the intertemporal real model, a consumer may increase his or her saving by
A) working more hours and consuming more goods in the present period.
B) working more hours and consuming fewer goods in the present period.
C) working fewer hours and consuming more goods in the present period.
D) working fewer hours and consuming fewer goods in the present period.
8) The condition = w' describes the representative consumer's
A) investment decision.
B) current consumption—savings decision.
C) current period work—leisure decision.
D) future period work—leisure decision.
E) future consumption-savings decision.
9) An increase in lifetime wealth is likely to
A) increase current labour supply and increase current consumption demand.
B) increase current labour supply and decrease current consumption demand.
C) decrease current labour supply and increase current leisure.
D) decrease current labour supply and decrease current consumption demand.
E) decrease current labour supply and decrease current leisure.
10) The slope of the demand for consumption goods is
A) greater than 1.
B) equal to 1.
C) the MPC.
D) the MRS.
E) equal to the wage rate.
11) Next period's capital is equal to current-period investment
A) plus the amount of current capital left over after depreciation.
B) minus the amount of current capital left over after depreciation.
C) plus the amount of current period depreciation.
D) minus the amount of current period depreciation.
E) plus the amount of current capital left over.
12) When drawn against the real interest rate, the output supply curve is upward sloping because labour supply is
A) increasing the real interest rate and labour demand is independent of the real interest rate.
B) decreasing the real interest rate and labour demand is independent of the real interest rate.
C) independent of the real interest rate and labour demand is increasing the real interest rate.
D) independent of the real interest rate and labour demand is decreasing the real interest rate.
E) increasing as the wage rate rises.
13) In the intertemporal monetary model, the total government expenditure multiplier is
A) larger than 1.
B) between 0 and 1.
C) equal to the MPC.
D) equal to 1/(1-MPC).
E) equal to 1.
14) If the nominal interest rate rises,
A) there is substantial inflation in the economy.
B) real interest rates are declining.
C) consumers and firms are less inclined to use credit cards.
D) inflation is declining.
E) the opportunity cost of holding cash rises.
15) The real business cycle model best explains why the nominal money supply is procylical by taking into consideration that
A) decisions of the Bank of Canada are unpredictable.
B) money is exogenous.
C) money is endogenous.
D) money is uncorrelated overtime.
E) money is neutral.
16) An important critique of real business cycle theory is the belief that cyclical movements in total factor productivity
A) rarely occur.
B) may, in part, be an artifact of measurement error.
C) are too small to account for the size of fluctuations in real GDP.
D) does not explain the overall fluctuations in the business cycle.
17) How many of the following business cycle facts can be explained if the primary cause of business cycles is temporary changes in government spending: procyclical consumption,procyclical investment, procyclical employment, and procyclical real wages?
A) one
B) two
C) three
D) four
E) none
18) Consumption smoothing refers to
A) the tendency of all consumers to choose the same amount of current consumption.
B) the tendency of consumers to seek a consumption path overtime that is smoother than income.
C) the tendency of consumers to seek an income path overtime that is smoother than consumption.
D) consumer's concerns about going heavily into debt.
E) balance savings with consumption overtime.
19) In the New Monetarist Model, for financial liquidity to affect the demand for investments goods requires
A) deficient financial liquidity.
B) consumers and firms to be surprised by monetary policy.
C) adequate financial liquidity.
D) an initially very high interest rate.
E) only that consumers and firms behave rationally.
20) In response to a financial liquidity shortage, if the central bank increases the money supply,
A) aggregate demand shifts to the right, correcting the liquidity shortage. B) output increases and the price level remains constant.
C) output increases and the price level increases.
D) aggregate demand shifts further left, exacerbating the problem.
E) aggregate supply shifts right, offsetting the decrease in aggregate demand.
SECTION 2
Answer all questions in the examination booklet.
Question I (15 points)
Consider a two period closed-economy model from Chapter 9.
a) (5 points) State the Ricardian equivalence theorem.
b) (5 points) Explain one possible reason why the Ricardian equivalence theorem may not hold in practice.
c) (5 points) Suppose that in the competitive equilibrium of the model, the current aggregate tax T=200, current aggregate consumption C=3000, and private saving is 95. Using the equilibrium conditions of the model, find the implied values of government debt B (the amount of government bonds issued) and aggregate income in the current period Y.
Question II (30 points) Stabilization policies in the RBC model
Consider a decrease in the current total factor productivity z that triggers an economic recession. Answer the following questions based on the monetary intertemporal model economy from Chapter 12 of Williamson (2013) “Macroeconomics.”
a) (10 points) Analyze the equilibrium responses consumption and investment. Be explicit about all economic mechanisms through which the decline in z influences the decisions of consumers and firms. Provide a graphical illustration of your response.
b) (10 points) The government considers increasing government spending G to help the economy to get out of the recession. Is such policy intervention feasible in the context of the monetary intertemporal model? Is it desirable? In other words, is active stabilization policy welfare improving? Explain your response and provide a graphical illustration.
c) (10 points) The government considers increasing money supply Ms to help the economy to get out of the recession. Is such policy intervention feasible in the context of the monetary intertemporal model? Is it desirable? Explain your response and provide a graphical illustration.
Question III (40 points): The consumer’s problem in a dynamic model
Consider atwo-period consumption-saving model from Chapter 9. A consumer’s income in the current period is exogenous. The incomes in the current and in the future periods are denoted by y andy’. There are notaxes. The consumer’s utility function is given by
U(c,c’) = lnc + β lnc’, 0< β <1,
where β denotes the discount factor.
To answer questions a) to f), assume that the credit market is perfect. The real interest rate on borrowing and lending is denoted by r.
a) (5 points) State in details the consumer’s optimization problem.
b) (5 points) Derive and interpret the two conditions that define the optimal choice of consumption in the current and in the future periods.
c) (5 points) Find the analytical expressions for the optimal values of consumption in both periods, and optimal savings s.
d) (5 points) Suppose y =480, y’=500 and β=0.9. Consider the real interest rate r=0.1. What are the optimal values of consumption in both periods? Is the consumer a lender or a borrower? Explain.
Represent the consumer’s choice of c, c’ and s on a graph. Make sure to label the axes and the points of the intercepts of the budget constraint with the horizontal and vertical axes. Indicate the value of the slope of the budget constraint, the endowment point, and the point of optimality.
e) (10 points) Keep the values y=480, y’=500 and β=0.9. Suppose the real interest rate increases to r=0.2. Find the new optimal values of consumption. Is the consumer a lender or a borrower? Explain.
How is the consumer’s welfare affected by the increase in the real interest rate? Compare with the case of r=0.1. Explain your response.
Draw a new graph to illustrate the impact of a higher real interest rate on the consumer’s choice. On this diagram, show the optimal consumption choice for the old and the new interest rates. Comment on the relative strength of the income and substitution effects of the real interest rate changes.
To answer questions f) and g), assume that the consumer can lend at the real interest rate r1=0.1 but can only borrow at the real interest rate r2=0.2.
f) (5 points) Draw a graph to illustrate the set of feasible consumption allocations. Be precise about the relevant interest rates. What are the optimal values of consumption in both periods? Is the consumer a lender or a borrower? Explain. Illustrate the optimal choice on the graph.
g) (5 points) How is the consumer’s welfare affected by this type of credit market imperfections? Compare with the case of perfect credit markets. Explain your response.