Final Examination
May 12, 2005

 

Directions: do all work on the exam itself, answering the question in the space provided.  If you require extra space, use the back of the exam, indicating that you have done so.  Each problem has the indicated weight.

Name:

 

1-1          

1-2

1-3

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1-5

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1-8

2-1

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3

 

 

 

First Part (5 point questions)

For the following statements, indicate whether they are TRUE or FALSE and explain why. 

 

1.               The labor supply curve is upward sloping

2.               An individual who expects to live for four time periods and who has a consumption demand function like that we studied in class expects to earn $100,000 in period 2 and $200,000 in period 3 of his life (and zero in periods 1 and 4).  The earnings are stated in real dollars.  His value of ξ is 1/3.  The nominal interest rate is 125% and the expected rate of inflation is 50%.  His demand for money in period 1 is $10,000.  (Hint: disagree and give me the right number).

 

 

 

 

 

 

 

3.               When the government taxes wages for useless projects, it makes people work harder.  When the government taxes wages to pay for things people would buy themselves, it makes them work less.

4.               The Lorenz curve shows the relation between tax revenue and tax rates.

 

 

 

 

 

 

 

 

5.               A nation with fixed exchange rates does not have as much flexibility in using monetary policy for domestic purposes as one with flexible exchange rates.

6.               Inflation robs us all

 

 

 

 

 

 

 

 

 

7.               The concept of the Phillips Curve rests on the premise that individuals can never be fooled about inflation.

8.               A Monetary Policy Rule provides the basis for setting the rate of inflation to counteract unemployment.

 

Second Part (20 point questions)

1.            For each of the following events, what will be the impact on the US trade deficit? Explain your answer. It is not enough to guess the right answers: you must explain why these are the correct answers. I want to see a well-labeled and well-explained graph of the demand for loans.  Note: in all of these questions, you may assume that the only nominal assets and liabilities in the US, Europe and the UK are $, €, and £.

1.      China revalues the Yuan (its currency) from 8 Yuan to the dollar to 5 Yuan to the dollar, and the result is a 60% increase in domestic Chinese prices.

2.      New research reveals a production function more accurate than the Cobb-Douglas.  (That is, the new function does a better job of fitting the facts)

 

 

 

 

 

 

 

 

 

 

3.      Following the debacle of the “runaway bride” engaged couples throughout the United States decide to forgo elaborate weddings, and spend the money on 25th wedding anniversary parties.  (You may assume that couples already married don’t change their plans.

4.      The government announces plans to spend $10,000,000 next year to build a monument to Irving Fisher, to be paid for with a temporary one year tax on this year’s wage incomes

 

 

 

 

 

 

 

 

 

 

5.      People want to double the amount of money they hold (formally, ξ doubles).  The Federal Reserve System responds by open market operations which double the money supply.

 

 

 

 

 

 

 

 

6.      Political turmoil breaks out in East Backwater.  People, both consumers and investors become less confident about the future. NB East Backwater uses the Euro.

2.            For each of the following situations, draw the impact on the Y and M curves for the United States and tell me the impacts on the price level and the interest rate.  I have drawn the initial Y and M curves for you.  Explain your reasoning.

Remember: these are the Y and M curves for the United States

 

The government of England announces plans to spend ₤10,000,000 this year to build a monument to David Hume (who first stated the quantity theory) to be paid for with freshly printed pound notes. 

 

 

 

 

 

 

 

 

 

Unemployment compensation is cut, lowering the natural rate of unemployment by half.

 

 

 

 

 

 

The Environmental Protection Agency outlaws the use of oil-based paints in the United States

 

 

 

 

 

 

 

Santa Claus repeats the Christmas Eve Caper in the United States.  Well, sort of.  He gives everyone a freshly printed $300 US government bond.

 

 

 

 

 

 

The United States repeals the law abolishing mandatory retirement, and most companies now reinstate their mandatory retirement programs.

 

 

 

 

 

Europeans discover a new way to avoid taxes.  But it requires that they get credit cards and pay their account balances off in US dollars.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Third Part (20 points)

The Republic of Saltwater, in many ways an idyllic island republic, is heavily agricultural.  Unemployment has been at 3% for many years.  Saltwater trades a lot with the United States and has adopted the US dollar as its currency; the position of head of the central bank is a sinecure awarded to retired politicians.  (In fact, virtually all goods and services produced and consumed in Saltwater are traded goods).  The Saltwater Meteorological Service has just issued a rather dismal weather forecast for the next growing season.  To put it bluntly, a drought is expected.    While it will last for only one year, the nation is concerned.

 

 

·        Using the Y and M curves, show the effect on Saltwater in the coming year.  What will be the impact on Prices, interest rates, and GDP?

·        The Westminster Institute, a Saltwater think tank, has proposed that the nation address the drought by a massive public works project, to build a monument to Adam Wurlitzer, the Founder of the nation.  They propose to finance the project by taxing each individual $100.  Assuming the proposal is adopted, what will be the effects on Prices, interest rates and GDP.  (Note your answers should be relative to those you gave above.