Final Examination
December 13, 2002

 

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.

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First Part (15 point questions)

For seven of the following eight statements, indicate whether they are TRUE or FALSE and explain why.  Note: you must indicate which question you are not answering below.  If you do not make a choice, I will pick a question at random.

 

 

I am not answering question______________

 

1        A tax on wage income, if it is temporary, will cause people to work less; if it is permanent, it will cause people to work more.

2        reR  = h - rN

3        The peak of the Laffer Curve shows the optimal level of taxation.

4        If people become more confident about the future, the current deficit on current account will decrease.

5        If the government starts increasing the money supply interest rates will fall.

6        MV = PY.  Always

7        The Theory of Real Business Cycles predicts that real wages will fall during a period of business expansion.  By the test of “does it fit the facts” it is inferior to the explanation based on unanticipated inflation.

8        To be effective, Monetary Policy Rules must be well publicized.

Second Part (30 point questions)

1                 Suppose that the Federal Reserve System engaged in a $100 Billion Open Market Operation.  

a)     Explain what an Open Market Operation is and how the Fed would carry it out.

b)      Assuming the Quantity Theory of Money works without qualification, explain what the impact of the Open Market Operation would be on the price level.  (You might also want to define the Quantity Theory of Money in your answer).

c)      Trace through any implications of the Open Market Operation on the level of investment.

2                 FORTUNATE is currently enjoying a period of relative stability.   For a number of years, the unemployment rate has been relatively constant at 6%, and the inflation rate has been steady at about 3%.   As a result of an election, a new administration is taking power.  Their election was an upset, with the possible exception of the party leader, no one saw it coming.  The party is pledged to change the nation’s tax policy.  In particular, the new party wants to pay off the national debt by levying a one time tax on all workers.  A special surcharge will be levied on last year’s income.   After this year, all tax rates will be lowered to reflect the savings from not having to pay interest on the national debt. The new administration plans no other changes.  In particular, they have pledged no impact on monetary policy.

a)     Show what effects you expect this policy change to have on FORTUNATE’s inflation rate, interest rate and unemployment in the current year.

Note: it is not enough to guess the right answers: you must explain why these are the correct answers.

b)     Show what effects you expect this policy change to have on FORTUNATE’s inflation rate, interest rate and unemployment in the long run.

Note: it is not enough to guess the right answers: you must explain why these are the correct answers.

Third Part (35 points)

I have attached a news column from the December 6, 2002 web page of CNN.   Comment critically.  Show you can apply what you have learned in this course. 

·        Is this tax cut a good idea? 

·        Assuming that it is adopted, what would be its likely impact on key economic variables? 

·        Do you agree or disagree with the analysis in this article.  Why or why not?

 

Some suggestions:

·        Do not comment on Messrs O’Neill, Lindsey, and Harvey Pitt.  Forget personalities. 

·        Do not get into the discussion of gold.

·        Remember, this is a chance to show you can apply the analysis you learned in this course.  I would expect to see graphs and words like “Demand for Loans” and “Y and M curves” dripping from your answers.