Final Examination
December 8, 2003

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	1-4
1-5	1-6	1-7	1-8
2-1	2-2	3

First Part (5 point questions)

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

1 As far as economic growth and development is concerned, the less government the better.

2 It is often said that unemployment is a sign of resources being reallocated. If there is true, then high unemployment can never be bad for that simply means that a lot of resources are being reallocated and that must mean sweeping gains in economic efficiency.

3 If a nation has a comparative advantage in producing a product, it is better at it than anyone else in the world.

4 Suppose that, when I burned a dollar bill in class, the government had increased the money supply by $1, thus keeping the money supply and hence the price level constant. No one would have gained by my action.

5 If the government decides to pay off 20% of the national debt by levying a one time tax on wages, there will be no impact on the demand for loans unless people do not have a bequest motive

6 When the Federal Reserve System sells a $1,000 bond to the public in an open market operation, it increases the amount of government debt held by the public by $1,000. When the United States Treasury sells a $1,000 bond to the public to finance (say) a new irrigation project, it too increases the amount of government debt held by the public. Thus it is clear that they must have the same effect on the money supply

7 The life cycle model of consumption explains why consumption is proportional to income in the long run but not the short run

8 While the primary cause of the 1929-1993 economic decline in the United States was the decline in the money supply, the “dust bowl” was a contributing factor.

Second Part (15 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 £.

a) Japan suffers a devastating earthquake, necessitating the rebuilding of much of its infrastructure.

b) California suffers a devastating earthquake, necessitating the rebuilding of much of its infrastructure.

c) Santa Claus repeats the Christmas Eve Caper in the member states of the European Monetary Union, doubling everyone’s supply of Euros.

d) Santa Claus repeats the Christmas Eve Caper in the United States, doubling everyone’s supply of Dollars

e) Santa Claus repeats the Christmas Eve Caper in the United States. BUT, confused by scenarios (c) and (d), he gives everyone X Euros for each X dollars they hold.

f) It suddenly becomes more attractive to use debit cards rather than credit cards in the United States

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

Backwater suddenly strikes oil; vast new quantities of crude oil come on the world market.

	French vineyards go on a month-long strike, effectively running this years production of wine.
	Terrorists destroy a Malaysian plant producing memory chips for Dell Computers.

	Santa Claus repeats the Christmas Eve Caper in the member states of the European Union, doubling each person’s supply of Euros.
	Santa Claus repeats the Christmas Eve Caper in the United States. BUT, confused by too much Christmas Spirit, he gives everyone he gives everyone X Euros for each X pounds they hold.

Russian citizens, who currently hold significant numbers of US dollars, decide to hold Euros instead.

Third Part (30 points)

The United States has just enacted some significant tax cuts; at the same time, it is running a large budget deficit. Two plans have been proposed for dealing with this situation.

· The first plan, the DEAN plan calls a special one-time tax bill for everyone equal to X times last year’s income. The money will be used to retire the national debt. (Accountants are still working out the value of X). The savings in interest expenses, amounting to hundreds of billions a year, will be sufficient to bring the budget into balance.

· The second plan, SNOW, freezing government spending. Over time, economic growth will raise tax revenue and bring the budget into balance. (Obviously this will mean many government programs will get their funding reduced, but partisans of the SNOW plan assume all government spending is wasteful anyway: you may adopt this assumption for the purpose of answering this question).

Now for the questions. In answering this question, remember the old proverb that well-labeled and well-explained graphs are worth a thousand or more words.

What will be the effect of these two plans on GDP, the price level, interest rates and the b balance on current account the first year? Tell me specifically which of these variables will go up, down, or remain the same. Be prepared for some of these answers to be ambiguous. Should both plans result in (say) an increase in interest rates, tell me which one will have the larger increase in interest rates.