2014 Proeftentamen - Macroeconomics

Faculty of Economics and Business

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Please read the information below before answering any exam questions!

Try-out exam 1: Macroeconomics (6011P0138)

Date and time of the exam:

Duration of the exam:

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and placed on the floor. During the exam you are not allowed to go to the toilet

.

Tools allowed: pencil, pen, eraser

Specific information on this exam: The set of questions has 9 pages (excluding this front page) and there is one extra page with lists with possible answers for the graphical analyses. Make sure you have got

everything.

The exam has 5 parts. The questions in parts 1, 2 and 3 are multiple choice questions, the questions in parts 4 and 5 are numerical questions. For the multiple choice questions, there is a guess correction, which works as follows. Assume the question earns x points, and there are n possible answers. If your answer is correct, you

get x points; if you do not answer, you get 0 points; if your answer is wrong, x/(2*(n-1)) points are subtracted. For each part of the exam, a negative amount of earned points is rounded to zero. Your grade is computed by

adding up your points for the 5 parts, dividing the sum by 3.6, and then rounding up or down.

You may use this set of questions as scrap paper.

The results of this exam will be published within 15 working days following the date of the exam. If the re-sit is scheduled to take place within 6 weeks following the current exam, the

results of the current exam will be published within 12 working days.

Inspection of the exam: To inspect your exam, please send an e-mail to [email protected]. The solutions will also be placed on Blackboard.

You may ask for copies of the assessed work and the elaborations/solutions, at cost price.

You are allowed to keep the question form(s) after the examination.

Good luck!

VERSION 1

PART 1: Answering sheet for the multiple choice questions,questions 1 until 9

(9 questions of 2 points = 18 points)

1. Consider an economy where three different goods are produced. In every year, allproduction is consumed. The table below gives the production quantities and theprices of the three goods in year 1 and year 2. Compute first the consumer priceindex in year 1 and year 2 (CPI1 and CPI2), with year 1 as base year; then computeinflation between year 1 and year 2 as (CPI2 CPI1)/CPI1. Inflation, expressed inpercent, is then equal to:

1. 0, 4, 8, 12, 16, 20, 24, 28, 32 of 36;

2. 1, 5, 9, 13, 17, 21, 25, 29, 33 of 37;

3. 2, 6, 10, 14, 18, 22, 26, 30, 34 of 38;

4. 3, 7, 11, 15, 19, 23, 27, 31, 35 of 39.

year 1 year 2

production quantity- of good 1 4 5- of good 2 3 3- of good 3 7 9

price- of good 1 12 15- of good 2 8 10- of good 3 4 3

2. Are the following statements true or not true?

I. As oil prices rose in the 1970s, the Dutch Guilder experienced a strong nominaldepreciation against the U.S. dollar.

II. As oil prices rose in the 1970s, tax revenues for the Dutch government decreased(expressed as a percentage of GDP), which forced the Dutch government todecrease government purchases (also expressed as a percentage of GDP).

1. Statement I is true; statement II is true.

2. Statement I is true; statement II is not true.

3. Statement I is not true; statement II is true.

4. Statement I is not true; statement II is not true.

1

3. The graph below shows

1. the Dow Jones.

2. the Nikkei.

70 80 90 2000 102000

4000

8000

16000

32000

un

its

4. Are the following statements true or not true?

I. A Central Bank of a currency that is attacked as investors start to sell largeamounts of the currency, can keep the exchange rate of its currency constant bydecreasing the interest rate, which stimulates the economy and leads to higherGDP growth.

II. Several Central Banks in the EMS have lost a lot of foreign exchange as a resultof the exchange rate crisis in the EMS in September 1992.





2

5. The graph below shows the nominal and the real effective exchange rate for Japansince 1980, where the exchange rate appreciates if the curve rises, and depreciates ifthe curve goes down. Which curve is for the nominal exchange rate, and which oneis for the real exchange rate?

1. The thick line is the nominal effective exchange rate, and the thin line is the realeffective exchange rate.

2. The thick line is the real effective exchange rate, and the thin line is the nominaleffective exchange rate.

20

40

60

80

100

120

1950 1960 1970 1980 1990 2000

Japan

I nd e

x ( 2

0 00 =

1 00 )

6. Consider the IS-LM and the AS-AD model for a closed economy with adaptive ex-pectations. An increase in the nominal money supply leads then to

1. an increase in the real interest rate, both in the short and in the long run.

2. an increase in the real interest rate in the short run, but no change in the realinterest rate in the long run.

3. a decrease in the real interest rate, both in the short and in the long run.

4. a decrease in the real interest rate in the short run, but no change in the realinterest rate in the long run.

3

7. The graph below gives government debt as a percentage of GDP in The Netherlandsfrom 1993 until 2001. Are the following statements then true or not true?

I. The government debt in the graph is the government debt after deducting thevalue of the assets of the Dutch government.

II. The graph implies that the Dutch government had a budget surplus every yearbetween 1993 and 2000.





94 96 98 200050

60

70

80

90

100

as

a p

erce

ntag

e of

GD

P

8. Are the following statements true or not true in the AD-AS-model?

I. With rational expectations, the classical dichotomy does not only hold in thelong run, but for anticipated aggregate demand shocks also in the short run.

II. Adaptive expectations and rational expectations have the same macro-economiclong run implications, but not the same macroeconomic short-run implications.





4

9. Consider a closed economy which is described by the Keynesian Cross Model, assumethat the consumption function is linear and assume that government purchases consistof an autonomous part and part that is proportional with aggegete income:

Y = C + I +G

C = C + c(Y T )I = I(r)

G = G+ gY

T = T

Y is aggregate production, C is aggregate consumption, I is aggregate investment,G is government purchases and T are taxes. r is the real interest rate. C, c, G,g and T are parameters. G is autonomous government purchases, and c and g aresuch that 0 < c < 1 and 0 < g < 1; assume also that c g < c + g < 1 and thatc(1 g) < c(1 + g) < 1 (such that the four possible answers below are all positive).The multiplier of autonomous government purchases is then equal to:

1. 11cg2. 11c(1g)3. 11c+g4. 11c(1+g)


(21 questions of 6/21 points = 6 points)

Below is described how the economy reacts to a decrease in autonomous investmentaccording to the IS-LM-model.

A number of terms or phrases in the description are left out. Look for the most ap-propriate term or phrase in the list which the term between curled brackets refers to. Thelist with possible answers is not in this exam copy, but is handed out seperately. Makeon your answering sheet the bullets black that correspond with the correct answers. Theanswer for the first phrase that is left out corresponds on your answering sheet with theanswer for question 10, the answer for the second phrase that is left out corresponds onyour answering sheet with the answer for question 11, etc. The answer for the last phrasethat is left out corresponds on your answering sheet with the answer for question 30.

Assume the economy is in equilibrium when it is hit by the shock.

Assume that the central bank keeps the nominal money supply constant.

5

Description

i. The shock causes planned aggregate expenditures to {10. change} (given the interestrate). This leads to a shift {11. shift} {12. curve} to the {13. direction}, and {14.disequilibrium} in the goods market.

ii. As a result, aggregate production starts to {15. change}. This has two consequences.First, the disequilibrium in the goods market declines. Second, {16. variable} {17.change}, which causes {18. disequilibrium} in the money market. The economicagents therefore try to {19. transaction} bonds, which causes the interest rate to{20. change}, until equilibrium in the money market is restored. These changesin the money market are described by a shift {21. shift} {22. curve} to the {23.direction}. In addition, as a result of the change in the interest rate, {24. variable}{25. change}, such that the disequilibrium in the goods market declines even further.This process continues until equilibrium in both the goods market and the moneymarket is restored.

iii. Compared with the initial equilibrium, in the new equilibrium

aggregate production {26. change} aggregate consumption {27. change} aggregate investment {28. change} the real money supply {29. change} the interest rate {30. change}



Below is described how the economy reacts to a decrease of autonomous real moneydemand according to the Mundell-Fleming-model.

A number of terms or phrases in the description are left out. Look for the most ap-propriate term or phrase in the list which the term between curled brackets refers to. Thelist with possible answers is not in this exam copy, but is handed out seperately. Makeon your answering sheet the bullets black that correspond with the correct answers. Theanswer for the first phrase that is left out corresponds on your answering sheet with theanswer for question 31, the answer for the second phrase that is left out corresponds onyour answering sheet with the answer for question 32, etc. The answer for the last phrasethat is left out corresponds on your answering sheet with the answer for question 48.

Assume that net export is only a function of the real exchange rate (and not of aggre-gate income).

Assume the economy is in equilibrium when it is hit by the shock.

6

Assume floating exchange rates.

An increasing exchange rate means that the domestic currency appreciates; a decreas-ing exchange rate means that the domestic currency depreciates.

Excess demand on the foreign exchange market means that there is more demand forforeign currency than supply of foreign currency; excess supply on the foreign exchangemarket means that there is more supply of foreign currency than demand for foreign cur-rency.

Unless mentioned otherwise, all variables refer to their domestic values.

Description

i. The shock causes the interest rate to {31. change}. However, this immediatelycauses an {32. flow} of capital, until the interest rate is again equal to the interestrate abroad. This capital flow causes {33. disequilibrium} in the foreign exchangemarket, such that the exchange rate {34. change}. As a result, {35. variable} {36.change}, which causes {37. disequilibrium} in the goods market, such that aggregateproduction {38. change}. The effect of the shock and the change in aggregate pro-duction on the equilibrium in the money market is described by a shift {39. shift}{40. curve} to the {41. direction}. This process continues until the economy is againin equilibrium.

ii. Compared with the initial equilibrium, in the new equilibrium

aggregate production {42. change} aggregate consumption {43. change} aggregate investment {44. change} net export {45. change} the real money supply {46. change} the interest rate {47. change} the exchange rate {48. change}

7

PART 4: Answering sheet for the numerical questions,questions 1 until 8


Give only your solutions (not your derivations)!

Consider a closed economy described by the IS-LM-model:

Y = C + I +G

C = C(Y T )I = I(i)

M

P= L(i, Y )

Y is aggregate production, C is aggregate consumption, I is aggregate investment, Gis government purchases, T is taxes, M is nominal money supply, and P is the aggregateprice level. i is the interest rate. G, T , M and P are determined exogenously.

Assume the following functional forms and parameter values:

G = 500, T = 400, M = 3000, P = 3C(Y T ) = 220 + 45(Y T )I(i) = 400 40iL(i, Y ) = 12Y 100i

Compute now the equilibrium values of the following variables:

1. aggregate production Y .

2. the interest rate i.

Assume now that the aggregate price level P increases from 3 to 5.Compute the new equilibrium values of aggregate production Y and the interest rate i,

assuming that the Central Bank keeps the nominal money supply constant:



Compute the new equilibrium value of aggregate production Y , assuming that the CentralBank keeps the interest rate at the level which you found in question 2, and compute thenominal money supply M which is required to achieve this.


6. the nominal money supply M .

Compute the new equilibrium value of the interest rate i, assuming that the Central Bankkeeps aggregate production constant at the level which you found in question 1, and computethe nominal money supply M which is required to achieve this.


8. the nominal money supply M .

8

PART 5: Answering sheet for the numerical questions,questions 9 until 14


Give only your solutions (not your derivations)!

Consider a small open economy described by the Mundell-Fleming-model:

Y = C + I +G+NX

C = C(Y T )I = I(r)

NX = NX()

M

P= L(i, Y )

i = i = r = r

=Pe

P

Y is aggregate production, C is aggregate consumption, I is aggregate investment, NXis net export, G is government purchases, T is taxes, M is the nominal money supply, P isthe domestic aggregate price level, and P is the foreign aggregate price level. r, r, i andi are the domestic and foreign real and nominal interest rates. and e are the real andnominal exchange rate, respectively. G, T , M , P , P , r and i are determined exogenously.

Assume the following functional forms and parameter values:

G = 250, T = 300, M = 1000, P = 1, P = 1, r = i = 5C(Y T ) = 200 + 35(Y T )I(r) = 400 40rNX() = 450 10L(i, Y ) = Y 10i

Compute now the equilibrium values of the following variables:


10. the exchange rate e.

Assume now that government purchases G and taxes T both decrease with 100.Compute the new equilibrium values of aggregate production Y and the exchange rate

e in a system of floating exchange rates:

11. aggregate production Y in a system of floating exchange rates.

12. the exchange rate e in a system of floating exchange rates.

Compute the new equilibrium value of aggregate production Y and the required nominalmoney supply M in a system of fixed exchange rates:

13. aggregate production Y in a system of fixed exchange rates.

14. the required nominal money supply M in a system of fixed exchange rates.

9

Lists for Part 2

curve

1. the IS-curve

2. the LM-curve

disequilibrium

1. excess demand

2. excess supply

direction

1. right

2. left

transaction

1. buys/buy/buying

2. sells/sell/selling

variable

1. consumption demand

2. investment demand

3. the nominal money supply

4. real money demand

change

1. increases/increase/has increased

2. does not change/do not change/has not changed

3. decreases/decrease/has decreased

shift

1. of

2. along

Lists for Part 3

curve

1. the IS*-curve

2. the LM*-curve

disequilibrium

1. excess demand

2. excess supply

direction

1. right

2. left

flow

1. inflow

2. outflow

transaction

1. buys/buy/buying

2. sells/sell/selling

variable

1. investment demand

2. net export

3. the nominal money supply

4. real money demand

change

1. increases/increase/has increased

2. does not change/do not change/has not changed

3. decreases/decrease/has decreased

shift

1. of

2. along

Solutions

Part 1 - Answering sheet for the multiple choice questions

1. 4. Denote the production quantity and the price of good i in year t by respectively xt,i andpt,i.

As year 1 is the base year, the consumer price index in year 1 is equal to 1:

CPI1 = 1

The consumer price index in year 2 is given by:

CPI2 =x1,1 p2,1 + x1,2 p2,2 + x1,3 p2,3x1,1 p1,1 + x1,2 p1,2 + x1,3 p1,3

=4 15 + 3 10 + 7 34 12 + 3 8 + 7 4

=111

100= 1.11

Inflation (pi) according to the consumer price index is then equal to:

pi =CPI2 CPI1

CPI1

=1.11 1

1= 0.11 = 11%

2. 4. Statement I: In the 1970s, several European currencies strongly appreciated against deU.S. dollar (as is apparent from the first graph of lecture 6). The nominal appreciation of theDutch guilder was partly caused by the fact that prices for natural gas also increased in the1970s as oil prices rose (such that an important part of Dutch export became more expensivewhich boosted the demand for the Dutch guilder). Statement II: As oil prices rose in the1970s, the price of natural gas and the revenues for the Dutch government increased as well.This allowed the Dutch government to increase government purchases and to implement astrongly expansionary fiscal policy.

3. 2. See lecture notes.

4. 3. See lecture notes.

5. 1. Recall that Japan experienced very low inflation, and sometimes even deflation, since the1990s (in contrast with most other countries). As a result, the nominal effective exchangerate has appreciated more than the real effective exchange rate (for the relation between theappreciation of the nominal exchange rate and the appreciation of the real exchange rate, seeChapter V). The thick line therefore represents the nominal exchange rate, and the thin linethe real exchange rate.

6. 4. An increase in the nominal money supply leads to a shift of the LM-curve to the right,such that the interest rate declines in the short run. In the long run, however, the classicaldichotomy holds, and the real interest rate does not change: in the long run, the aggregateprice level increases according to the AD-AS-model, such that the LM-curve shifts back to itsinitial position.

7. 4. Statement I: The government debt in the graph is gross government debt, not net govern-ment debt. Statement II: Between 1993 and 2000, the government budget was most of thetime in deficit; this did not lead to higher government debt as a percentage of GDP, however,because GDP strongly increased in this period.

8. 1. Statement I: With rational expectations, anticipated demand shocks do not make theeconomy deviate from a long run equilibrium, such that the classical dichotomy does not onlyhold in the long run, but also in the short run for anticipated demand shocks. Statement II:With adaptive expectations, anticipated demand shocks do make the economy deviate froma long run equilibrium, in contrast to rational expectations. So adaptive expectations andrational expectations do not have the same short run implications.

9. 1. Assume that the goods market is in equilibrium, such that Y = C+ I+G. As governmentpurchases increase with 4G, equilibrium production Y changes with 4Y , where 4Y =4C+4I+4G. From the consumption function follows that4C = c4Y ; from the investmentfunction follows that 4I = 0; and from the function for government purchases follows that4G = 4G+ g4Y . We therefore find that 4Y = c4Y + 0 +4G+ g4Y , such that (1 cg)4Y = 4G. This leads to 4Y = 11cg4G, such that the multiplier is given by 11cg .


10. 3 , 11. 1 , 12. 1 , 13. 2 , 14. 2

15. 3 , 16. 4 , 17. 3 , 18. 2 , 19. 1 , 20. 3 , 21. 2 , 22. 2 , 23. 2, 24. 2 , 25. 1

26. 3 , 27. 3 , 28. 3 , 29. 2 , 30. 3


31. 3 , 32. 2 , 33. 1 , 34. 3 , 35. 2 , 36. 1 , 37. 1 , 38. 1 , 39. 1 , 40. 2 , 41. 1

42. 1 , 43. 1 , 44. 2 , 45. 1 , 46. 2 , 47. 2 , 48. 3

Part 4 - Answering sheet for the numerical questions

1. Y = 3000, 2. i = 5, 3. Y = 2600, 4. i = 7

5. Y = 3000, 6. M = 5000, 7. i = 5, 8. M = 5000

Part 5 - Answering sheet for the numerical questions

9. Y = 1050, 10. e = 50, 11. Y = 1050, 12. e = 46, 13. Y = 950, 14. M = 900

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2014 Proeftentamen - Macroeconomics

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