MACROECONOMIC THEORY I

ECO2142 B
Fall 2015

prof. Francesca Rondina

MIDTERM 1
October 5th, 2015

Version 1

Name

Student ID

This exam is closed book/closed notes.

The use of NONPROGRAMMABLE calculators is permitted. Cellular phones and all other elec-
tronic devices must be turned off and put away during the exam.

The exam consists of a total of 33 questions each worth 3 points for a total of 100 (everyone will
receive 1 point for free). In addition, there is one bonus question worth 5 points.

You have 1 hour and 20 minutes to complete the 33 + 1 questions.

Good luck!

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1. This morning Anthony purchased a Rocky Mountain bike from a store in Vancouver for $1,000.
The bike is new, and was produced in July 2015 in a Rocky Mountain plant in British Columbia,
Canada. Anthony paid and additional $150 to Move Inc. for the delivery of the bike from the store
in Vancouver to his house in Toronto.
In the 2015 National Identity for Canada, the total contribution of this transaction to GDP is

(a) $0
(b) $150
(c) $1,000
(d) $1,150

2. Paul has just bought 12 one-liter bottle of maple syrup from the website of Maple & Co., a maple
farm in Quebec, Canada. The syrup was produced in the farm in May 2015, and will ship from
Quebec to Pauls home today. Paul is a U.S. citizen and lives in Chicago, IL.
In the 2015 National Identity for Canada, in which expenditure group is this transaction recorded?

(a) In investment (I).

(b) In consumption (C)
(c) In exports (X).
(d) This transaction is not recorded in the 2015 National Identity for Canada.

3. Last Monday, Diane took a two-hour Spanish class at a Language School in Ottawa. The teacher
of the class was prof. Pablo Cortez, who is Argentinian and only moved to Canada one month ago.
The class cost $50. This transaction

(a) increased GDP for Canada and did not affect GDP for Argentina.
(b) increased GDP for Argentina and did not affect GDP for Canada.
(c) increased GDP for both Canada and Argentina.
(d) did not affect GDP for either Canada or Argentina.

4. Claires marginal propensity to consume is 0.75. You observed that, after a change in taxes (T ),
Claires consumption decreased by $30. If Claires income (Y ) did not change, you can deduce that
taxes

(a) increased by $40.

(b) increased by $10.
(c) decreased by $10.
(d) decreased by $30.

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5. Using 2005 as the base year, you computed that CPI in the country of Myland was 105 at the end
of 2009 and 107.1 at the end of 2010. Between the end of 2009 and the end of 2010, the inflation
rate in Myland was

(a) 2%
(b) 5%
(c) 7.1%
(d) 12.1%

6. In Yourland, the CPI for 2006 (with base year 2003) was 98.5. Between 2003 and 2006 this country
experienced

(a) a decrease in prices (deflation) of 1.5%

(b) a decrease in prices (deflation) of 0.985%
(c) an increase in prices (inflation) of 1.5%
(d) we dont have enough information to answer this question.

7. You observed that in 2012 the growth rate of Real GDP in Country A was 5%. You also know that
in the same year this country experienced inflation. Which of the following statements is true? In
2012, the growth rate of Nominal GDP in Country A must have been

(a) negative.
(b) lower than 5%.
(c) exactly 5%.
(d) higher than 5%.

8. Consider a closed economy operating according to the Classical model. Assume that in this economy
savings are not affected by the level of the real interest rate. In this economy, an increase in
government spending (G) will

(a) increase Public Saving and decrease National Saving.

(b) increase both Public Saving and National Saving.
(c) decrease both Public Saving and National saving.
(d) decrease Public Saving and increase National Saving.

9. Assume that the economy operates according to the Classical model. If the production function is
Y = 15K 0.6 L0.4 , then the labors share of national income in this economy is equal to:

(a) 0.4
(b) 0.6
(c) 1
(d) 1.5

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10. Murphy Estates is a winery located in St. Catharines, Canada. The wine produced by this winery
is mostly sold to customers in the United States, and it is included in the CPI basket of goods and
services typically consumed by a U.S. citizen. The same wine is not included in the CPI basket of
goods and services typically consumed by a Canadian citizen. An increase in the price of the wine
produced by Murphy Estates would

(a) increase the GDP deflator for both the United States and Canada.
(b) increase the GDP deflator for the United States, and decrease the GDP deflator for Canada.
(c) increase the CPI for the United States and leave the CPI for Canada unchanged.
(d) increase the CPI for both Canada and the United States.

11. Assume that First Bank is currently holding a reserve-deposit ratio of 10%, and that the total
amount of deposits in the balance sheet of this bank is $50,000. If First Bank decides to decrease
its reserve-deposit ratio to 8%

(a) the amount of their extended loans will need to be reduced by $4,000.
(b) the amount of their extended loans could be increased by $1,000.
(c) the amount of their reserves will need to be increased by $1,000.
(d) the amount of their deposits will need to be reduced by $5,000.

12. Country A operates according to the Classical model, and produces output using a Cobb-Douglas
production function. Assume that this country suddenly experiences a large migration inflow,
which considerably increases the stock of labor L. Also assume that the stock of capital K, and the
parameters A and in the Cobb-Douglas production function remain unchanged. Recall that if
an economy produces output according to the Cobb-Douglas production function Y = AK L(1) ,
then M P L = (1 )AK L and M P K = AK (1) L(1)
Which of the following do you expect to observe?

(a) Output will decrease, the real wage will increase, and the real rental price of capital will remain
unchanged.
(b) Output will increase, and both the real wage and the real rental price of capital will increase.
(c) Output will increase, the real wage will decrease, and the real rental price of capital will
increase.
(d) Output will increase, and both the real wage and the real rental price of capital will decrease.

13. Assume that the economy is closed and operates according to the Classical model. Consider the
market for loanable funds, and assume that savings are fixed and do not depend on the real interest
rate. You know that the Investment function is I = 200 15r (where r is the real interest rate),
Government spending is G = 130 and taxes are T = 90. If the equilibrium real interest rate is
r = 2, then in this economy Private Saving is

(a) 40.
(b) 130.
(c) 170.
(d) 210.

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14. Assume that the marginal product of capital is M P K = 30 K 0.5 L0.5 . If the stock of labor in

the economy is L = 100, what is the quantity of capital demanded when the equilibrium real rental
price of capital is R/P = 60?

(a) K = 300
(b) K = 100
(c) K = 45
(d) K = 25

15. Assume that the Quantity Theory of Money holds, and that the economy is closed and operates
according to the Classical model. Which of the following variables will not be affected by an open
market purchase of Government bonds implemented by the Central Bank?

(a) the real interest rate.

(b) the inflation rate.
(c) the money supply.
(d) nominal GDP.

16. Which of the following actions would increase the M1 measure of the money supply?

(a) Mary goes to her bank and withdraws $200 cash from her personal savings deposit.
(b) Gina goes to the ATM and withdraws $40 cash from her checking account.
(c) Paul uses $500 from his checking account to repay his credit card balance.
(d) Tony transfers $1,000 from his checking account to his personal savings deposit.

17. According to the Quantity Equation, if the money supply is $6 billion and the velocity of money is
equal to 2, then Nominal GDP is

(a) $3 billion.
(b) $6 billion.
(c) $8 billion.
(d) $12 billion.

18. Assume that the Government of a country successfully implemented a set of policies that reduced
the unemployment rate during 2014. According to Okuns law, the growth rate of Real GDP in
this country in the same year must have been

(a) negative.
(b) zero.
(c) positive.
(d) none of the above, Okuns law does not provide information about Real GDP in this country
in 2014.

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19. Consider the money demand function obtained from the quantity equation: (M/P )d = (1/V )Y.
If real GDP increases while the velocity of money remains unchanged, the quantity of real money
balances that people want to hold will

(a) become negative.

(b) decrease.
(c) remain unchanged.
(d) increase.

20. Assume that the labor market for nurses is currently in equilibrium, and that the real wage is $20
per hour. If a new law sets the minimum wage for nurses to $15 per hour, then

(a) the number of nurses employed will decrease.

(b) the number of nurses employed will not change.
(c) the number of nurses employed will increase.
(d) the equilibrium real wage in the labor market for nurses will increase.

21. Which of the following would reduce the steady-state unemployment rate?

(a) A major technological innovation which requires workers to acquire new skills, thus increasing
the job separation rate and decreasing the job finding rate.
(b) A change in employment protection laws that increases the job separation rate.
(c) A new employment insurance program, which has the unintended consequence of reducing the
job finding rate.
(d) A new public job training program which successfully increases the job finding rate.

22. A fundamental characteristics of the Classical model is the Classical dichotomy, which implies that:

(a) the money supply will affect the equilibrium quantity of labor and capital used in production.
(b) the inflation rate is determined by the amount of saving and investment in equilibrium.
(c) the equilibrium in the real markets is not affected by the nominal variables.
(d) monetary policy can affect the level of investment in the economy.

23. Consider the money demand equation (M/P )d = L(i, Y ) together with the Fisher equation i =
r + E. If people expect that the Central Bank will increase the growth rate of the money supply
in the future, but there is no actual change in the money supply now:

(a) expected inflation will increase, the quantity of real money balances demanded will increase,
and the price level will decrease.
(b) expected inflation will increase, the quantity of real money balances demanded will decrease,
and the price level will increase.
(c) expected inflation will increase, the real interest rate will increase, and investment will increase.
(d) expected inflation will decrease and the quantity of real money balances demanded will not
change.

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 Problem 1 - Use the following information to answer questions 24 - 28
Consider a closed economy operating according to the Classical model. The production function is:
Y = (20)K 0.25 L0.75
where K and L are the capital and labor used in the production of output Y .
The consumption and investment functions are:
C = 40 + 0.8(Y T )
I = 160 20r
where T is the amount of taxes and r is the real interest rate.
You know that the stocks of the factors of production in this economy are: K = 5 and L = 80. In
addition, you know that taxes are T = 50 and Government spending is G = 60.
Recall that if an economy produces output according to the Cobb-Douglas production function
Y = AK L(1) , then M P L = (1 )AK L and M P K = AK (1) L(1)

24. The equilibrium real wage in this economy is:

(a) W/P = 7.5

(b) W/P = 15
(c) W/P = 40
(d) W/P = 800

25. In this economy

(a) National Saving is 110.

(b) Private Saving is 10.
(c) Public Saving is 100.
(d) Public Saving is 10.

26. The equilibrium real interest rate is:

(a) r = 0.75
(b) r = 1.6
(c) r = 3
(d) r = 10

27. Assuming that everything else remains unchanged, which of the following would increase the
equilibrium interest rate r?

(a) A change in the investment function from I = 160 20r to I = 170 20r.
(b) A decrease in government spending from G = 60 to G = 40.
(c) A change in the consumption function from C = 40 + 0.8(Y T ) to C = 25 + 0.8(Y T ).
(d) An increase in the stock of capital from K = 5 to K = 8.

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28. Assuming that everything else remains unchanged, which of the following would decrease the
equilibrium interest rate r?

(a) An increase in the Marginal Propensity to Consume (M P C) from 0.8 to 0.9.

(b) An increase in the stock of labor from L = 80 to L = 100.
(c) A decrease in taxes from T = 50 to T = 35.
(d) A decrease in the technology parameter in the production function from A = 20 to A = 15.

Problem 2 - Use the following information to answer questions 29 - 33

Assume that in the country of Moneyland the reserve-deposit ratio (rr) is 0.16 and the currency-
deposit ratio (cr) is 0.05. The Central Bank is responsible for deciding and implementing the
monetary policy in this country.

29. Which of the following policies could the Central Bank of Moneyland implement to increase the
monetary base B?

(a) An increase in the bank rate.

(b) A switch of government deposits away from chartered banks.
(c) An open market purchase of federal government bonds.
(d) An open market sale of federal government bonds.

30. Assume that the policy implemented by the Central Bank of Moneyland successfully increases
the monetary base B by $2 million. Given the values of the reserve-deposit ratio (rr) and the
currency-deposit ratio (cr) in this country, the overall change in the money supply M will be

(a) a decrease by $4.2 million.

(b) a decrease by $0.32 million.
(c) an increase by $4.2 million.
(d) an increase by $10 million.

31. Assume that the citizens of this country suddenly decide to hold all of their money in the form of
deposits, so that the currency-deposit ratio becomes cr = 0. Nothing changes in the preferences of
private banks, so the reserve-deposit ratio remains rr = 0.16. The value of the money multiplier in
this case would become:

(a) 0.16
(b) 5
(c) 6.25
(d) 16

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32. If the reserve-deposit ratio (rr) in this country increases, then

(a) private banks will use a larger fractions of their deposits to give out loans, and the policies
implemented by the Central Bank will have a smaller impact on the money supply M .
(b) private banks will use a larger fractions of their deposits to give out loans, and the policies
implemented by the Central Bank will have a larger impact on the money supply M .
(c) private banks will use a smaller fractions of their deposits to give out loans, and the policies
implemented by the Central Bank will have a smaller impact on the money supply M .
(d) private banks will use a smaller fractions of their deposits to give out loans, and the policies
implemented by the Central Bank will become unable to affect the money supply M .

33. Assume that Moneyland operates according to the Classical model and that the Quantity Theory
of Money holds. If the Central Bank of Moneyland successfully implements a policy that increases
the money supply M , then which of the following will also happen?

(a) The real interest rate in this country will increase.

(b) The price level in this country will increase.
(c) This country will experience deflation.
(d) Nominal GDP in this country will decrease.

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 34. BONUS QUESTION. Consider a closed economy operating according to the Classical model.
This economy produces output according to a Cobb-Douglas production function. The consumption
and investment functions are:
C = 50 + 0.6(Y T ) 5r
I = 240 10r
where r is the real interest rate. You know that output is Y = 540, taxes are T = 40, and
Government spending is G = 10.
In this economy, an increase in Government spending to G = 25 would:

(a) decrease investment by 15 and leave consumption unaffected.

(b) decrease the equilibrium real interest rate.
(c) decrease investment by 15 and increase consumption by 5.
(d) decrease investment by 10 and decrease consumption by 5.
(e) increase National Saving by 5.
(f) decrease Private Saving by 15.

Answers

1. d 8. c 15. a 22. c 29. c

2. c 9. a 16. a 23. b 30. d
3. a 10. c 17. d 24. a 31. c
4. a 11. b 18. c 25. d 32. c
5. a 12. c 19. d 26. c 33. b
6. a 13. d 20. b 27. a 34. d
7. d 14. d 21. d 28. b

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