Econ 1120 – intro macro – Fall-2013 –November 18, 2013 prelim #2 (Make-up) print your name: Your C. U. NetID: your c. U. Student number: Check your ta’s name

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ECON 1120 – INTRO MACRO – Fall-2013November 18, 2013
PRELIM #2 (Make-up)

PRINT YOUR NAME: ____________________________________ Your C.U. NetID: _____________
YOUR C.U. STUDENT NUMBER: ____________________________


_____________TA = Naoko Iida (Friday sections)

_____________TA = Donghwee Kwon (Tuesday sections)

_____________TA = Jongrim Ha (Thursday sections)

_____________TA = Bryce Little (Wednesday sections)


  • There are two parts in this exam.

    • Part I: 18 multiple choice questions @ 3 points each (54 points)

    • Part II: 4 short essay questions (46 points)


  • Prelim2 score weights 25% of final grade.

  • You will have five bluebooks. Write your ID, name on the front page of EACH book.

  • On the top of the front page, write “Multiple Choice,” “Essay Q1,” “Essay Q2,” “Essay Q3,” and “Essay Q4,” respectively.

  • Write down your answers in different bluebooks. Your contents should match with the title of the bluebook.

  • Read all questions carefully.

  • Write legibly and remember to label all graphs and axes in diagrams


  • NO QUESTIONS CAN BE ASKED DURING THE EXAM ABOUT EXAM CONTENT: If you need to use the restroom, or you need a pencil or scratch paper, or some other supply that we might have, raise your hand and wait for the proctor to come to you. Only one person can be out of the examination room at a time, and the proctor will hold onto your exam papers while you are out at the restroom.



Part I: Multiple Choice Questions.

  1. Suppose the price of oil decreases and at the same time the Fed raises the discount rate. Which of the following is most likely to happen?

  1. AD curve shifts to the right and AS curve shifts to the right.

  2. AD curve shifts to the right and AS curve shifts to the left.

  3. AD curve shifts to the left and AS curve shifts to the right.

  4. AD curve shifts to the left and AS curve shifts to the left.

  1. Suppose you are the chairman of the Federal Reserve, so you can adjust the federal funds rate. Suppose further the current inflation rate is 2% and the federal funds rate is also 2%. If you increase the federal funds rate, then you can _________ inflation, and you will also _______ unemployment for a while.

  1. lower; push up

  2. lower; lower

  3. push up; lower

  4. push up; push up

  5. lower; stabilize

  6. stabilize; lower

  1. When unemployment moves below the non-accelerating inflation rate of unemployment (NAIRU), which of the following statements is true?

  1. Inflation risk appears to be rising.

  2. The government is going to announce a tax cut.

  3. The Fed is likely to lower interest rates to stabilize the situation.

  4. The level of potential GDP will increase.

  1. Which theory can explain the upward-sloping aggregate supply curve?

  1. The life cycle model of consumption

  2. The fact that the Fed only has control of short term interest rates

  3. Inventory adjustments

  4. Sticky wages

  5. None of the above

  6. All of the above

  1. An increase in successful R&D will most likely result in which of the following changes in the short-run and the long-run aggregate supply curves and the long-run Phillips curve?

SR AS curve LR AS curve LR Phillips curve

  1. remains remains shifts to the left

  2. remains shifts to the right remains

  3. shifts to the right remains shifts to the right

  4. shifts to the right shifts to the right shifts to the left

  1. In 1986, the U.S. congress passed the Gramm-Rudman-Hollings act. The law created a policy mechanism that would automatically __________ government spending with the intention to __________ the budget deficit.

  1. increase; decrease

  2. increase; increase

  3. decrease; increase

  4. decrease; decrease

  1. A _______ is a fractional claim of ownership on a firm.

  1. bond

  2. stock

  3. dividend

  4. capital gain

  1. During a recession, a government uses fiscal policy to expedite an economic recovery by passing a spending bill. Critics of the bill think the spending would help, but there could be a substantial delay before the allotted funds enter the economy, potentially stimulating an economy that has already recovered. The critic’s primary issue regarding the efficacy of the spending bill can be summarized as the duration of a:

  1. response lag

  2. recognition lag

  3. implementation lag

  4. political lag

  5. none of the above

  1. According to the life-cycle theory of consumption, most of the increase in current income will be ______ if the change is perceived as temporary and will be ______ if the change is perceived as permanent.

  1. saved; saved

  2. saved; spent

  3. spent; saved

  4. spent; spent

  1. According to the life-cycle theory of consumption, which of the following statements is false?

  1. Households make lifetime consumption decisions based on their expectations of lifetime income.

  2. The path of consumption over a lifetime is more stable than the path of income.

  3. The ratio of current consumption to current income is constant over a lifetime.

  4. A one-time-only tax refund is not an effective expansionary fiscal policy in recession.

  1. If the real wage rate increases and we observe that labor supply decreases, we can conclude that:

  1. the income effect dominates the substitution effect, and leisure is a normal good.

  2. the substitution effect dominates the income effect, and leisure is a normal good.

  3. the income effect dominates the substitution effect, and leisure is an inferior good.

  4. the substitution effect dominates the income effect, and leisure is an inferior good

  1. Which of the following statements about Social Security are correct?

  1. It resembles an individual savings account for retirement.

  2. It works as a partial insurance for temporary unemployment.

  3. It provides a defined-benefit pension.

  4. Income taxes on Social Security benefits are a primary source of the Social Security’s revenue.

  5. Social Security taxes get spent on other government programs.

  1. I, III

  2. I, IV

  3. II, IV

  4. III, V

  5. II, V

  6. IV, V

  1. The gap between Social Security’s costs and revenues grows continuously, and, unless action is taken to close this gap, the trust funds will eventually be depleted in 2041.Which of the followings is one of the root causes of this gap?

  1. Low returns to the investment of trust funds

  2. Falling fertility rate

  3. Stagnant life expectancy

  4. Influx of non-resident immigrants

  5. Excessive inflation

  1. Refer to Figure below. What is the graph named? And an increase in the tax rate will decrease tax revenue if the economy is at point

  1. Laffer curve; A

  2. Laffer curve; B

  3. Laffer curve; C

  4. Offer curve; A

  5. Offer curve; B

  6. Offer curve; C

  1. According to the economists such as Milton Friedman, when economy is suffering from the inflation, the best action plan is to

  1. use a monetary rule that accommodates real growth but not inflation.

  2. cut taxes and increase incentives to save and invest, which will increase aggregate supply.

  3. do nothing; the economy will return to quickly.

  4. reduce government spending or increase tax.

  1. Keynesian economics is primarily associated with which of the following concepts?

  1. Rational expectation

  2. Active intervention by the government

  3. Real business cycle theory

  4. Monetary rule

  5. Long-run market clearing

  1. Which of the followings is NOT an expected result of free trade?

  1. Under appropriate conditions, both countries pay less and consume more.

  2. If career mobility is restricted, workers’ welfare may decrease in some sector.

  3. Infant industries using new technologies are more likely to grow.

  4. If one country has a comparative advantage in labor-intensive industries, such industries may hire more workers.

  5. The trading volume between two countries increases in general.

  1. The following table shows possible output levels of wine and beer from 1 unit of labor in country A and country B. The total labor force is the same in both countries.

Country A

Country B







Which of the following statements is true?

  1. Country A has an absolute advantage in producing beer, and has a comparative disadvantage in producing beer.

  2. Country B has both an absolute advantage and a comparative advantage in producing beer.

  3. Country B has both an absolute disadvantage and a comparative disadvantage in producing beer.

  4. Country A has an absolute advantage in producing beer, and has a comparative advantage in producing beer.

  5. Country B has absolute disadvantages in producing both wine and beer, and has a comparative advantage in producing wine.

Part II: Essay Questions
Question 1 (10 points)

  1. A speculating investor purchases one share of stock for $5 and holds onto it for one day. The next day, the stock is trading for $6, and the investor sells her stock at the market price. What was the investor’s realized capital gain (in %)? (3 Points)

6/5=1.2, 20%

  1. A different investor is considering two options: (1) put $2 in a bank to earn positive interest, or (2) invest $2 in a stock. An investment banker offers the investor a stock to purchase for the price of $2. The banker says the stock will probably pay a $1 dividend each year for the next two years, and that it is a good deal because she will most likely get her $2 back after some time. Is the banker’s price fair? Please answer yes or no, and briefly explain why with no more than two sentences. (4 Points)

No. The price of a stock should equal the discounted value of its expected future dividends, where the discount factors depend on the interest rate and risk. The investor can earn interest on the $2 without risk by depositing it in the bank, whereas she could lose the entire $2 by purchasing the risky stock… the stock should be priced less than $2 to compensate the investor for time and risk.

i. No (2 Points)

ii. Time Value and/or Risk (2 Points)

  1. The S&P 500 began the year at the level 1,000 and ended the year at 1,100. This indicates the aggregate market value of the 500 companies in the index rose by 10%. Is it true that all 500 firms’ market values increased? Please answer yes or no, and briefly explain why in one sentence. (3 Points)

No. The rising level only indicated to us that value gained by firms whose share prices increased was larger than the value lost by firms whose share prices fell.

i. No (1 Point)

ii. Explanation (2 Points)

Question 2 (12 points)

Money supply(M1) growth

Real GDP growth (%)










South Korea



  1. Please define the quantity theory of money and explain each component (economic variable) of the theory. (3 Points)

MV=PY (M: Money supply, V: Velocity of money, P: Price level, Y: Real output, or PY: Nominal Output)

  1. Please define the velocity of money and explain why early economists believed that the velocity is constant. (3 points)

V is the number of times a unit of money (e.g. a dollar bill) changes hands, on average, during a year. Early economist believed that the V is determined largely by institutional considerations, such as how often people are paid and how the banking system clears transactions between banks.

  1. Let’s assume that V is constant over time. According to the monetarism, which of the above 4 countries is expected to have the highest future inflation? Please suggest your thoughts on the answer. (3 points)

China. According to the quantitative theory, expected inflation rate of each country is (US -4.9%, Japan +3.2%, China +6.0%, South Korea +2.4%)

  1. Please describe how Monetarists and Keynesians differ in thinking about active intervention by central banks that increase the money supply to boost the economy. (3 points)

Monetarists were skeptical of the central banks’ ability to manage the economy. Time lags may make attempts to stimulate and contract the economy counterproductive. Keynesian, on the other hands, advocated the application of coordinated monetary and fiscal policy tools to reduce instability in the economy.

Question 3 (12 points)

Adam, Beth and Charlie are all 40 years old. They have no assets, debt, or liabilities. They know that they will work for 20 more years and will live 5 years after that. Their salary each year is $20,000 for 10 years in their 40s and it is $40,000 for 10 years in their 50s. They earn nothing after their retirement. Note that average propensity to consume (APC) is defined as: APC =CY.

  1. Adam has a consumption function: C = 6,000 + 0.5Y, where Y is the income in each year. What are his consumption and APC in his 40s? What are his consumption and APC in his 50s? (4 points)

40s: C = 6,000 + 0.5*20,000 = $16,000. APC = 16,000/20,000 = 0.8.

50s: C = 6,000 + 0.5*40,000 = $26,000. APC = 26,000/40,000 = 0.65.

  1. Beth has a consumption function: C = 0.5Y. What are her consumption and APC in her 40s? What are her consumption and APC in her 50s? (4 points )

40s: C = 0.5*20,000 = $10,000. APC = 10,000/20,000 = 0.5.

50s: C = 0.5*40,000 = $20,000. APC = 20,000/40,000 = 0.5.

  1. Charlie decides on his consumption according to the life-cycle theory of consumption. What are his consumption and APC in his 40s? What are his consumption and APC in his 50s? (4 points)

According to the life-cycle theory of consumption, his consumption will be constant over his life. $20,000*10 + $40,000 10 = $600,000 is the maximum amount he can consume in the rest of his life. He will live for 25 more years, so in each year of his life, he will consume 600,000/25 = $24,000.

40s: C = $24,000. APC = 24,000/200,000 = 1.2.

50s: C = $24,000. APC = 24,000/400,000 = 0.6.

Question 4 (12 points)

Who will run the Fed next year?

Mar 30th 2013 | WASHINGTON, DC |The Economist

THAT the two most powerful men in America might occasionally have things to discuss is no surprise. But when Ben Bernanke, the Federal Reserve chairman, disclosed on March 20th that he had recently spoken with Barack Obama, listeners assumed the subject was his future.

Mr Bernanke has yet to say what he plans to do when his term as chairman ends on January 31st next year. Former colleagues believe he does not want another term: eight of the most tumultuous years in the Fed’s history are plenty. That may be premature: he may want to oversee the exit from the policies—from ultra-low interest rates to money-printing—that he put in place to revive growth.

Then again, as Mr Bernanke noted, he isn’t “the only person in the world who can manage the exit”. As for Mr Obama, the premium on continuity is lower today than it was in 2009 when, with the financial crisis still at its height, he reappointed Mr Bernanke, a Republican.

Should Mr Bernanke step aside, the list of possible successors is headed by Janet Yellen, the Fed’s vice-chair, by virtue of her position, experience, qualifications and liberal credentials. She has held two other spots on the policymaking Federal Open Market Committee (FOMC): as president of the Federal Reserve Bank of San Francisco and, in the 1990s, as a governor.

An accomplished academic, Ms Yellen is a strong backer of Mr Bernanke’s expansionary policies and one of the most dovish members of the FOMC.

Central bankers are supposed to be inflation hawks: some worry she would be slow to tighten policy in the face of faster-rising prices. Since unemployment seems likely to be a bigger threat than rising inflation for years to come, such dovishness seems appropriate. Any future chairman would in any case have to work within the more transparent policy framework that Mr Bernanke, with Ms Yellen’s assistance, has implemented and that commits the Fed to a 2% inflation target in the long run.

  1. Dr. Yellen is described as one of the most dovish members of the FOMC. What is the meaning of ‘dovish’ in this context? Use the following three words: unemployment, interest rates and inflation. (3 Points)

Dovish people make the case for a more sustained attack on unemployment with prolonged zero (or below) interest rates, even at the cost of temporarily higher inflation.

  1. Former chairman Paul Volcker pursed the most hawkish policy in the history of the Fed. Suppose former Fed chairman Paul Volcker was reappointed and there was no one who predicted this nomination. What happens to our short-run Philips curve? Please specify the reason as well (3 Points).

Inflation rate depends on the expectations. So, the PC will shift as expectations change. Since he is a symbol of hawkish monetary policy, inflationary expectations decrease, which leads to declines in the rate of inflation even though the unemployment rate may remain the same. Thus, the PC will shift to the left.

  1. Explain the rational expectation hypothesis (2 Points).

People know the true model of the economy and that they use this model to form their expectations of the future.

  1. President Obama nominated Dr. Yellen to be Chair of the board last month. Assume that all people have rational expectations and the US economy is in a recession. Evaluate anticipated and unanticipated expansionary policies. (4 Points)

According to rational expectations hypothesis, anticipated policy changes have no effect on real output regardless of period. If the Fed implements expansionary policy, the change will have effect on the average price level. So, government unanticipated policy can affect real output only if it surprise people.

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