Macroeconomics Pdf 117681 | Mit14 02f09 Quiz2 Sol

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14.02 Principles of Macroeconomics
Fall 2009

Quiz 2
Thursday, November 5th
7:30 PM – 9 PM

Please answer the following questions. Write your answers directly on the quiz. You
can achieve a total of 100 points. There are 5 multiple-choice questions, followed by
2 free response questions. You should read all of the questions first.
Good luck!

NAME: ________________________________________________

MIT ID NUMBER: ________________________________________________

TA: ________________________________________________

CLASS TIME: ________________________________________________

EMAIL: ________________________________________________

(Table is for corrector use only)
1 2 3 4 5 6 7 8 Total
Multiple
Choice
Questions
Long
Question 1

Long
Question 2
Total

1 Multiple choice (30 points)
1. (6 points) The increase in use of ATMs decreases the currency/deposit ratio (cu). According
to the Keynsian theory of sticky prices:
(a) output increases and the interest rate goes down,
(b) output increases and the interest rate goes up,
(c) output decreases and the interest rate goes up.
ANSWER:A
2. (6 points) In the standard IS-LM model, an increase in Government spending (G) without
changing taxes has
(a) a positive e¤ect on equilibrium consumption,
(b) a negative e¤ect on equilibrium consumption,
(c) an ambigous e¤ect on equilibrium consumption.
ANSWER: C. The increase in G shifts the IS-LM upwards and to the right, which
makes both output and the interest rate higher in equilibrium. However, the nal
e¤ect on consumption is ambigous since consumption depends positively on output and
negatively on the interest rate.
3. (6 points) According to the misperception theory, an expected increase in money supply
(a) increases output and increases interest rate,
(b) increases output and decreases interest rate,
(c) has an e¤ect on neither output nor interest rates.
ANSWER:C.
4. (6 points) Consider a fractional reserve banking system with a legally required reserve-deposit
ratio of m. Suppose that an individual deposits ID dollars in one bank. Then, the economy-
wide change in total deposits
(a) will be at most ID = m;
(b) will be equal to ID = m;
(c) will be equal to m ID:
1
ANSWER. A. The total change in deposits is equal to ID/m if nobody wants to
hold currency and banks lend to their limit. If these two assumptions are relaxed,
the increase in deposits is lower. So, in general, the increase in total deposits is at
most ID/m.
5. (6 points) According to the Taylor rule, a positive output gap (i.e. real GDP above potential
real GDP) will most likely result in
(a) the Fed adjusting its estimate of potential real GDP,
(b) the Fed decreasing the nominal federal funds rate,
(c) the Fed increasing the nominal federal funds rate.
ANSWER. C. The Fed will increase the nominal FFR to bring back output
to its potential level.
2 IS-LM with Liquidity Trap (35 points)
Consider the following IS-LM model with prices xed at P = 1 (we are in the short run):
Md
P = Y r
C = 1+0:5Y
I = 10:5r
G = G
Y = C+I+G
Ms M
P = P
Md Ms Md Ms
P P ,with P = P ifr>0
r = ie
e = 0
1. (7 points) Explain the minimum value that the real interest rate, r, can take.
Weknow the nominal interest rate has to be positive. This implies that the real
interest rate must satisfy the non negativity constraint r 0:
2. (7 points) Derive the IS curve.
Using the goods market equilibrium condition we have that the IS curve is
r = 4Y +2G
2
3. (7 points) Write down the LM curve.
Using the Money market equilibrium condition we have
r = ( 0 if Y M
Y M otherwise
4. (7 points) What are the equilibrium interets rate and output level in the economy? What is
the condition for the equilibrium interest rate to be positive?
The interest rate will be positive if
M<4+2G
The equilibrium interest rate in this case will be
r = 2+GM
2
Y = 2+M +G
2
Otherwise well have
r = 0 and Y = 4+2G
5. (7 points) Suppose that the economy described above is going through a recession and the
government is trying to stimulate the economy. When will monetary policy be e¤ective in
stimulating the economy? Explain why under certain conditions monetary policy fails to be
e¤ective as a policy instrument.
Monetary policy will be e¤ective as long as the money supply is low and maintains
the interest rate positive. In particular the condition is M < 4+2G: If money suppy
is higher than this value, then monetary policy becomes an inne¤ective channel
for economic stimulus. The reason for this is that monetary policy is e¤ective
only when it is able to lower the interest rate in order to increase investement,
however this channel is killed once the interest rate constraint binds.
3 AS-AD(35 points)
[Supply side] Consider a labor market characterized by the following production and labor supply
functions:
F(N) = 20NN2
Ns = 1w
2 p
3

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...Principles of macroeconomics fall quiz thursday november th pm please answer the following questions write your answers directly on you can achieve a total points there are multiple choice followed by free response should read all first good luck name mit id number ta class time email table is for corrector use only long question increase in atms decreases currency deposit ratio cu according to keynsian theory sticky prices output increases and interest rate goes down b up c standard lm model an government spending g without changing taxes has positive e ect equilibrium consumption negative ambigous shifts upwards right which makes both higher however nal since depends positively negatively misperception expected money supply neither nor rates consider fractional reserve banking system with legally required m suppose that individual deposits dollars one bank then economy wide change will be at most equal if nobody wants hold banks lend their limit these two assumptions relaxed lower so...

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