MGEA06 Final Exam – Winter 2019 Iris Au 1 MGEA06 – Introduction to Macroeconomics: A Mathematical Approach Final Exam, Winter 2019 Last name/Family name: ________________________________________________ First name: ___________________________________________________________ ID#: _________________________________________________________________ Date & Time: Monday, April 22, 2019, 7:000pm – 10:00pm Instructor: Iris Au Aids Allowed: Non-programmable calculator Time Allowed: 180 minutes Total number of pages (including the cover page): 16 Question(s) Marks Question(s) Marks Question(s) Marks 1 – 2 (out of 4) 19 – 21 (out of 6) 34 – 35 (out of 4) 3 – 5 (out of 6) 22 – 24 (out of 6) 36 (out of 10) 6 – 8 (out of 6) 25 – 27 (out of 6) 37 (out of 10) 9 – 12 (out of 8) 28 – 29 (out of 4) 38 (out of 10) 13 – 15 (out of 6) 30 – 31 (out of 4) Total (out of 100) 16 – 18 (out of 6) 32 – 33 (out of 4) The University of Toronto’s Code of Behaviour on Academic Matters applies to all University of Toronto Scarborough students. The Code prohibits all forms of academic dishonesty including, but not limited to, cheating, plagiarism, and the use of unauthorized aids. Students violating the Code may be subject to penalties up to and including suspension or expulsion from the University. Room: MGEA06 Final Exam – Winter 2019 Iris Au 2 Instructions – please read carefully 1) Questions related to the content of the exam will NOT be answered. 2) On the cover page of this booklet PRINT your family name and first name. Enter your student number. Write down your assigned room. If you fail to do one of the above tasks, 4 marks will be deducted from your final score. 3) If you DO NOT write in your assigned room, 5 marks will be deducted from your final score. 4) DO NOT UNSTAPLE the booklet. If you do it, 10 marks will be deducted from your final score. 5) This exam consists of TWO parts. Part 1 consists of 35 questions which required you to put your answers in the designated boxes. If answers are not written in the designated boxes, no marks will be given for that question. For questions that required you to show work, you must do so in order to receive full credit. We will ONLY grade your work in the white space between the question and the designated answer box. If you do not show your work, you will not receive full credit even your answer is correct. However, you may receive partial credit for showing your work even your final exam is incorrect. Each question is worth 2 marks, and there is no deduction for wrong answers. Part 2 consists of 3 questions which required you to provide detailed explanation. Be sure to label your diagrams as clearly and completely as possible and to explain why the curves shift and to which direction. You can write your written explanation beside (and below if necessary) the diagram. When providing written explanation, you can use point form, use / to represent increase/decrease and symbols for variables that we used in class (say, Y = output). Also, the flow of your answer matters. A clear, well-organized answer is worth more than a long rumbling paragraph. 6) DO NOT put your answer on the blank pages of the left-hand sided of the booklet, we WILL NOT grade any answers on those pages. However, you can use those pages as rough/draft paper. Good luck & have a great summer break! MGEA06 Final Exam – Winter 2019 Iris Au 3 PART I –70 MARKS (2 MARKS PER QUESTION) Questions 1 – Question 2: An economy can be described by the circular-flow model, and the circular flow diagram for this economy is shown below. The sign “ ” means the value is not given to you. Government purchases of Government borrowing = $140 goods & services = $400 = Taxes Government transfers = $40 Private savings = Consumer spending = $1,400 Wage, profit, interest, rent = $2,000 Gross domestic product Investment spending = $240 Wage, profit, interest, rent = $2,000 Borrowing and stock issues by firms = $240 Exports = $60 Foreign borrowing & sale of stock = $220 Imports = $100 Foreign lending & purchase of stock = $260 Question 1 According to the circular-flow diagram above, complete the following sentences. The economy runs a trade _______________ (surplus/deficit) of _______________ (size of the trade balance). The country _________________ (lends/borrows) from the rest of the world, and it experiences a net (financial) capital ________________ (inflows/outflows). Question 2 Find the amount of taxes paid by households and the level of private savings. Taxes: Private savings: Government Households Firms Rest of the world Markets for good & services Factor markets Financial Market MGEA06 Final Exam – Winter 2019 Iris Au 4 Question 3 Sort each of the following events into the appropriate category on whether the change signals Category 1 – An increase in GDP and improved standard of living Category 2 – An increase in GDP without improved standard of living Category 3 – No increase in GDP and improved standard of living Category Event Income inequality decreases and people dislike inequality. Household unpaid work becomes formalized in GDP. Questions 4 – Question 5: A city has an adult population of 14 million. Among those who are above 15 years old, 1.5 million of them are not available for work, 9.8 million are employed full-time; 1.8 million have part-time jobs; and the remaining people are actively looking for jobs. Also, one-third of the current part-time workers would like to work full-time and 10% of full-time workers feel that their current work did not truly reflect their ability. Question 4 Find the employment rate and the unemployment rate. Be sure to show your work and rounded your answer to 2 decimal places. Employment rate (in % terms): Unemployment rate (in % terms): Question 5 Based on the information given, find the percentage of labour force that is considered to be underemployed. Be sure to show your work and rounded your answer to 2 decimal places. Percentage of labour force that is underemployed: MGEA06 Final Exam – Winter 2019 Iris Au 5 Question 6 A fresh grad gets a job in a human resource company and her starting (annual) salary is $46,500. If her annual salary is increasing at a rate of 3.4% per year, what will her annual salary be in 12 years Be sure to show your work and keep your answer to 2 decimal places if necessary. Annual salary in 12 years: Question 7 Suppose the per-worker production function is given as follows: y = 4k 0.25 h 0.75 where k = (physical) capital per worker, h = human capital per worker If each worker is endowed with 256 units of (physical) capital and 81 units of human capital, find the marginal product of human capital. Be sure to show your work and rounded your answer to 3 decimal places if necessary. Marginal product of human capital: Question 8 Determine whether each of the following statements is true or false. __________ An increase in the size of the labour force will raise both the levels of aggregate output and per-worker output. __________ Diminishing marginal product of (physical) capital implies that the government should not pursue policies that encourage the accumulation of capital because the benefits of having an additional unit of capital will be less the cost of acquiring an additional unit. MGEA06 Final Exam – Winter 2019 Iris Au 6 Question 9 Institutional factors, including rules, norms, and routines that guide behaviours, might impact long-run economic growth. Determine the effect of the following factors on long-run economic growth. Long-run economic growth (faster or slower) Factor Deeply rooted traditions. Property rights are not well-defined and are not being enforced properly. Question 10 Suppose the growth rate of human capital per worker is 2.0%, and the human capital share of income is 0.7 (70%). If total factor productivity is growing at 1.5%, use the growth accounting equation to find the growth rate of physical capital per worker that gives an output per worker growth rate of 3.8%. Keep your answer to 2 decimal places & be sure to show your work. Growth rate of physical capital per worker (in percentage terms): Question 11 Determine the effect of each of the following events on the equilibrium level of national savings in the loanable funds market of a closed economy (assuming output remains unchanged). Increase / Decrease / No change Event Due to higher minimum wages, the public expects the inflation rate to increase by 1 percentage point next year. The flip-flopping on the nation’s carbon pricing policy has created uncertainty in business environment. Question 12 You have been offered to invest in a project that requires you to pay $1,000 up front and another $380 in a year. This project will give you $400 a year later plus another $520 and $680 in two and three years respectively (after that the project does not worth anything). You ______________ (will or will not) invest in the project above if the current interest rate is 5% because the project has a net present value of ____________________ (enter a dollar amount here and keep 2 decimal places). MGEA06 Final Exam – Winter 2019 Iris Au 7 Questions 13 Consumption C 1 C 0 C 2 YD (disposable income) Question 14 Determine whether each of the following statements about the income-expenditure model is true or false. __________ An unexpected decrease in consumer spending will increase unplanned investment spending. __________ When the level of imports becomes more sensitive/responsive to a change in income, the equilibrium level of output will fluctuate less when there is a change in autonomous expenditure because the multiplier becomes smaller. Question 15 P A C B E AD 1 AD 2 Y An economy’s consumption function would shift from curve C 0 to curve C 2 when there is a(n): Put a “ ” beside for all correct responses. _______ decrease in wealth. _______ decrease in the price level. _______ decrease in expected future disposable income. _______ increase in the unemployment rate. A decrease in investment due to pessimistic GDP forecasts will cause a movement from point E on AD 2 to point _________ (A, B, or C). A significant decrease in the income level of consumers will cause a movement from point E on AD 2 to point _________ (A, B, or C). MGEA06 Final Exam – Winter 2019 Iris Au 8 Question 16 – Question 18: Consider a closed economy that can be described by the AD-AS model. In addition, prices can adjust to a change in aggregate demand or aggregate supply. Planned aggregate expenditure: AEPlanned = 2,000 – 5P + 0.5Y Short-run aggregate supply (SRAS): P = (50 + 0.1Y)( W 200 ), where W = wage Long-run equilibrium level of output: Y = 2,000 Initially, the economy is in its long-run equilibrium with equilibrium price of 200 and wage of 160. Question 16 Now, suppose there is a change in commodity prices such that the SRAS curve becomes: Short-run aggregate supply (SRAS): P = (86 + 0.1Y)( W 200 ), where W = wage The SRAS curve has shifted horizontally to the __________ (left or right) by __________ (how much). Question 17 Find the change short-run equilibrium level of output. Show your work and keep your answer to 2 decimal places if necessary.
Change in output: Question 18 Compared to the initial long-run equilibrium, find the change in the equilibrium levels of price and wage when the economy reaches its (new) long-run equilibrium. Show your work and keep your answer to 2 decimal places if necessary. Change in price: Change in wage: MGEA06 Final Exam – Winter 2019 Iris Au 9 Question 19 Determine whether each of the following statements about fiscal policy is true or false. __________ If the economy is at potential output and consumption spending suddenly decreases because of a fall in consumer confidence, the appropriate fiscal policy is a decrease in government transfers. __________ Automatic stabilizers are government spending and taxation changes that cause fiscal policy to be contractionary when the economy contracts. Question 20 Assume that marginal propensity to consume is 0.8 and full-employment level of output is $800 billion. If the actual real GDP is $700 billion, find the change in lump-sum taxes that would bring the economy back to its full-employment level of output (assume taxes and transfer payments do not depend on income and the economy is a closed economy). Change in lump-sum taxes: Question 21: Complete the following statements about the budget balance. If the economy is operating well below potential/full-employment output, then cyclically adjusted budget balance deficit is likely to _________________ (smaller /greater/the same) than/as the actual budget balance. Suppose that country’s debt is $7 billion at the beginning of the fiscal year. During the fiscal year, the government spending is $1.8 billion, tax revenues equal $2.7 billion, and transfer payments reach $0.7 billion. At the end of the fiscal year, the debt is _________________ billion. MGEA06 Final Exam – Winter 2019 Iris Au 10 Question 22 – Question 24: Alpha has a very simple banking system, in which there is only one chartered bank (The Frist Bank). The central bank of Alpha imposes a minimum required reserve ratio of 5%. Households in Alpha hold a fixed amount of $1,200 in the form cash for their daily transactions and will deposit any excess amount into their bank accounts. The initial balance sheet of the First Bank is as follows: Assets Liabilities & Equity Loans $8,800 Demand deposits $9,000 Bank reserves $500 Equity $300 Note: Unless otherwise stated, the excess reserves held by the First Bank will remain fixed at the current level as shown in the initial balance sheet and will lend out any surplus of reserves beyond this. Question 22 Suppose the government of Alpha transfers $75 of its deposits from the First Bank to the central bank of Alpha. When the banking system is back to equilibrium, determine whether each of the following statements is true or false. __________ The amount of reserves held by the First Bank falls by $75. __________ The level of loans made by the First Bank falls by $1,500. Question 23 Return to the initial situation. Recently, there are privacy and security concerns over the use of more advanced payment methods such as phone payments; the public changes their cash holdings by $120. Complete the balance sheet of the First Bank when the banking system is back to equilibrium. (You need to decide whether cash holdings increase or decrease.) Assets Liabilities & Equity Loans Demand deposits Bank reserves Equity $300 Question 24 (Continued from Question 23) If the central bank of Alpha finds the changes in the level of money supply undesirable and want to keep it from changing, what should they do Name two actions that can be carried by the central bank of Alpha, and be sure to be very specific about the actions carried by the central bank (for example, write down open market purchase or open market sales NOT open market operations). 1) _____________________________________________________________________________ 2) _____________________________________________________________________________ MGEA06 Final Exam – Winter 2019 Iris Au 11 Question 25 Identify which function of money is represented in each of the following events. Function of money (medium of exchange, store of value, unit of account) Event Nora is especially excited because she has been saving money each week in her piggy bank at home so that she can afford a trip to Banff, Alberta next summer. Nora walks into her favorite department store to pick out a new dress. She checks out the price tag and is excited to see that the dress is on sale and is now relatively cheaper than another dress she was considering Question 26 – Question 27: The money demand (MD) function is given by: MD = P (0.14Y – 250i), where P = aggregate price level, Y = income, i = interest rate Note: i is expressed in decimal points (i.e., if i = 0.1, then the interest rate is equal to 10%) Question 26 Find the equilibrium interest rate if the aggregate price level is $4, income is $5,000 and the level of money supply is $2,750. Be sure to show your work & keep your answer in 2 decimal places if needed. Interest rate (in % terms): Question 27 If the central bank adopts an interest rate targeting of 2%, find the level of money supply that will achieve this goal. Be sure to show your work and keep your answer in 2 decimal places if needed. Money supply: MGEA06 Final Exam – Winter 2019 Iris Au 12 Question 28 – Question 31: Use the income-expenditure model to answer the questions. Suppose a small open economy with fixed prices can be described by the following equations: Consumption: C = 600 + 0.7YD Government spending: G = 300 Planned investment: IPlanned = 500 – 400i Taxes: T = 60 + 0.06Y Exports: X = 600 – 10EFC/DC Transfers: TR = 280 – 0.04Y Imports: IM = 214 + 0.03Y + 25EFC/DC NOTE: YD = disposable income. Unless otherwise stated, interest rate, i, is held constant at 0.1 (i.e., 10%) and exchange rate, EFC/DC, is held constant at 4 (FC per DC). For each question, keep your answer to 2 decimal places if necessary and be sure to show your work. Question 28 Find the equilibrium level of output. Output: Question 29 (Continued from Question 28) Find the country’s trade balance. Does the economy have a trade surplus or trade deficit Trade balance: Trade deficit or Trade surplus: MGEA06 Final Exam – Winter 2019 Iris Au 13 Question 30 – Question 31 The economy is in equilibrium as shown in Question 28. Due to a trade war, the foreign government imposes a tariff on domestic goods. As a result, autonomous exports changes by 10%. Hint: you need to decide whether autonomous exports increase or decrease. Question 30 Compared to the initial equilibrium in Question 28, find the change in equilibrium level of output. Change in output: Question 31 (Continued from Question 30) Suppose the change in autonomous exports also causes the interest rate to change by 1 percentage point and the exchange rate to change by 0.4 FC per DC. Compared to the initial equilibrium in Question 28, find the change in equilibrium level of output. Hint: You need to determine whether interest rate increases or decreases, and whether DC appreciates or depreciates as a result of the change. The initial interest rate is 10% while the initial EFC/DC is 4. Change in output: MGEA06 Final Exam – Winter 2019 Iris Au 14 Question 32 – Question 33: Canada adopts a flexible exchange rate regime and the Canadian economy is experiencing an inflationary gap. In response, the government runs a contractionary fiscal policy. Question 32 P LRAS 0 SRAS 0 A AD 0 YFE Y Question 33 (Continued from Question 32) Suppose countries in the Eurozone are the major training partners of Canada. How will the change in fiscal policy impact the foreign exchange market (i.e., show the effect of the change fiscal policy on the diagram below and be sure to identity the new equilibrium.) E€/C$ S 0 C$ A D 0 C$ C$ Show the effect of the change in fiscal policy on the AS-AD diagram. Be sure to identity the new equilibrium. This change in stabilization policy will cause the aggregate price level to _____________ (increase / decrease / remain unchanged). MGEA06 Final Exam – Winter 2019 Iris Au 15 Question 34 Consider the market for Canadian dollars where the price per Canadian dollar is given in terms of Turkish lira. For each of the following the scenarios below, determine whether the Canadian dollar will appreciate or depreciate. Canadian dollar (Appreciate or depreciate) Scenario Inflation in Turkey was 8% while inflation in Canada was 2%. Canadian wheat becomes more popular after studies show that including wheat in our diet is good for our health. Question 35 The following table shows some of the country’s international transactions with the rest of the world. Exports of goods and services $1,425 million Imports of goods and services $1,800 million Income receipts from abroad $420 million Income receipts to foreigners $400 million Net unilateral transfers $0 million What is the country’s financial account balance Be sure to show your work. Financial account balance: MGEA06 Final Exam – Winter 2019 Iris Au 16 PART II – 30 MARKS (10 MARKS PER QUESTION) Questions 36 (10 marks) A closed economy is currently in its long-run equilibrium. Recently, there is advancement in payment technology such that households have more options to make payments and the importance of money being a medium of exchange falls. Note: Be sure to show the shift(s) of curve(s) and identify the new equilibriums in the diagram below. a) What happens to the short-run equilibrium levels of output and price Explain. (5 points) b) What happens to the long-run equilibrium levels of output and price Explain. (5 points) Question 37 (10 points) The Bank of Canada believes that a change in the target for the overnight rate will affect the Canadian economy through 4 different channels. a) Name the four channels. (4 points) b) Suppose the International Monetary Fund (IMF) lowers the Canadian economic outlook in 2019. If the inflation rate in Canada is well within the target range; in light of the statement made by the IMF, what recommendation would you give to Stephen Poloz, the Governor of the Bank of Canada (i.e., what happens to the target for the overnight rate and why) (3 points) c) Based on your answer in part (b), choose any of one of the four channels mentioned in part (a) and explain the effect of this change in monetary policy on aggregate demand. Only the first explanation will be graded. (3 points) Question 38 (10 points) Suppose the world consists of two countries, Beta and Celta, only. The market for loanable funds in Beta and Celta can be described by the following equations: Country Demand for loanable funds Supply of loanable funds Beta DFB = 150 – 8iB SFB = 100 + 12iB Celta DFC = 240 – 3iC SFC = 170 + 7iC Note: Interest rates are expressed in percentage points (i.e., if i = 5, then i = 5%). In the absence of international capital flows, the (autarky) equilibrium interest rate in Beta and Celta are 2.5% and 7% respectively. a) Find the equilibrium interest rate when the international flows of capital are allowed. (4 points) b) Which country experiences net capital outflows What is the size of the outflows (3 points) c) Suppose the budget surplus in Beta is larger than before. Explain, in words only, what happens to the world interest rate (increase or decrease and why) (3 points)