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Previous Examinations

Previous Exam 1

Page 1

1. Definitions:[20 pts]

a. Clarify the difference between changing relative prices and inflation. Why do we need an index to measure inflation? Name two important indices of inflation.
b. Define the consumption function? What is MPC? What is the multiplier? Give an economically intuitive explanation.

Page 2.

c. Consider the simple macromodel: 1 $Y = C + I$ and 2. $C =a + bY$ . Why is each equation true. What is the driving force in this model? Briefly explain. What important aspects of macroeconomics are left out. How does time enter this model?
d. How is unemployment measured? (You must consider the three categories: working, not working and .....) What is the difference between structural and frictional unemployment?

Page 3

2. Math [40 pts]

a. Index numbers.

Given the following data for a representative market basket:

     Good    Units   1980   1985   1990
     ==================================
      A       5       2.0    2.0   4.0
      B      30       1.0    3.0   5.0
      C      10       1.0    5.0   3.0

(1) [1 pts] CPI(85,80)?

(2) [1 pts] CPI(90,80)?

Given the following date:

  Year        1985
  ================ 
 Nominal GDP  2055      
 Real GDP  
 GDP deflator  150

(3) [1 pt] What is the real GDP in 1985?

(4) [2 pt] What is the difference in the basket of goods for the CPI and the GDP deflator?

Page 4

b. Demand and Supply:

Given the following market:

D = 80 - 4P

S = 4P

1. (2) What is the market equilibrium price and quantity?

2. (2) Suppose the government taxes each supplier $2 for each unit purchased? What is the new equilibrium quantity? How much does each supplier get and how much does each demander pay from his own pocket?

3. (2) What is the total amount of the government subsidy.

4. (4) Now consider this market as a dynamic adjustment:

D(t) =80 - 4P(t)

S(t) =4P(t)

P(t) = P(t-1) - v(S(t-1) -D(t-1))

where

v

= 1/8. Suppose

P(1) =11

. Work out two rounds of the dynamics of this market. As

t \rightarrow \infty to what values will the market converge. Are their any markets in the real
world with this characteristic.

Page 5 c. Macro Model 1: Given the following simple dynamic Keynesian model:

Y

_t= C_t+ I _t

C

_t = a + b Y_t-1
where

a

= 100

b

= 0.75

I

= 300

(1) [2 pts] Suppose the model is initially in equilibrium. What is the equilibrium?

(2) [4 pts] Suppose in period 1

I

increases from 300 to
320 and remains at 320. What is

Y

₁ and

Y

₂

?

(3) [2 pts] What value does Y

gradually approach
as t goes to infinity.

(4) [2 pts] Suppose that

I in period 3 falls from 320 to 300
and stays there. What is Y

_oo

Page 6 Given the following model: (

G

government expenditures and

T

taxes)

Y = C + I + G

C = a + b(Y - T)

where

a

= 200,

b

= 7/8,

I

= 500,

G

= 500,

T

= 500

(1) [2 pts] What is

Y

? For the rest of the questions assume this represents

Y

_FE.

(2) [4 pts}If business decides to reduce

I

to 440 and at the same time consumers decide to reduce

a

to 180 . How could government compensate using:

(a)

G

alone. What is the resulting deficit?

(b)

T

alone. What is the resulting deficit?

(3) [2 pts] Could government compensate and maintain a balanced budget? Explain?

(4) [2 pts] If government applied Keynesian policy correctly through out the business cycle, would there be a deficit? Briefly discuss. Empirically(politically), why is implementing Keynesian policy correctly virtually impossible.

Page 7

(5) Given the following model containing

E, exports and Im imports: Y = C + I + G + E - Im

C = a + b(Y-T)

Im = hY

Derive the multiplier for this model (5 pts). Is this multiplier larger or smaller than the simple multiplier? Explain economically.

Page
BONUS Finish the exam before trying this one.

(4 points. (1 pt) Suppose in problem 4 of supply and demand

v

were 1/4th. What happens as

t

increases?
(3 pts) What is the range of

v for which the market converges
to equilibrium. Could you ever have an unstable market in the real world.
(temporarily)

Page 8 3. Technical Essay [10 pts] Define GDP. What is the value added approach to the GDP? What is the difference between GDP and GNP? What is the expenditure and income approach to calculating the GDP? What is the difference between real and nominal GDP? What are the limitations of the GDP concept-- social welfare and underground economy? Page 9 Current Events [30 pts] WARNING: If I can not read your handwriting you will lose points. Look at this as a practical lesson in business. You don't irritate the customer and you don't irritate the boss. If you have doubts, print. a. How did the tax cut of 63-64 change the philosophy of legislators about balancing the budget. How is this reflected in the data. How does the magnitude of the budget deficit since Reagan took office compare to past presidents. What did Reagan do to create the deficit? Did he anticipate his actions would create such a disaster? b. What is the approximate amount of the government budget currently? What \% goes for interest on the debt, defense, medicine, social security? What is an entitlement program and why are these problems difficult to cut? Why is medicine such a major problem for government? What is the funding problem with social security once the baby boom retires? Why is it politically so hard to balance the budget? c. Attempts to balance the budget:What is the Gramm-Rudman budget balancing act. To what extent has the federal government followed this plan. What is Clinton's plan to balance the budget? Is it working? What are the economic aspects of the House Republicans' Contract with America. How many were passed? What is their plan to balance the budget. Will the Senate go along? What is happening? Page 10 Page 11

Previous Exam 2

I. Definitions [20 pts. 5 each]

Page 1
- 1. What is a built-in (automatic) stabilizer? Two examples? If a balanced budget amendment is passed, explain what happens to built in stabilizers.
- 2. A repeated item in the news is the US trade deficit? Do the quoted figures really represent the US trade balance? Explain. What is an exchange rate? What is the relationship between exchange rates and the value of imports and exports?
Page 2
- 3. What is the velocity of money. What is the quantity theory of money? State the equation and explain. To what extent can the consequences of a small change in the money supply be predicted? To what extent can the consequences of a large change in the money supply be predicted?
- 4. What are the principle differences between the monetarists and the Keyesians.

II. Math Section: SHOW ALL WORK!! Page 3 1. Given a very large number of standard banks whose initial position is:

    Assets     Liabilities
    ======================
              |
     R  $20M  |   DD $100M
              | 
     GS  30M  |
              |  
     L   50   |

The required reserve ratio is 20\% 1. [1 pt.] To expand the money supply should the FED buy or sell securities? 2. [1 pt.] What will happen to interest rates? 3. [3 pt.] Assuming the FED's transaction to expand the money supply is $10M and to maximize profits the banks keep reserves down to the legal minimum explain numerically what happens if the FED transaction is with a bank. Consider a plausible course of action at the first two banks. (The first two terms of the geometric series.) 4. [3 pt.] Explain in words the mechanism which causes the expansion. 5. [2 pt.] Briefly discuss a contraction. 6. [2 pt.] What is the money multiplier resulting from part 3. 7. [3 pt.] Why is this multiplier larger than the one in the economy. Discuss with words or symbols. Page 4 2. (5 points) Consider the following model which perhaps explains Reagan:

Y = C + I + G

C = a + b(Y - T)

T = tY

I = c + d(1-t)Y

where

Y

is GDP,

C

is consumption,

I

is investment,

G

is government expenditures,

T

is taxes and

a,b,c,d,t

are known constants.

a. (2) What is the multiplier for this model?

b. (2) In this model is it possible for a decrease in

t

to increase

T

. Explain either intuitively from the economics of the model or mathematically?

c. (1) Explain eqn 4 intuitively. Does this capture the spirit of Laffer or is it an alternate mechanism?

Page 5

{\bf 5 point bonus question. Answer if you have time at the end of the exam. If you think you are smart, show me!!!}

Given a two country world: (

E

Exports and

H

Imports)

Country 1

Y

₁ = C₁ + I₁ + G₁ + E₁ - H₁

C

₁ = a₁ + b₁(Y₁ - T₁)

H

₁ = h₁Y₁

Country 2

Y

₂ = C₂ + I₂ + G₂ + E₂ - H₂

C

₂ = a₂ + b₂(Y₂ - T₂)

H

₂ = h₂Y₂

where

E

₁ = H₂ and

E

₂ = H₁

1. Derive the multiplier for a change in

I

₂ on

Y

₁.

2. Explain the economics in words.

Page 6

5. [20 points] IS-LM Model

IS:

Y = C + I + G

C = a + b(Y - T)

I = I

₀ - ci
LM:

Ms/p = eY - fi

where

Ms

is the money supply,

p

is the price level,

i

is the interest rate,

e

f

I

₀ and

c

are known constants and the other variables are defined in problem 1.
The solution to the IS model is:

Y = k(A - ci)

where

k = 1/(1-b)

and

A =a+I

₀+G-bT
The solution to the IS-LM model is:

Y = K[A + (c/f)Ms/p]

where

K = k/[1 + (ekc/f)]

IS-LM model: (Investment - Savings/Liquidity - Money)

Variables:

Y

real GNP,

C

consumption,

I

investment,

G

government expenditures,

T

taxes,

i

interest rate,

Md

demand for money,

Ms

supply of money,

p

price level,

Md/p

real demand for money,

Ms/p

real supply of money,

a

b

I

₀

c

e

,and

f

are known constants

Given

G

= 150

T

= 150

M

s = 100

p

= 2.

a

= 150

b

= 2/3

I

₀ = 300

c

= 2500

e

= 0.25

f

= 1250 and

K

= 1.2

Change equations:

del Y = Kdel G

del I = -(ce/f)del Y

del (Ms/p) = {f\over Kc}(k -K) del G

.

a [3 pts] Why is

K < k

? Explain either mathematically or economically?

b. [3 pts] What is the equilibrium

Y

? Draw a rough sketch of this equilibrium of the IS/LM curves.

c. [3 pts] To reduce unemployment the government desires to raise

Y

by 48. What is the required

del G

? What is an alternative fiscal instrument which could be used to achieve the same objective?

d. [3 pts] How much investment is crowded out? Use a graphic version of the IS/LM to explain economically what has happened.

e. [3 pt] Now suppose the real money supply Ms/p is increased to compensate the crowding out. What is

del Ms/p

? Explain using the graphically IS/LM model.

f. [ 2 pts] Suppose

Y

before increasing

G

is less than the full employment

Y

. If increasing

G

increases

Y

beyond the full employment

Y

what will happen? Explain using the IS/LM graph.

g. (3 pts] Return to part c. above. What is the required

del G if at the same time del a is 10. How does this affect the rest of the problem? Explain with a graph.

Page 7
IS/LM Page 2

Page 8

III. (10 points) Technical Essay:3. Define discovery, invention, and innovation and give an incentive system for each. Why do the incentives for discovery and invention lead to very different incentives for the flow of knowledge? Since 1790 what institutional arrangements have developed to promote each. To what extent should government try to promote these activities. What are the dangers. How can these dangers be minimized. Why is promotion of discovery, invention and innovation more important than either Keynesian fiscal policy or monetary policy.

Page 9

IV. (30 pts) Current Events

You must answer all parts to the current events question. The question come from each groups presentations. One half your essay can come from the topic of your choosing.
1. Social Security: Why will the retirement of the baby boom create a crisis in the social security system. What will happen when the social security trust fund starts to sell government securities to obtain funds for the retired baby boomers. What will happen when all the private retirement funds start to sell securities to pay for the retired.
2. Medicine: Briefly discuss three factors why US medicine is so expensive. What will happen to medicare expenses when the baby boom retires.
3. Military: Assume Presidents from all parties in the foreseeable future will be faced with police actions in third world countries. How should the military be restructured? Is there still a treat from the various countries from the former Soviet Union?
4. Welfare: Narrowly define welfare as payments to the poor such as food stamps and aid to dependent children. Are these programs indexed to the CPI like social security? Have real payments been increasing or decreasing per family. Why does welfare destroy families? Why is the public in such an uproar? Will programs such as the one proposed in Wisconsin have positive results? Briefly discuss.
5. What is the problem with primary and secondary education in the US. What is been done about it. What is your prognosis?
6. What percent of prison population are high school dropouts. Given the increase in world economic competition, how does this relate to question 5. What does it cost to incarerate a prisoner for a year. Is the total cost of prisons more that for education? What is your solution.
7. What is the function of a research university in international economic competition. Use UT and biotechnology to illustrate your answer.
8. What is the IC

incubator. How does it promote
startups? To what extent should this type of activity be promoted by public
funds. Briefly explan.

Students will get three pages to write their current events essay.

norman@emundo.co.utexas.edu
Mon 26 Aug 96