08 Jun Question S ECTION 1: M ULTIPLE C HOICE Q UESTIONS
Question
S ECTION 1: M ULTIPLE C HOICE Q UESTIONS
1. Some persons are counted as out of the labor force because they have made no serious or
recent effort to look for work. However, some of these individuals may want to work even
though they are too discouraged to make a serious effort to look for work. If these individuals
were counted as unemployed instead of out of the labor force, then
(a) both the unemployment rate and labor-force participation rate would be higher.
(b) the unemployment rate would be higher and the labor-force participation rate would be
lower.
(c) the unemployment rate would be lower and the labor-force participation rate would be
higher.
(d) both the unemployment rate and labor-force participation rate would be lower.
2. Suppose a central bank implements a monetary expansion. Which of the following would
we expect to occur in the medium run?
(a) an increase in output
(b) an increase in the interest rate
(c) an increase in the nominal wage
(d) all of the above
(e) none of the above
3. A tax cut combined with tight money, as was the case in the United States in the early 1980s,
should lead to a
(a) rise in the interest rate and a fall in investment.
(b) fall in the interest rate and a rise in investment.
(c) rise in both the interest rate and investment.
(d) fall in both the interest rate and investment.
4. A decrease in the price level shifts the
demand curve
.
curve to down (or to the right), and the aggregate
(a) IS; shifts tot he right
(b) IS; does not shift
(c) LM; shifts to the right
(d) LM; does not shift
5. If the investment demand function is I = c − di and the quantity of real money demanded is
eY − f i, then monetary policy is relatively potent in influencing aggregate demand when d
is
and f is
.
(a) large; small
ECON304: Intermediate Macroeconomics Problem Set #2 Solutions
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(b) small; small
(c) small; large
(d) large; large
6. A movement along an aggregate demand curve corresponds to a change in income in the
IS-LM model
, while a shift in an aggregate demand curve corresponds to a change in
.
income in the IS-LM model
(a) resulting from a change in monetary policy; resulting from a change in fiscal policy
(b) resulting from a change in fiscal policy; resulting from a change in monetary policy
(c) at a given price level; resulting form a change in the price level
(d) resulting form a change in the price level; at a given price level
7. For this question, assume that the economy is initially operating at the natural level of output.
We know with certainty that a simultaneous reduction in taxes and reduction in the money
supply will cause which of the following?
(a) an increase in output and an increase in the aggregate price level in the short run
(b) a reduction in output and a reduction in the nominal wage in the short run
(c) a reduction in investment in the medium run
(d) a reduction in the interest rate in the medium run
(e) an increase in the aggregate price level, no change in output, and no change in the
interest rate in the medium run
8. Crowding out occurs when an increase in government spending
investment
.
the interest rate and
(a) increases; increases;
(b) increases; decreases;
(c) decreases; increases;
(d) decreases; decreases;
9. If the short-run IS-LM equilibrium occurs at a level of income below the natural level of
, shifting the
curve down (or
output, then in the medium-run the price level will
to the right) and returning output to the natural level.
(a) increase; IS
(b) decrease; IS
(c) increase; LM
(d) decrease; LM
ECON304: Intermediate Macroeconomics Problem Set #2 Solutions
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10. Suppose people in the adult population in a small country are classified based on their age:
Labor Force Status
Number employed
Number unemployed
Number in Population
less then 55
55 and older
400,000
25,000
600,000
100,000
7,000
200,000
Suppose that the natural rate of unemployment is 5% for those under 55 and 3% for those 55
and older. The cyclical unemployment rate for
(a) those under 55 is 0.88%, which is greater than the cyclical unemployment rate for those
55 and older.
(b) those under 55 is 0.88%, which is less than the cyclical unemployment rate for those
55 and older.
(c) those under 55 is -0.83%, which is greater than the cyclical unemployment rate for
those 55 and older.
(d) those under 55 is -0.83%, which is less than the cyclical unemployment rate for those
55 and older.
(e) 0 for both age groups.
S ECTION 2: S HORT A NSWER Q UESTIONS
1. A decrease in government spending reduces output more in the aggregate expenditure model
than in the IS-LM model. Explain why this is true.
2. Consider the following economy. The goods market is described by
C = c0 + c1 (Y − T )
T = t0 + t1 Y
I = b0 + b1 Y − b2 i
G = g0 ,
where the definitions of variables follow the text. The money market is described by
Ms
M0
=
P
P
Md
= µ0 + µ1 Y − µ2 i,
P
where Ms is nominal money supply, M0 is the nominal money target set by the central bank,
µ1 determines the relative increase in money demand due to an increase in income, and µ2
determines the responsiveness of real money demand to a change in the nominal interest rate.
(a) Solve for the IS curve (Y as a function of i).
ECON304: Intermediate Macroeconomics Problem Set #2 Solutions
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(b) Solve for the LM curve (i as a function of Y ). How does monetary policy affect the
goods market in this model?
(c) Solve for equilibrium output, Y , where the IS and LM curves intersect. Graph the
curves on a single figure. Label the axes and curves. Show the expressions for the
intercepts and slopes of both curves. What happens to the slope of the LM curve when
real money demand is more responsive to interest rates (i.e., as µ2 increases)? What is
the economic interpretation?
(d) What is the government spending multiplier? What is the monetary policy multiplier?
What is the difference between the two multipliers? Under what condition is the monetary policy multiplier larger than the government spending multiplier? What is the
economic interpretation of this condition?
(e) Graph the money market and IS-LM models (see Figure 5-4 in the text for an example)
under the condition is the monetary policy multiplier larger than the government spending multiplier. Accurately depict the slopes of the money demand, LM, and IS curves.
Show the ceteris paribus effect of an increase in Ms from M0 to M1 where M0 < M1 .
Use an arrow to depict which way the LM curve shifts. Label the intercept of both LM
curves using the expression from part (c). What is the effect on equilibrium output?
What is the drawback of the ceteris paribus assumption in this model? (Hint: Consider
the price level, P . Why can’t output rise forever by increasing the money supply?).
3. Thus far we have assumed taxes are levied lump-sum. In reality, however, this is not the
case. Taxes are levied proportionally against income. Consider the following equations:
C = c0 + c1 Y D ,
YD = (1 − τ )Y,
I = b0 ,
G = g0
where c0 , c1 , and τ (the income tax rate) are parameters, and G and I are both exogenous.
(a) Solve for equilibrium output.
(b) What is the multiplier? Does the economy respond more to changes in autonomous
spending when τ = 0 or when τ > 0? Explain.
(c) Explain the intuition behind how changes in autonomous spending affect equilibrium
output and how a positive income tax rate changes the dynamic multiplier process.
(d) Write a mathematical expression that shows the dynamic multiplier process.
(e) Show that your expression in part (d) equals the multiplier from part(b).
(f) Show the dynamic income multiplication process graphically in the goods market given
an increase in G from G0 to G1 . Be sure to label the intercept and slope of the aggregate demand curve as well as show any shifts in curves and changes in equilibrium.
Describe how the goods market moves from the initial to the final equilibrium.
(g) Suppose the government decreases the income tax rate (assume everything else is
fixed). What does the model of the goods market predict will happen to aggregate
income? What if τ = 1?
ECON304: Intermediate Macroeconomics Problem Set #2 Solutions
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