Econ 1120 Fall 2016 Makeup PRELIM 2 Answers

1. B. MPC + MPS = 1 and APC + APS = 1 are always true. 2. B. Consumption + Desired investment = $260, but only $200 worth of stuff was currently made, so there is $60 of unplanned depletion of inventory. Actual investment (-40) always equals actual saving (-40). Actual investment is SMALLER than planned investment (-40<20). Leakages do not equal injections. 3. D. If MPC=0.9 then the government multiplier is 1/(1-.9)=10. So ∆Y*=Kg∆G 100=10∆G ∆G=10. 4. C. The marginal propensity to consume can be calculated as follows: when output increases from 3000 to 4000, consumption increases from 2000 to 2800. Therefore, the MPC is (2800-2000)/(4000-3000)=0.8. In turn, the multiplier is 1/(1-0.8)=5. Therefore, Y* increases by 200*5=1000. 5. C. Suppose the economy is closed and there is no government. Then S = Y – C. Exogenous decrease in subsistence consumption implies upward shift of the saving curve. However, since $3000 is fixed, in equilibrium people save the same amount but have less income and less consumption. (A) makes the saving curve shift downward and people consume more. (D) and (E) Exogenous increase in desired investment leads people to save and consume more. 6. E. So there is only +2mil for the cash part and then the +8mil that goes into the banking system becomes +80mil since the money multiplier is 10. So added together you get +82 million. 7. C. Note that Y* is currently at Y*=4000. So Greenspan is producing more than YFE, so it is in an inflationary gap. 8. C. The government multiplier is 2. The tax multiplier is -1. Current Y*=$4000. The change in G is +200. This increases Y* by +400. The change in taxes is +1000 and this changes Y* by -1000. So the net is -600. 9. C. Selling securities will decrease the money supply. The amount is equal to -5/.16=-31.25. 10. A. A classic example of the time value of money. The promise will worth less than $2000. So B and E are incorrect. If the interest rate is higher, or the time to maturity is longer, the promise will worth even less. Therefore, C and D are incorrect. 11 B. The crowding-out effect is bigger when investment is sensitive to interest rate. Therefore, B is correct but A is incorrect. Monetary policy influences the economy through the interest rate. Therefore, the fact that investment curve is sensitive to interest rate is good news for monetary policy. 12 B. Suppose money demand depends on interest rate, price level, and income level. If the Fed sells government securities to the public, money supply decreases and interest rate rises. Consequently, cost of investment becomes higher so that planned investment declines. Since Y = C + I + G (if the economy is closed) Y will also decrease and at the end money demand will decrease because income level falls. 13. D. Above r*=5% these is excess supply of money, so people will attempt to get rid of money by buying bonds, driving the price of bonds up and the interest rate down. 14. C. (A) Money supply increases but money demand rises as well so that direction of the equilibrium interest rate change is uncertain. (B) Again, money supply increases but money demand increases as well due to the rise in income. (C) Money supply increases while money demand falls so that the equilibrium interest rate clearly declines. (D) Money supply shifts to the right but money demand shifts to the left the equilibrium interest rate can either rise or fall.