1. The Keynesian cross and the IS-LM model [10 points]

Transcription

1 1. The Keynesian cross and the IS-LM model [10 points] 1.1. Consumption in the economy is, with 0.8. Furthermore, 400, 0, 200 and, with 300, 2000 and Assume that the saving rate increases to The interest rate and all other exogenous variables remain constant. Mark the correct statements. [2 points] a) The increase of the saving rate reduces the propensity to consume by 50%. b) The increase of the saving rate reduces the propensity to consume by 25%. c) Income falls by 50% in equilibrium. d) Income falls by 25% in equilibrium. e) Income falls by 30% in equilibrium What explains these results? Mark the correct statements. [2 points] a) The multiplier decreases. b) The multiplier increases. c) The paradox of thrift. d) The paradox of consumption. e) None of the answers above Assume that a financial crisis increases the saving rate of households. Mark the correct statements How does this affect the equilibrium in the IS-LM model? [2 points] a) Income falls but the interest rate increases because households save more. b) Income falls. The interest rate falls if it is above the zero lower bound. c) The IS curve shifts to the right (changing its slope). d) The IS curve shifts to the left (changing its slope). e) The LM curve shifts to the right (changing its slope) Which of the following statements are true in a liquidity trap? [2 points] a) The IS curve is horizontal. b) Households have too much liquidity available for consumption. c) Banks are not willing to lend to firms. d) Households are willing to hold unlimited additional liquidity. e) The LM curve is horizontal. 1

2 Assume that you advise the government after the financial crisis, based on the IS-LM model. Which policy options are effective in the IS-LM model to stimulate the economy if the economy finds itself in a liquidity trap? [2 points] a) Expansionary monetary policy. b) Increase of government expenditure. c) Tax reduction. d) Decrease of government expenditure. e) Restrictive monetary policy. 2. The Mundell-Fleming model [10 points] 2.1. Consider a small open economy without capital mobility ( 0). There is a discussion in this economy whether to introduce full capital mobility ( ). The interest rate is higher than in the rest of the world:. Answer the following questions Assume flexible exchange rates. What are the consequences of full capital mobility for the equilibrium in the economy described above? Mark the correct statements. [2 points] a) The real exchange rate decreases and the IS curve shifts to the left. b) Income is lower in the new equilibrium. c) The real exchange rate increases and the IS curve shifts to the right. d) The real exchange rate decreases and the LM curve shifts to the right. e) Income is higher in the new equilibrium Now assume fixed exchange rates. What are the consequences of full capital mobility for the equilibrium in the economy described above? Mark the correct statements. [2 points] a) The interest rate in the rest of the world decreases and the IS curve shifts to the left. b) Income is lower in the new equilibrium. c) Money supply decreases and the LM curve shifts to the left. d) Money supply increases and the LM curve shifts to the right. e) Income is higher in the new equilibrium. 2

3 In which scenario(s) would the consequences of full capital mobility be the same in both exchange rate regimes? Mark the correct statements. [2 points] a) The government increases expenditure at the same time as capital becomes fully mobile so that without changes of the real exchange rate. b) The central bank increases money supply at the same time as capital becomes fully mobile so that without changes of the real exchange rate. c) The government decreases expenditure at the same time as capital becomes fully mobile so that without changes of the real exchange rate. d) The central bank reduces money supply at the same time as capital becomes fully mobile so that without changes of the real exchange rate. e) In none of the mentioned scenarios Consider a small open economy with full capital mobility ( ) International investors unexpectedly ask for a risk premium for investments in domestic currency. How does this affect the equilibrium? Mark the correct statements. [2 points] a) Both income and the interest rate increase if the exchange rate is fixed. b) Income falls and the interest rate increases if the exchange rate is fixed. c) Income falls and the interest rate increases if the exchange rate is flexible. d) Both income and the interest rate increase if the exchange rate is flexible. e) None of the answers above is correct Additionally, investors expect that the domestic currency depreciates. Mark the correct statements. [2 points] a) This reduces the equilibrium interest rate and amplifies the effects of the higher risk premium. b) This increases the equilibrium interest rate and amplifies the effects of the higher risk premium. c) The IS curve shifts left. d) The FE curve shifts down. e) The FE curve shifts up. 3

4 3. The labour market [10 points] 3.1. Assume a neoclassical production function that depends on the factors labour and capital. Mark the correct statements The assumption of constant returns to scale implies that. [2 points] a) doubling the production factor capital or the production factor labour doubles the output. b) doubling both production factors doubles the output. c) there are diminishing marginal products to labour. d) there are diminishing marginal products to capital. e) the marginal product to capital is constant If the production function is Cobb-Douglas,. [2 points] a) the share of income generated by each factor is constant. b) the share of income generated by each factor is increasing. c) the share of income generated by each factor is falling. d) the labour share of income is constant. e) the production function has constant returns to scale An increase in total factor productivity implies that. [2 points] a) returns to scale are not constant. b) the marginal product of labour increases. c) the marginal product of capital increases. d) the labour demand curve shifts to the right. e) the labour demand curve shifts to the left Assume that labour effort depends on the wage, as in the efficiency-wage model. Mark the correct statements Unit labour costs. [2 points] a) are constant. b) are increasing in the wage if the wage is smaller than the optimal efficiency wage. c) are decreasing in the wage if the wage is smaller than the optimal efficiency wage. d) are increasing in the wage if the wage is higher than the optimal efficiency wage. e) are decreasing in the wage if the wage is higher than the optimal efficiency wage. 4

5 The optimal efficiency wage. [2 points] a) is lower than the wage which clears the labour market. b) is higher than the wage that clears the labour market. c) implies involuntary unemployment. d) maximizes profits. e) implies full employment. 4. The AD-AS model [10 points] 4.1. Assume that the economy is hit by a negative demand shock: the interest rate in the rest of the world falls. Further assume that the exchange rate is flexible. Mark the correct statements Because of the demand shock [2 points] a) the FE curve shifts up and the IS curve shifts left. b) the FE curve shifts up and the IS curve shifts right. c) the FE curve shifts down and the IS curve shifts left. d) the domestic currency depreciates. e) the domestic currency appreciates Furthermore, [2 points] a) the short-run AS curve shifts left right as the economy moves towards its long-run equilibrium. b) the short-run AS curve shifts right as the economy moves towards its long-run equilibrium. c) the AD curve shifts left. d) the AD curve shifts right. e) the short-run AS curve does not shift In the transition to the new long-run equilibrium [2 points] a) the price level falls. b) income increases temporarily above the equilibrium level attained in the long run. c) income decreases temporarily below the equilibrium level attained in the long run. d) the price level increases. e) income remains constant. 5

6 4.2. Now assume that the central bank wants to stabilize the price level. Mark the correct statements In order to stabilize the price level, [2 points] a) the central bank has to reduce money supply. b) the central bank has to increase money supply. c) the central bank has to keep money supply constant. d) the central bank has to intervene in the foreign-exchange market. e) the central bank has to stabilize also the expected price level Which factors reduce the effectiveness of the central-bank intervention? [2 points] a) An intervention in the foreign-exchange market to stabilize the exchange rate. b) A simultaneous positive supply shock. c) Adaptive, slowly adjusting expectations. d) An expected appreciation of the domestic currency. e) A liquidity trap. 5. Budget deficits and public debt [10 points] 5.1. Analyze government expenditure in the AD-AS model with fixed exchange rates. Mark the correct statements There is an unexpected reduction in wasteful government expenditures. It follows that,. [2 points] a) in the short run, the price level and income increase. b) in the short run, the price level decreases or remains constant. Income decreases. c) in the long run, the price level increases and income remains constant. d) in the long run, the price level decreases and income remains constant. e) in the long run, the price level and income remain constant Furthermore, [2 points] a) the short-run effect on income is larger, the larger the price effect after the reduction in wasteful government expenditures. b) the short-run effect on income is independent of the price effect after the reduction in wasteful government expenditures. c) the short-run effect on income is smaller, the larger the price effect after the reduction in wasteful government expenditure. d) the multiplier is larger if income taxes are reduced at the same time. e) the multiplier is larger if income taxes are increased at the same time. 6

7 5.2. Now analyse the effect of government expenditures in the neoclassical model with complete markets. Mark the correct statements Assume that wasteful government expenditures increase unexpectedly. Then [2 points] a) consumption of private households falls because of the substitution effect. b) consumption of private households increases because of the substitution effect. c) consumption of private households increases because of the wealth effect. d) consumption of private households falls because of the wealth effect. e) the sum of expenditures by the government and private households remains constant Now assume that a lump-sum tax is levied to finance the additional government expenditures. The increase of the tax [2 points] a) reduces private consumption. The effect on income depends on the size of the multiplier. b) reduces private consumption because disposable income decreases. c) has no effect on private consumption for a given increase of government expenditures. d) reduces investment because the disposable income decreases. e) reduces the budget deficit Now assume that the increase in government expenditures and the lump-sum tax do not occur in the current period but are announced for the next period. Assume that the present discounted value of changes in government expenditures and taxes remains the same. Does this affect the results? [2 points] a) Yes, because the current disposable income does not change if government expenditures increase in the next period. b) No, because private households smooth consumption. c) Yes, because investment only falls once government expenditures have increased in the next period. d) No, because the present discounted value of government expenditures does not change. e) None of the statements above is correct. 7

8 6. Debt and sovereign debt crises [10 points] 6.1. Assume that risk neutral investors decide whether to invest in a risk-free bond with interest rate or a government bond with default risk. With probability investors loose their investment in the government bond (including the interest payment). With probability 1 investors receive interest rate as return. Mark the correct statements The arbitrage equation of investors is. [2 points] a) b) 1. c) d) 1 1. e) Assume that the default risk of the government bond depends on the interest rate as follows:, 0. Under the assumption that 0.1, 0.4, 0.02, there. [2 points] a) exists a unique equilibrium with a unique interest rate for the government bond. b) exists no equilibrium. c) exist multiple equilibria in which the interest rate for the government bond takes different values. d) exist multiple equilibria with different default risk. e) exists one equilibrium in which there is no default risk Now assume that 0. All other parameter values remain the same. Under this assumption, there [2 points] a) exists a unique equilibrium with a unique interest rate for the government bond. b) exists no equilibrium. c) exist multiple equilibria in which the interest rate for the government bond takes different values. d) exist multiple equilibria with different default risk. e) exists one equilibrium in which there is no default risk. 8

9 In the model described above, self-fulfilling sovereign debt crises can only occur if. [2 points] a) we assume that 0. b) we assume that 0. c) the primary deficit is higher than the budget deficit. d) expectations of investors and interest payments of the government influence each other. e) the budget deficit is higher than the primary deficit In the model described above, the risk of sovereign debt crises is lower if. [2 points] a) the central bank commits to purchase government bonds if government default is imminent. b) government debt is low. c) the risk-free interest rate is low. d) investors have rational expectations. e) the central bank is committed to the goal of price stability. 7. General questions [30 points] 7.1. In a demand-determined equilibrium... [2 points] a) supply and demand determine the price. b) demand determines the income level. c) there is slack capacity so that income does not react to changes in demand. d) higher government expenditures increase the income level for a fixed exchange rate Actual expenditures deviate from planned expenditures because [2 points] a) of unplanned investment. b) firms desire to build up inventories. c) firms desire to reduce inventories. d) the statistics are measured imprecisely In the equilibrium of the Keynesian cross, the income level [2 points] a) is equal to actual expenditure. b) is equal to planned expenditure. c) is equal to unplanned expenditure. d) is equal to an amount not mentioned in the answers above. 9

10 7.4. If firms produce at their capacity limit and prices are flexible, [2 points] a) the effects of monetary and fiscal policy are the same as when prices are fixed. b) monetary policy does not affect real money supply. c) the real exchange rate does not change. d) higher government expenditures have no real effect If investors require a lower risk premium to hold deposits in a bank, then [2 points] a) the opportunity cost for holding money falls. b) the opportunity cost for holding money increases. c) the LM curve shifts up. d) the LM curve shifts down Assume a vertical FE curve. An increase of the interest rate in the rest of the world then implies [2 points] a) an increase in income. b) a decrease in income. c) no change in income. d) a devaluation of the domestic currency If the nominal wage is flexible, [2 points] a) a change in the price level has no effect on the real wage and employment. b) the real wage and employment increase after an increase in the price level. c) the real wage and employment fall after an increase in the price level. d) the nominal wage and nominal income increase after an increase in the price level What can cause involuntary unemployment? [2 points] a) Minimum wages. b) Efficiency wages. c) Shorter work-hours. d) Higher income taxes Nominal wage rigidity [2 points] a) implies that the long-run AS curve shifts left. b) can be caused by long-term wage contracts. c) implies a positive slope of the short-run AS curve. d) may cause income to deviate from potential income. 10

11 7.10. The LAS curve [2 points] a) is horizontal. b) is vertical. c) has a positive slope. d) intersects with the AS curve where the price equals the expected price level Assume flexible exchange rates. A reduction of money supply [2 points] a) shifts the AD curve left. b) shifts the AD curve right. c) implies appreciation of the domestic currency. d) implies depreciation of the domestic currency An increase of government expenditures with flexible exchange rates [2 points] a) shifts the AD curve right. b) shifts the AD curve left. c) does not shift the AD curve. d) reduces net exports because of crowding out Which statements on the difference between the budget deficit and the primary deficit are correct? [2 points] a) The interest payments are included only in the primary deficit. b) The budget deficit is always higher than the primary deficit. c) The interest payments are included only in the budget deficit. d) The budget deficit is always lower than the primary deficit Assume that the primary deficit of a country is 6% (in percent of income), the real output growth rate is 4% and the real interest rate is 2%. Assume that the central bank refuses to finance the deficit by printing money. How high is the debt ratio in the long-run equilibrium? [2 points] a) -2% b) 2%. c) 0.66%. d) 2.25%. 11

12 7.15. Private households feel less wealthy after a tax increase that reduces government debt without changing government expenditures, if [2 points] a) financial markets are complete. b) taxation distorts optimal decisions. c) financial markets are incomplete. d) taxes are lump sum. 12