Department of Economics

Iowa State University

Intermediate Macroeconomics

Fall 2000 Final Exam Alexander

1. True/False (15 points each)

In seven to ten sentences and using diagrams where appropriate, explain whether three of the following statements are true or false.

a) The chained calculation of Real GDP involves using the geometric average of the current year and the base year prices.

b) Under flexible exchange rates and perfect capital mobility, an increase in government consumption expenditures will cause full-crowding out of private domestic investment.

c) The expectations augmented Phillips Curve indicates that the tradeoff between inflation and unemployment is illusory in the long-run.

d) A decrease in the inheritance tax will cause individuals to save less.

e) An expected decrease in the marginal tax rate in the future will cause a decrease in investment today.

f) If an economy ever achieves the Golden Rule level of capital accumulation, that economy is doomed to the same standard of living forever.

2. IS/LM (45 points)

The model is: TE = C + I + G

C = a + b ( Y - t Y + TR )

I = c - d i + eY

L = f Y - g i

where a = 100 e = .15 g = 4000

b = .75 f = .50

c = 1000 G = 300

d = 1000 TR = 800

t = .20 M/P = 2000.

a. What is the equation that describes the IS curve?

b. What is the equation that describes the LM curve?

c. What are the equilibrium values for Y and i?

d. The Clinton-Hastert balanced budget agreement calls for changes in spending and taxes to maintain a balanced budget. Assume that the fiscal authorities have managed to get the Federal Reserve to agree to alter the money supply to ensure that there is no change in output from any fiscal policy change Furthermore, assume that the budget agreement results in an increase in the marginal tax rate of +.05 this year (t = +.05). Assuming that change in tax rates, what change in the money supply will be necessary to ensure that Y = 0. (I want an exact number). What will the change in the interest rate be? Show all work!

e. Draw a diagram depicting these two policies (the change in tax rates and in the money supply) on Total Expenditures, the money market, and IS/LM.

3. AD/AS (35 points)

Using IS/LM, AD/AS, and the money market, explain and graphically depict the effects of an increase in the price of oil on Y, i, and P when the economy is at full employment. Indicate the short-run and long-run effects of this change and explain the adjustment the economy goes through.

**4. Solow Growth Model (30 points)

Assume that an economy can produce output using the following production function:

Y = K^1/4 Z^3/4

where Y is output, K is capital, and Z is Labor Efficiency units (i.e., Z = L*E).

Assuming that the rate of depreciation, d, equals .15, the rate of population growth, h, equals .025, and technological progress, e, equals .025, and that the savings rate, s, equals .25,

a) Derive and graphically depict the steady state condition.

b) Derive and graphically depict the Golden Rule level of capital accumulation. What savings rate is necessary to achieve k^**?

**5. IS/LM/BP (45 points)

Using IS/LM/BP explain and graphically depict the effect of the following scenarios on output, the interest rate, consumption, money demand, the foreign exchange market, and net exports. Each scenario requires 5 diagrams and an explanation.

a. Exchange rates are fixed, capital is perfectly mobile, and there is a decrease in the money supply.

b. Exchange rates are flexible, capital is perfectly mobile, and there is a decrease in the marginal tax rate.

c. Exchange rates are flexible, capital is mobile, and there is a decrease in the money supply.

** For students taking the full 2 hour final.