From: levine@haas.berkeley.edu
To: e201b-1@haas.berkeley.edu, e201b-2@haas.berkeley.edu
Date: 1999-11-11 23:17:00+00:00
Subject: Midterm process & past questions

I) The midterm

A voluntary take-home midterm will be available next week (11/17-23). Email me
if you would like to take it and I will email back an exam. You have 80 
minutes
to complete the exam from the start time you designate.  The grade 
distribution
of midterm exams will equal that of final exams, so it will not influence by
much your expected grade (although it may reduce the uncertainty).

II) Past midterm and final exam questions

A real mideterm has about 80 points worth of questions, a final exam has about
160
points worth of questions. This document is a compilation of questions from
past
exams, and is much longer than any single exam. Plausible midterm questions 
are
marked with a *. Many of the questions were relevant in a given year; thus, 
the
year of
the exam is sometimes included in [brackets].


Short Answer: True, False, or Uncertain, and Why? The grade you receive 
depends
solely on the quality of your explanation. If you are not sure of what the
question
assumes, simply state your own assumptions clearly, and answer based on these
assumptions.

* 1. [10] The US unemployment rate would decline rapidly if unemployment
insurance
were cut.

2. [10] The rate of growth of M1 and M2 have both been fairly rapid recently
(Assume
this sentence is true.) Thus, we can expect that the inflation rate will soon
increase
rapidly. [1991]

3. [10] In the late seventies the US had both high inflation and relatively
high
unemployment. Thus, the Phillips' curve theory is wrong, since it predicts 
that
inflation
and unemployment are negatively related.

4. [10] Recently Canada has informally maintained a fixed exchange rate with
the US.
(This sentence is true.) As long as they target exchange rates, monetary 
policy
will not
be effective in Canada. (You may want to refer to Canadian and US dollars as
C$'s
and US$'s in your answer.)

5. [10] If the Japanese would lower their interest rates to expand their
aggregate
demand, then Japanese purchases of US goods would increase. [Hint: Consider 
the
exchange rate.]

6. [10] "Why is our money ever less valuable? Perhaps it is simply that we 
have
inflation because we expect inflation, and we expect inflation because we've
had it."
(Robert M. Solow, Technology Review, Dec/Jan 1979: 31)

7. [10] The current U.S. Federal Government Budget Deficit (BD) is not a
problem in
the short run (i.e., this year). [1992]

8. [10] Fiscal policy is less effective in France than in the United States.
[Hint: Consider
differences both in the open-economy multiplier and the exchange rate regime.]

9. [10] Low-wage countries such Greece and Portugal will gain more from the
creation
on a common market than will high-wage countries such as Germany and Denmark.
[1993]

* . [10] True unemployment is above measured unemployment.

* 11. [10] We should not worry much about inflation.

* 12. [10] The multiplier is higher when marginal tax rates, marginal savings

rates, and marginal propensity to import are all high.

* 13. [10] Budget deficits in a recession are a good thing.

* 14. [10] For each dollar of revenue lost to the government, capital gains 
tax
cuts are
less effective at spurring investment than are increases in the investment tax
credit.

* 15. [10] The federal government should increase spending on education.

* 16. [10] Unions are responsible for a significant fraction of U.S.
unemployment.
[1994]

17. [10] Free trade hurts American workers, but helps workers in low-wage
nations.

18. [10] It is good for the nation when monetary policy accommodates fiscal
policy.

* 19. [10] Frictional unemployment represents people rationally choosing to
search for
a job. Thus, no government policy is called for to address it.

* 20. [10] European unemployment rates and unionization rates are both above
U.S.
levels, proving unions cause unemployment. [1994]

21. [10] In class we assumed money demand depended on output and interest 
rates
(L
= kY - hi). In the IS-LM framework, when the demand for money (k) increases at
any
given level of output, output and interest rates will rise.

22. [10] A balanced budget rule (so long as it corrected for cyclical factors)
would be
a good thing.

23. [10] Increasing consumption increases output. (Hint: Is this a trick
question?)

24. [10] In an open economy, monetary policy is less effective than in a 
closed
economy.

* 25. [10] No policy can cost-effectively reduce the rate of long-term
unemployment.

26. [10] Because the stock market falls when output and employment rise, the
market
is not a good predictor of future output growth.

27. Japan will grow faster than Russia next year. [1995]

* 28. Japan will grow faster than Russia over the next 15 years. [1995]

29. Russian inflation will decline next year. [1995]

30. The creation of the EMU will reduce Italian long-term interest rates.
[1996]

31. The process of qualifying for the EMU has reduced French economic growth.
[1996]

[10] "A Booming Economy Made it All Much Easier: For the Shrinking Deficit,
Thank
the Economy." [New York Times, 1997]

[10] The recent actions of the Labour government concerning the Central Bank
should
lower expected inflation in the United Kingdom. [1997]

[10] The recent appreciation of the U.S. dollar is bad for Argentine. [1997]

[10] Ireland should join the European Monetary Union. [Hints: Ireland's 
economy
is
closely tied to Europe but most closely to the United Kingdom; Irish inflation
has
historically been above the EC average; the Irish economy has been growing
rapidly for
several years and is likely approaching the output level associated with the
non-accelerating inflation rate of unemployment; and the Irish currency has
been near
the top of its permissible band of fluctuation against other European
countries.] [1997]

[10] "Investors give East Europe a miss: Problems with legal system, taxes,
crime and
corruption deter foreign funds." [Financial Times, 1997]

[10] The EMU should include Italy. [1997]

[10] The multiplier is higher when marginal tax rates, marginal savings rates,
the
marginal propensity to import are all low and the investment accelerator is
high.

* [10] The government should subsidize private savings.

* [10] The capital gains tax should cut, but only if it is reformed.

* [10] The government should subsidize student loans for college.

Longer answers

32. [26] In 1990 the strange and wonderful nation of Bezerkly could best be
modelled
with the following one-sector model of a closed economy:

Y = C + I + G
C = C0 + c Y = 50 + .8 Y
I = I0 + fY = 50 + .1 Y
G = G0 = 100

This model differs from the standard textbook model because when sales 
increase
by
$1, Bezerk investors see that they need new factories, and investment 
increases
by $f,
where the parameter f is between zero and one.

a) [8] Derive the government spending multiplier in this model either
symbolically or
numerically. Compare it to multiplier when f = 0. (Recall that if f= 0, then
the multiplier
in this model dY/dG = 1/(1-b) = 1/(1-.8) =

5. To help you with your arithmetic, Y = 2000 in the example above.)

b) [8] Explain in words the intuition behind the comparison of the two
multipliers.

c) [10] What happens to output if G0 falls to 90? What happens to national
savings?
Show national savings (S - gov't deficit)=I after the shock.

33. [20] As time passed the Telegraph was invented and brought news from the
outside world about the wonderful concept of money. Soon thereafter money is
introduced into the Bezerker economy, undoubtedly by some non-politically
correct
dean or economist.

In addition, repetitive drumming in by microeconomics, finance, accounting and
macroeconomics professors convinces managers to pay attention to interest 
rates
when
choosing how much to invest. Now the nation is best modelled with the 
following
IS-LM model of a closed economy:

C = C0 + cY = 50 + .8 Y
I = I0 + fY - bi = 50 + .1 Y - i
G = G0 = 100
L = kY - hi = Y - 10i Money demand
M/P = 1800 Money supply

A. Derive the formulae for the IS curve and the LM curves. (Don't use numbers
for this
question.)

B. What are the equilibrium levels of income and interest rate? (Do use 
numbers
for this
question.)

34. [30] While in class we focussed on fixed vs. flexible exchange rates, many
nations
have intermediate cases. For example, some nations have band, where rates are
fixed
plus or minus some percent. For example, a nation may fix its rates at 10 
pesos
per
dollar plus or minus 4 percent, thus fixing between 9.6 and 10.4 pesos per
dollar. In
other cases the fixed rate has a crawl built into it: We fix at 10 pesos to 
the
dollar,
depreciating 1 percent per month. Other nations combine the two: a band each
month,
with built-in depreciation over time. What are the advantages and 
disadvantages
of
these hybrid systems compared to pure fixed rates?

[30] After evaluating all other relevant arguments for and against adoption of
a fixed
currency, policymakers in the small open economy of Haasland are still
undecided. The
costs seem to exactly equal the benefits. The last piece of information they
are to
consider is that Haasland has historically been subject to more shocks of
consumer and
investor confidence than supply or price shocks. Given this fact and the 
desire
of
Haasland policymakers to stabilize output, what exchange rate policy would you
recommend? [Hint: Make reference to IS-LM diagrams in which you show the 
effect
on output and interest rates of a negative shock to the IS curve (consumer or
investor
confidence) and a negative shock to the LM curve (supply or price shock) under
both
fixed and floating exchange rates.]

[30] In 1984, the small open economy of New Zealand had a policy of 
maintaining
a
fixed exchange rate. Suddenly, due to a political crisis, the risk premium for
investment
in New Zealand increased dramatically. Policymakers were left with two 
options:
1)
raise interest rates or 2) devalue the currency. Recommend a response based on
an
analysis of the impact of these policies on output, interest rates and
inflation, making
reference to an IS-LM diagram. [Hint: Would it matter where output was 
relative
to
Y*, the output level associated with the non-accelerating inflation level of
unemployment?]


David I. Levine                 Associate professor
Haas School of Business    ph: 510/642-1697
University of California    fax: 510/643-1420
Berkeley CA  94720-1900                            email:
levine@haas.berkeley.edu
http://web.haas.berkeley.edu/www/levine/