QUEENS UNIVERISTY
Faculty of Arts and Science
Department of Economics
ECONOMICS 222 B
FINAL EXAMINATION
December 20, 2000, 9.00 AM
INSTRUCTOR: Urvashi Dhawan Biswal
INSTRUCTIONS:
-This examination is THREE HOURS in length. The exam has three parts.
Read the instructions for each part carefully.
-Notice the number of points awarded to each question and budget your time
accordingly.
-Only calculators are allowed. Do not hand in the question sheet.
Please note: If the instructor is unavailable in the examination room and
if doubt exists as to the interpretation of any question, the candidate is
urged to submit with the answer paper a clear statement of any assumptions
made.
PART I - 30 MARKS
DO ANY 5 OF THE 7 QUESTIONS (Each question is worth 6 marks)
Question 1. 1
Show where each of the following transactions belongs on the Canadian
balance of payments table, using an exchange rate of 120 Japanese yen per
Canadian dollar. (Specify whether the transaction appears as credit or
debit, and which account)
(a) A Japanese investment banking firm buys 100 million dollars worth
of newly issued Canadian government Treasury bills
(b) Canadian steel firms send 1000 executives to Japan to take courses
in the Japanese method of steel production and Japanese management
techniques, paying 1 million yen per executive
(c) A wealthy Japanese businessman gives $10,000 to the Toronto Zoo.
Question 1. 2
Argue whether the following statement is true, false or uncertain.
An economy in which output exceeds absorption will have a capital account
deficit.
Question 1. 3
Consider two large open economies. Let H stand for the home country and F
stand for the foreign country. The desired savings and investment
functions are as follows:
SF = 10 +100r
SH = 40 +100r
IF = 30 -200r
IH = 75 -300r
Calculate equilibrium values of world interest rate (r) and the current
account (CA) for the home country.
Question 1.4
Why is the equilibrium in the asset market described by the condition that
real money supply equal real money demand? Explain.
Question 1.5
Suppose the money demand function is
Md/P = 0.2Y -1000i
where i is the nominal interest rate. The real interest rate is 5% and
the expected inflation is also 5%. The nominal money supply is equal to
2600 and the real output is 2000. Calculate velocity and the price level.
Interpret velocity.
Question 1.6
What is a business cycle? Explain the movement of the following
macroeconomic variables during a recession and specify their timing of
change:
(a) price level
(b) unemployment
(c) money growth
(d) trade balance
(e) real interest rate
Question 1.7
Argue whether the following statement is true, false or uncertain.
Flexible exchange rate systems are always preferred over the fixed
exchange rate systems because the country keeps control over its monetary
policy.
PART II - 30 MARKS
COMPULSORY QUESTION
READ THE QUESTION CAREFULLY
Question 2: Assume a closed economy for all the parts of this question.
Draw diagrams in parts (b) and (c) to support your responses. You can use
IS-LM-FE model or the AD-AS model to answer parts (b) and (c).
(a) Explain briefly the following concepts: IS curve, LM curve, FE
curve, and AD curve.
[2]
(b) Analyze the following statement, and show what would happen in the
long run if such advice were followed by the Bank of Canada:
The decline in the North American stock market has reduced peoples wealth.
As a result, their consumption has fallen, reducing aggregate demand and
output. So the Bank of Canada needs to reduce the money supply, since with
lower income, peoples demand for real money balances will be higher
Comment on the effectiveness of this contractionary monetary policy in
maintaining price stability in the country.
[9]
(c) Examine the impact of the following on the real interest rate,
real output, price level, and real wage rate, in the short run as well as
in the long run:
(i) a temporary increase in the price of oil
(ii) a permanent increase in the price of oil
Compare the magnitude of price change in the long run under the two
situations.
Explain the difference intuitively.
[14]
(d) Suppose the economy is faced with a permanent increase in the price
of oil, as described in part (c), (ii). Comment on the effectiveness of
monetary and / or fiscal policies in this scenario, in the short run as
well as in the long run. [5]
PART III - 40 MARKS
DO ANY 2 OF 3 QUESTIONS
Question 3.1
Consider an economy given by:
Cd = 2000 +0.9Y - 100,000r - G
Id = 1000 - 45,000r
Md/P = Y - 6000i
G=500, YFE = 1000, M=2100, expected inflation = 0.03
(a) Find the equilibrium values of real interest rate (r), price level
(p), and desired consumption.
[5]
(b) Suppose desired government spending falls by 150. Calculate the
short run equilibrium values of real output (Y), real interest rate (r),
and desired consumption. Draw a diagram to explain your results. Comment
on the equilibrium values of these variables in the long run. Explain
intuitively. [6]
(c) [No calculations required for this part] Suppose this economy
opens its door to international trade under a flexible exchange rate
system. Derive the open economy IS curve diagrammatically and provide a
brief explanation. [4]
(d) Evaluate the merit of the following statement made in the context
of a small open economy with flexible exchange rate: A contractionary
fiscal policy will boost net exports in the long run.
[5]
Question 3.2
(a) Consider an economy described by the following IS-LM
equations:
IS curve: r = 2.47 - 0.0004Y
LM curve: 0.5Y - 500r = 88950/P
Derive the equation of the aggregate demand curve.
[4]
(b) Consider an economy described by the following AD and AS
equations:
AD: Y=1000 +100M/P
AS: Y=1500
(i) If the real exchange rate is 3 bushels per bottle, the domestic
money supply is 30 florins and the foreign price level is 8 crowns per
bushel, calculate the nominal exchange rate. Is this also the fundamental
value of the exchange rate? Comment.
[5]
(ii) Suppose domestic money supply increases to 50 florins. Is the
currency overvalued or undervalued, and by how much? Explain why this
happened and suggest two ways of correcting this situation.
[5]
(c) Suppose that the Netherlands is a small open economy in which the
real interest rate does not deviate from the world interest rate.
According to the Mundell-Fleming model, what happens to the macroeconomic
variables (r, Y, NX) when the world interest rate falls?
[6]
Question 3.3
(a) Explain how Bank of Canada changes money supply by altering the
overnight rate. Describe the process.
[5]
(b) Suppose the Feds in U.S announce an expansion in money supply.
Assuming flexible exchange rate system, examine the impact of this policy
on Canada, given that Canada is a small open economy. Identify the short
run and long run effects on the nominal exchange rate, real exchange
rate, net exports, real interest rate and real output in Canada. Draw
diagrams. Discuss your results. [12]
(c) Is there any role for Bank of Canada in a situation like this (part
b)? Explain. [3]