As with the practice midterm questions, there are issues dealt with here that are no longer relevant. Also, some questions relate to open-economy macroceconomics from Chs. 9 and 10, that were not covered in this version of the course. Previous final exams are also available from the Reserve Room in the Library.
1. Keeping in mind that the AS equation can be rewritten as y = y-1 - a4(omega - pi), what is the value of omega relative to pi when:(a) y-1 is greater than ye; (b) labour productivity has increased exogenously and y-1 is less than ye; (c) inflation has been negative but constant for some time?
2.(a) During a recession why does the real wage rise? (b) During a recession, the number of people who want to work may in fact rise because of the higher real wage and because of reduced nonwage income. Explain this observation and indicate how each of these factors contributes to the slope and position of the labour-supply curve.
3. If Canadians want lower interest rates while the economy stays at potential output, they should encourage the Governor of the Bank of Canada to continue with his announced contractionary monetary policy. Why is this better advice than to let the Governor suddenly shift to expansionary policy?
4. "One reason for the higher natural rate of unemployment in the 1970's compared to the 1950's and 1960's is the increase in unemployment insurance payments which raised the reservation wage of those who received these payments and made them less willing to work." Carefully analyze the conclusion reached in this statement.
5. If the empirical evidence suggests that current consumption falls as interest rates rise, what happens to the slope of the IS curve? Does an increase in the money supply cause output to rise more or less than if consumption were not responsive to the interest rate?
6. If individuals stopped optimizing their money balances because of the high cost of "shoe-leather", what happens to the income and interest elasticities of the demand for money? Does this mean that the central bank can no longer control interest rates and aggregate demand?
7. Assume that the government passes legislation that forces everyone to retire at the age of 63 instead of 65 as was previously the case. (a) How will this influence consumption expenditures, investment expenditures and total output in an IS-LM model (i.e., prices are constant)? (b) How will this influence the supply of labour, equilibrium employment and the equilibrium real wage? (c) In a complete macromodel, what will be the effect on output, the inflation rate and the unemployment rate in the short run while nominal wage growth is fixed? (d) In the long run, what further adjustments will occur in the inflation rate and will the effect in (a) or (b) above dominate the determination of output?
8. In the short run, an exogenous increase in expected inflation can lead to rising actual inflation, but not in the long run. Explain this statement using a standard macromodel.
9. Dornbusch-Fischer-Sparks argue that the short-run aggregate-supply curve is relatively flat. Is this caused by slow wage adjustments or by relatively constant marginal product of labour?
10. The Minister of Finance has argued that a recession under current macroeconomic conditions would be useful. How would we judge the optimality of such an event?
11.(a) In a country plagued by high inflation how can wage indexation help the central bank bring about a permanent reduction in the inflation rate? (b) In a country plagued by high unemployment why does wage indexation hinder the government's attempt to restore full employment?
12. If the Bank of Canada has a target annual growth rate for M1 of 5%, what is the relative size of annual open-market operations if the currency/demand-deposit ratio is falling over time?
13. If the present government wanted to increase investment expenditures, should the Governor of the Bank of Canada announce expansionary monetary policy or should the Minister of Finance announce tighter fiscal policy?
14. If all workers who were paid every week are now paid once a year, it is unlikely that the demand for money would change very much. Why?
15. Consider the effect of an increase in government expenditures on income or output under the following circumstances. Indicate whether the change in government policy is beneficial or not and by what criteria. If the policy is not optimal, briefly outline a better alternative. (a) Only the goods and money markets are considered. (b) The change is unexpected in a situation where all three markets (goods, money and labour) are in equilibrium. (c) The labour market has 100% indexation and exhibits excess supply. (d) As in (b) above, but this is an open economy operating under flexible exchange rates.
16. With the aid of an indifference map show how Canadians will adjust their purchases of domestic and foreign goods if the exchange rate rises.
17. "Stagflation" is characterized by rising unemployment and inflation. Show that the source of stagflation is an unexpected decline labour's marginal product.
18. Show that a tax on labour income and a temporary increase in foreign inflation have the same effect on the real wage paid by firms and on the level of employment.
19. Is a fixed exchange-rate regime compatible with the credibility of announced target growth rates of the money supply?
20. Is it possible to keep the terms of trade constant if the domestic government increases its expenditures predictably?
21. In an open economy, show that predictable increases in the growth rate of the domestic money supply will have different effects on the exchange rate than positive domestic monetary shocks.
22. Starting from full equilibrium in 1990, the government implements a wage subsidy that pays firms 10% of the value of the hourly wage for all workers in order to reduce unemeployment by increasing the demand for workers. (a) Is this a useful counter-cyclical, stabilization-policy change? (b) Will this policy reduce the unemployment rate in the long run? (c) What does this move do to annual investment expenditures? (d) If this policy is implemented at the beginning of 1991, after labour-market contracts for the year have been signed, what is the effect on output, the inflation rate, and the interest rate during 1991? (e) What is the long-run effect on output, the inflation rate and real wages?
23. If the aim is to increase long-term growth of an economy by providing each worker with more capital, is it better to reduce government expenditures on goods and services or to cut the corporate tax rate?
24. If the current generation decides to leave larger bequests to future generations to help them pay for the government debt generated by current deficit spending, how would this affect aggregate-demand management by the government for stabilization-policy purposes?
25. An open economy operating under flexible exchange rate has an IS curve given by y = a0 - a1(i* + r - p ) - a5(t-1 + p - p* - r). What happens to r when the rest of the world decreases the growth rate of its money supply and the home country has fully adjusted to this change.
26. Canada's interest rate is 10% while Britain's is 13%. The price of the pound for current delivery is $2.00, while the price for future delivery is $2.20 (i.e., the pound is expected to rise in value). Which direction will capital flow, what is your prediction for the exchange rate and will this stimulate the demand for Canadian goods?
27. Assess the evaluation that controlling nominal interest rates in the face of a "noisy" LM curve does not necessarily stabilize the economy, since investment depends on the real interest rate, not the nominal rate.
28. With the end of the cold war, governments are planning to cut drastically their defence spending. (a) What happens to output, inflation and the real interest rate, if the cut in defence spending is announced in advance and believed by the public? (b) What happens to output, inflation and the real interest rate, if the cut in defence spending is not announced in advance? (c) Would the existence of complete wage indexation present any problems for the implementation of this policy? (d) What happens to the budget deficit under (a) above?
29. If the government were to introduce legislation that makes severance pay mandatory for layoffs, who would be in favour and who would be against this move.
30. If we observe that y > ye and that xs < 0 what would cause such a situation?
31. If firms discover that the disequilibrium costs of not having the appropriate capital stock decline, what happnes to investment expenditures and to output and inflation?
32. The Economist magazine has recently argued in favor of policies that reach the goal of zero inflation. Using the appropriate IS-LM-AS model, what are the implications of following such policies for output, the real and nominal interest rates and for the growth rate of the money supply in the following circumstances: (a) in the long run? (b) in the short run if the central bank announces in advance this goal? (c) in the short-run if the central bank does not announce this goal? (d) in an open economy with a fixed exchange rate?
33. In general, rational expectations would have to predict pi into the indefinite future when mu changes just once. Why is that the case? Why would this requirement to predict an infinite number of pi's not apply if a3 = 0?
34. Explain the negative slope of the AD curve in an open economy with fixed exchange rates and then with flexible exchange rates.
35. What automatic stabilizers would you put in place to remedy goods-market shocks in a closed economy? In an open economy?
36. A temporary pre-announced cut in income taxes may not affect output for two separate reasons. Explain each of them.
37. In the land of Og, workers have managed to get 110% wage indexation. Draw an initial equilibrium with this feature in an AS-AD diagram. Now subject the economy to a positive monetary shock and explain the effect on output and inflation. What is the optimal degree of indexation?
38. In a closed economy, "crowding out" means that expansionary fiscal policy will reduce investment expenditures. What does it mean in an open economy?
39. Show in a diagram a person who has some nonwage income and is indifferent between working H hours and not working at all. (a) Indicate the reservation wage. (b) If the government now taxes a part of all income, show the new budget line and indicate whether the person is more likely to supply H hours of work now. (c) Instead, show that this person will offer to work more hours if an overtime premium is paid (e.g. time-and-a-half for any hour above H).
40. Currently the Canadian economy is operating at an unemployment rate below the natural rate. (a) Is the current real wage higher or lower than the equilibrium real wage? (b) If nominal wages are fixed in the short run, what government policies could move the economy back to equlibrium? (c) If the government also wanted to stimulate investment, would you rule out one of the choices made in (b)?
41. The new governor of the Bank of Canada, J. Glittering Coin, has been promised a large bonus if he can achieve quickly a zero inflation rate exactly. Currently pi = 3% and this has been the case for many years. (a) Will he get his bonus if he announces and implements a reduction in the growth rate of the money supply to zero (i.e., mu = 0)? (b) Will he get his bonus if he surreptitiously lowers the growth rate of the money supply to zero? (c) Will he get his bonus if Canada has a fixed exchange rate? (d) If he also gets stinging criticism from macroeconomists for increasing unemployment, should he announce or not announce his new policy? (e) Is is possible that a one-time change in m will keep the inflation rate at zero for every period after that?
42. If the demand for labour is written as n = n-1 - b10(omega - pi - xs) and the supply of labour is written as n = n-1 + b12(omega - pi), show: (a) that omega = pi in equilibrium; (b) that omega > pi when there was excess demand in the last period; and (c) the optimal relationship between omega and pi in the face of a "supply" shock.
43. An automatic stabilizer involving fiscal policy would be a buffer stock of goods that the government would use to maintain constant aggregate demand in the face of shocks to the goods market. How would this work when xg < 0 if the government had information on inventories of all private businesses?
44. It is expected that the doubling of tuition fees at universities will increase employment and reduce the real wage. Explain how this would happen.
45. Show that a fixed exchange rate will insulate the domestic economy in the face of domestic monetary shocks but not in the face of foreign monetary shocks.
46. Show that a reduction in the terms of trade (t = p - p* - r) has adverse welfare effects for domestic residents, either as consumers or as workers.
47. If a large number of Canadians moved to the land of Og, what are the long-run effects on output, the inflation rate, and the nominal interest rate in Canada, assuming that there are no other international transactions.