econ

The University of New Haven Department of Economics

EC 133/Macroeconomics/Rodriguez/ Exam III Questions

Exam III date: Monday, December 16, 2013: 2-4 p.m.

Please answer each question with a succinct essay.

1. Suppose the Federal Reserve’s Open Market Committee decides to purchase bonds on the

market. What is the anticipated impact on the money supply? Show your work by illustrating

the process of money creation/destruction by providing the ‘T-accounts’ of two hypothetical

banks. In this economy, the required reserve ratio is 10 percent.

2. Economist George Ayittey, in an interview on PBS about economic development in Africa, states

that of the 54 African countries, only 8 have a free press. For Africa’s economic development,

Ayittey argues strongly for the establishment of a free press. Why would a free press be vital for

the enhancement of property rights and the rule of law? How could a free press help reduce

corruption?

3. Explain what is moral hazard? Explain the Federal Reserve’s mandate to be the ‘lender of last

resort.’ Explain how the Fed, in acting as a lender of last resort, constitutes an instance of

institutionalized moral hazard.

4. What is the fiscal (spending) multiplier? How does direct government spending propagate

throughout the economy? What is the fiscal multiplier if the marginal propensity to consumer

is 0.90? Explain why (at least two reasons) anyone would oppose the arguments underscoring

direct government spending.

5. What is the most important factor in explaining increases in real GDP per capita in the long run?

6. Explain the arguments for and against active stabilization policy.

7. According to an article in the Economist in May 2009 :

German domestic consumption is holding up, and [small and medium-sized firms]

serving the home market are doing relatively well. Exporting firms, by contrast, are in

acute pain. Machine-tool manufacturers expect sales to slump by 60%, for example.

Why would German exporting firms be having a particularly difficult time in 2009? What

problems would this decline in exports pose for the German economy?

8. Explain the role of the debt ratings agencies in the financial system. Explain how the ratings

process works? Is it different from the equity ratings services? Is moral hazard an issue in the

debt ratings “game”?

9. Dambisa Moyo argued in her talk that much of the developing would prefer economic gains to

political freedom. Is this a false dichotomy? Why does Ms. Moyo hold China’s recent economic

history as a development model for the third world?

10. In class, I have characterized the process of monetary policy as one where three agents – banks,

consumers, and firms (the private sector) are involved in a social dilemma. A classic aphorism is

“using monetary policy to solve unemployment is like pushing on a string.” Both arguments

speak to the sterility of monetary policy in resolving the present economic malaise. Explain the

argument and explain why many think monetary policy is of no meaningful use.

11. Shift the (long-run) Aggregate Supply Curve arise from changes in four different sources (or

factors)? State them and explain them.

12. The following excerpt is from an article from the Reuters news agency (May 11, 2009).

The White House on Monday raised its forecast for this year’s U.S. budget deficit by $89

billion due to the recession, millions of new unemployment claims and corporate

bailouts. The new estimate predicted a deficit of $1.84 trillion, or 12.9 percent of gross

domestic product, for the fiscal year ending September 30. It updated the White

House’s February forecast of a $1.75 trillion deficit, or 12.3 percent of GDP.

Assuming that other factors that affect the demand and supply of loanable funds remain the

same, what would the effect of a larger budget deficit on the equilibrium real interest rate and

the equilibrium quantity of loanable funds? What would the effect be on the equilibrium

quantity of saving and investment ? Illustrate your answer using a graph showing the market for

loanable funds.

13. International data show a positive correlation between a positive correlation between political

stability and economic growth.

a. Through what mechanism could political stability lead to strong economic growth?

b. Through what mechanism could strong economic growth lead to political stability.

14. An article in the Wall Street Journal refers to FedEx as an “economic bellwether.”

a. What is an “economic bellwether”?

b. Briefly compare how sensitive FedEx’s sales are likely to be to changes in the business

cycle to how sensitive the following firm’s sales are likely to be to changes in the

business cycle. Put differently, explain whether FedEx’s sales are likely to fluctuate

more or less than the sales of each of these other firms as the economy moves from

recession to expansion and back to recession.

i. Ford Motor Company

ii. McDonald’s

iii. Toll Brothers (home builders)

iv. Paramount Pictures (movies)

15. Some believe there is a short-run Aggregate Supply Curve. The short-run AS curve is upward

sloping whereas the long-run AS curve is not. There are three reasons offered to support the

existence of the short-run AS curve: (i) sticky-wages, (ii) sticky-prices, and (iii) misperceptions

theory.

16. What are Fanny Mae and Freddie Mac? What role did they play in the financial collapse?

17. What impact would an increase in bank reserve requirements have on the money supply? What

about a decrease in the Federal Reserve’s discount rate. Explain how each would work by

illustrating with a bank T-account.

18. Many individuals frown upon a generalized inflation because they feel it eats the value of their

moolah. But there is an inconsistency in this argument: a generalized inflation, by definition,

affects both the prices of what they buy and the wages which they earn. Still there are real

costs of inflation. Describe three `costs’ in detail.

19. Imagine you own a business and that during the next recession you lay off 20 percent of your

workforce. When economic activity picks up and your sales being to increase, why might you

not immediately start rehiring workers?

20. For each of the following events, explain the short-run and long-run effect on output and the

price level, assuming policymakers take no action.

a. The stock market declines sharply, reducing consumers’ wealth.

b. The federal government increases spending on national defense.

c. A technological improvement raises productivity.

d. A recession overseas causes foreigners to buy fewer U.S. goods.

21. In 1939 President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual.

What was the context for this? Using the AS-AD model explain what President Roosevelt might

have been trying to achieve. Did it work?

22. From 1950 to 2000, manufacturing employment as a percentage of total employment in the U.S

economy fell from 29 percent to 13 percent. At the same time, manufacturing output

experienced slightly more rapid growth than the overall economy.

a. What do these facts say about growth in labor productivity (defines as output per

worker) in manufacturing?

b. In your opinion, should policymakers be concerned about the decline in the share of

manufacturing employment? Explain.

23. Hard-up State Bank (HSB) holds $250 million in deposits and maintains a reserve ratio of 10

percent.

a. Show a T-account for HSB.

b. Now suppose that HSB’s largest depositor withdraws $10 million in cash from her

account. If HSB decides to restore its reserve ratio by reducing the amount of loans

outstanding, show its new T-account.

c. Explain what effect HSB’s action will have on other banks.