PART II [50%] To be answered ONLY by students of Professor Indart s section (L0101) Answer ALL six questions

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1 PART II [50%] PART II To be answered ONLY by students of Professor Indart s section (L0101) Answer ALL six questions 1. (12 marks) Indicate whether you agree with the following statements. Draw the proper diagram(s) to help you explain your answer. Marks will be given for your explanation. a) (3 marks) John spends all his disposable income on tuna [x-axis product] and beef [yaxis product]. John has a negative income elasticity for tuna and it is known that his substitution effect for tuna is stronger than his income effect. Suppose that there is a decrease in the stock of tuna and the price of tuna increases. Statement: John will maximize his level of satisfaction or utility by purchasing more tuna and therefore his demand curve for tuna has a positive slope. b) (3 marks) A perfectly competitive industry is initially in both short-run and long-run equilibrium with n identical firms. Suppose that the most recent budget has reduced personal income tax rates. The product has a negative income elasticity. Statement: In the new short-run equilibrium, the industry price will fall and industry output will rise; each firm will produce a smaller output and make economic losses. c) (3 marks) A perfectly competitive industry is initially in both short-run and long-run equilibrium with n identical firms. Suppose that the most recent budget has reduced personal income tax rates. The product has a negative income elasticity. The industry has a constant cost long-run supply curve. Statement: In the new long-run equilibrium, the industry price will fall and the industry output will also fall; each firm will produce an unchanged output and some firms will leave the industry. d) (3 marks) A firm in the short-run production period generates the following information at its current level of output: the industry price is $15; the marginal revenue is $9; the average total cost is $18; the marginal cost is $9 and average fixed cost is $5. Statement: This firm is not in perfect competition and should shut down to minimize its economic losses. Page 1 of 18

2 2. (9 marks) The public s demand for water from Natural Springs is P = Q, where Q is the number of cases of water bottles and P is the price of a case of bottles. Only one firm currently has access to Natural Springs water, and can produce a case of bottles according to this formula: Total Cost = 100Q. a) (3 marks) Calculate the following values for the profit-maximizing equilibrium: price, quantity, profits, consumer surplus, and price elasticity of demand. Show all your work. b) (3 marks) Suppose that the government now intervenes in this market and imposes a price ceiling of $300 per case of bottles of Natural Springs water. Calculate the following values for the profit-maximizing equilibrium: price, quantity, profits, and consumer surplus. Show all your work. c) (3 marks) Let s go back to the initial situation depicted in part a) above, and suppose now that the government intervenes to permit a large number of firms to gain access to Natural Springs, each of which faces the same cost equation as shown above. No single firm can influence the market price. Now calculate the following equilibrium values for the Natural Springs water market: price, total industry quantity, and the profits of a typical firm. Show all your work. 3. (4 marks) Below are data from the national accounts of a country. Assume that all relevant items you need to answer the questions have been provided. Wages and Salaries 800 Capital Consumption Allowances 60 Personal Taxes 250 Undistributed Corporate Profits 80 Corporate Profits before Taxes 300 Corporate Profits Taxes 170 Imports 140 Exports 130 Rental Income 50 Personal Consumption Expenditure 920 Gross Investment Spending 200 Indirect Taxes minus Subsidies 40 Transfer Payments to Households 70 Interest Income 150 Net Unincorporated Business Income 50 Use the above data to compute the following: a) (1 mark) Gross Domestic Product (GDP) b) (1 mark) Government Spending on Goods & Services (G) c) (1 mark) Dividends Paid to Households (D) d) (1 mark) Personal Income (PI) Page 2 of 18

3 4. (8 marks) Consider an economy defined by the following equations: Consumption C = YD Taxes TA = Y Government Transfer Payments TR = 50 Investment I = 460 Government Expenditure G = 400 Exports X = 200 Imports Q = Y Full employment GDP Y fe = 2,800 a) (3 marks) What is the equilibrium level of GDP (Y)? What is the size of the recessionary or inflationary gap? Show all your work. b) (2 marks) What is the size of the government deficit or surplus? What is the value of the marginal propensity to spend? What is the value of the simple (Keynesian) expenditure multiplier? Show all your work. c) (3 marks) What will happen to the equilibrium level of national income if the government were to reduce lump-sum taxes (that is, those taxes that are independent of Y) by 50? What is the balance in the government budget now? Show all your work. 5. (9 marks) The Canadian economy is initially in short-run equilibrium at a level of GDP below full-employment (Y fe ). Suppose now that the demand for Canadian exports increases by $5 billion as a result of a strong expansion in the US economy. a) (3 marks) Using a fully-labelled AD-AS diagram, show the initial equilibrium (point E 1 ) and the new short-run equilibrium (point E 2 ) as a result of the increase in exports. Assume a positively-sloped AS curve. b) (3 marks) Suppose that the simple aggregate expenditure multiplier is equal to 2. Will equilibrium GDP change by $10 billion in the AS-AD model as shown in part a) above? Explain clearly with the help of the diagram. c) (3 marks) Redraw the initial AS-AD equilibrium (before exports increase) in a new fully-labelled diagram. Now consider the following shock to the economy: as a result of technological improvement, workers become more productive and earn larger incomes. Show the impact on the diagram. Will the price level rise or fall? Briefly explain why the price level might rise or fall. Page 3 of 18

4 6. (8 marks) Italy and France produce only two goods, wine and wool, using a single input, labour. An Italian worker in an eight-hour day can produce 100 bottles of wine or 100 bales of wool, while a French worker can produce 75 bottles of wine or 25 bales of wool in an eight-hour day. a) (2 marks) In the absence of trade, what is the opportunity cost in Italy and in France of one unit of wine? b) (2 marks) If trade is opened up between the two countries, in which product will each of the countries specialize? Explain your answer. c) (2 marks) Suppose that labour productivity in both wine and wool production in France doubles. How does this change your answer in b)? Explain. d) (2 marks) If mutually advantageous trade occurs between Italy and France, what will be the range of the international terms of trade between bales of wool and bottles of wine? Explain. Page 4 of 18

5 PART III To be answered by students from Professor Pesando s section (L0201) ANSWER ALL QUESTIONS. Question 1 (8 Marks) Consider an economy with fixed prices. All amounts are in $billions. The following relationships hold: C = YD T = 0.1 Y I = 25 G = 20 X = 15 M = 0.07 Y (a) (b) (c) Calculate the AE schedule. What is the equilibrium level of income? If income were less than the equilibrium level, would firms alter their levels of output? Why or why not? If the marginal tax rate were increased to 20 percent, what would happen to the value of the multiplier? Explain your answer. (There is no need to calculate the new value of the multiplier.) Question 2 (8 Marks) Banks have a target reserve ratio of 10% and hold no excess reserves. The public holds a fixed amount of cash. The Bank of Canada increases bank reserves by $10 billion (by purchasing securities in the open market). (a) (b) (c) (d) What is the total change in the bank deposits? In bank loans? What will happen to: i) the interest rate in Canada? ii) the foreign exchange value of the Canadian dollar? Using the AD-SRAS diagram, explain what happens to output (real GDP) and prices in the short run as a result of this change in monetary policy. Would your answer to part (b) differ if the Bank of Canada did not change reserves, but banks decided to lower their target reserve ratio? Explain. Page 5 of 18

6 Question 3 (10 Marks) The market for toothpaste is perfectly competitive and in a long-run equilibrium. Each firm is identical and has the usual U-shaped marginal cost curve. The demand curve is downward sloping. Toothpaste sells for $2. Due to a government campaign to promote better oral hygiene, people start brushing their teeth more often and hence the demand for toothpaste increases. (a) (b) (c) Show with the appropriate diagram what happens in the short run to market output, market price, and the output and profits of each firm. Will market price remain at the level in part (a) in the long run? Explain your answer. The government decides to provide a subsidy of $5,000 to each firm in order to increase the consumption of toothpaste. Will this subsidy increase output in the short run? In the long run? Explain your answer. Question 4 (12 Marks) Explain, briefly, whether the following statements are True, False or Uncertain? (ALL points are awarded for your explanation.) (a) Countries High (H) and Low (L) each produce two goods, beer and chocolate. If Country H has an absolute advantage in the production of both goods, Country H will also have a comparative advantage in the production of both goods. (b) In an economy with fixed prices, the government is running a budget deficit of $10 billion at the equilibrium level of national income. Taxes equal a fixed (lump sum) amount plus 20 percent of income. If the government increases lump sum taxes by the amount of the budget deficit (i.e., by $10 billion), the budget will be balanced. (c) (d) You have waited in line to buy tickets for a long time, but are not sure if you want to wait much longer. However, since leaving will result in your losing the time already spent ( you have already waited for so long ), you should not leave. If a town hires no police officers, the social cost of crime is $200,000 per year. If the town hires four police officers (at a salary of $50,000 per year), there will be no crime. Therefore, the town should hire four police officers. Page 6 of 18

7 Question 5 (6 Marks) (a) (b) The consumption of a good (alcohol) gives rise to a negative externality estimated to be $2 per bottle. The demand curve for alcohol is downward sloping. If the government introduces a tax on sellers to achieve the allocatively efficient outcome, will the market price increase by $2 per bottle? Explain. The expected inflation rate increases from 2 percent to 4 percent. By how much will the market interest rate change, if at all? Will borrowers benefit at the expense of lenders? Explain. (c) If disposable income is zero, savings are -10. If disposable income is 200, savings are 30. What is the marginal propensity to consume out of disposable income? Question 6 (6 Marks) The marginal cost of producing a bottle of mineral water is equal to $8. There are no fixed costs. The industry is perfectly competitive. The demand curve for mineral water is as follows: Price Quantity demanded (a) (b) (c) What is the equilibrium price and quantity? The government imposes a $2 sales tax to be paid by buyers. What is the new market price and quantity? What price do buyers pay? Illustrate with a diagram. After the government imposes the exercise tax, is the new outcome allocatively efficient? Why or why not? Page 7 of 18

8 PART IV To be answered by students from Professor Hare s section (L0301) Use a Separate Exam Booklet for Section A and Section B Section A [15 marks] Answer Question 1 1. Calhoun reads from Paul Krugman s book, Peddling Prosperity, in which Krugman states: Depression, runaway inflation and civil war can make a country poor. But only productivity growth can make it rich. Calhoun has also absorbed the key issues in the assigned readings by Richard Lipsey, Paul Krugman [Age of Diminished Expectations], William Easterly [on Robert Solow], William Baumol, Andrew Sharpe and William Lewis. From these readings Calhoun understands: a. the importance of technological change as a source of economic growth, primarily from the analysis of Robert Solow and the presentation of Richard Lipsey; b. in the long run, the only way a country can achieve higher standards of living is through labour productivity increases, from the analysis of Paul Krugman, William Baumol and William Lewis; c. per capita income gaps between countries are directly related to labour productivity differences between these countries from the analysis of William Lewis; Calhoun also knows that Canada has a widening per capita income gap with the United States and a widening labour productivity gap with the United States from the work of Andrew Sharpe and Roger Martin. Required: Write a report to Prime Minister Harper which includes an analysis of the following issues: a. the importance of technological change and the linkages between technological change, labour productivity and higher standards of living [GDP per capita] using the analysis of Lipsey, Solow, Krugman and William Lewis; b. why increases in labour productivity are the only way to increase a country s standard of living in the long run through the analysis of Paul Krugman; c. the relationships between standards of living in different countries and labour productivity differentials in these countries as presented by William Lewis; d. the economic significance of the twin gaps between Canada and the United States and the primary causes of the widening of these gaps in recent years. Page 8 of 18

9 Section B [35 marks] Answer FIVE out of SEVEN Questions [7 marks each] Indicate on the Outside of Your Exam Booklet Which Five Questions You Answered 2. Natasha spends all her disposable income on flying fish filets [x-axis product] and shark steaks [y-axis product]. It is known that Natasha has a negative income elasticity for flying fish filets but Natasha s substitution effect is larger than her income effect. The price of flying fish filets increases. As a result, Natasha s friend Alexander, suggests that when Natasha maximizes her level of consumer satisfaction after the price increase, Natasha would want to consume more flying fish filets than initially. Alexander therefore suggests that the income consumption curve for Natasha would be negatively sloped but Natasha s demand curve for flying fish filets would have a positive price elasticity of demand [formula calculation]. Position, consumer indifference curve diagram and explanation 3. Assume that the following conditions hold in an economy: Products: Factors: Factor intensity: Technology: computers and rickshaws capital [K] and labour [L] computers are capital intensive and rickshaws are labour intensive convex isoquants and constant returns to scale in both industries Positions X, Y and Z are all found in the Edgeworth-Bowley production box. Position X and Position Y are both on computer isoquant C 2000 and Position X and Position Z are both on rickshaw isoquant R Further, from Position Y and Position Z it is not possible to produce more computers without, at the same time, producing fewer rickshaws. Full factor employment occurs at all three positions. Clancy holds that production efficiency can be increased by movements either from Position X to Position Z or from Position Y to Position Z. In addition, Clancy contends that only at Position Y is there a production efficient allocation of factors in this economy. Position, Edgeworth-Bowley production box and explanation 4. A perfectly competitive agricultural industry is in short run equilibrium with n identical firms. Each firm is initially making economic losses but producing a positive output. The government introduces the offer-to-purchase agricultural support programme. The price floor is set at the level where each firm would just make normal profits and all transactions occur at the price floor. Dillon takes the position that the industry would produce a larger output and sell at a higher price; each firm would produce an unchanged output and make normal profits and the total government purchase expenditure would depend upon the price elasticities of demand and supply. Position, industry/firm set of short run diagrams and explanation Page 9 of 18

10 5. A perfectly competitive industry is in long run equilibrium with initially n identical firms. The industry has a constant cost long run supply curve. Energy prices fall such that the average variable cost curve for each potential firm would shift vertically downwards by exactly $2.00 per unit of output. As a result of this long run shock, Holly suggests that the industry s output would increase; the industry price would fall by exactly $2.00; each firm would produce a larger output and more firms would enter the industry. Position, industry/firm set of long run diagrams and explanation 6. Countries which are producing cumquats join to form a quantity setting cartel. Justin wants you to explain fully the issues in the following two parts [ Part a and Part b ] to this question: a. i. how is the cartel established; ii. are the cartel profits most likely to exceed the level of profits for each firm before the cartel was formed; iii. how is the individual production quota for each member determined; iv. why would a single member of the cartel wish to cheat? Position, cartel and cartel member set of diagrams and explanation b. After the cartel has been established, two cartel members [two countries] are considering their strategies of to cheat and to meet their quotas. The cartel members evaluate these options under the Prisoner s Dilemma game, whereby they can not communicate with each other. The payoffs have been determined as follows: if both countries meet their quotas they each earn $40 million; if one meets and the other cheats then the payoff for the cheating member is $55 million and $15 million for the country which meets and, finally, if both countries were to cheat, each country would receive revenue of $25 million. Fiona reviews these options and takes the position that under the rules of the Prisoner s Dilemma game, where no communications are allowed between the competitors, both countries would select the meet their quotas option. Position, profit matrix and explanation Page 10 of 18

11 7. Suppose that Canada experienced price stability with too high a level of unemployment. Sullivan suggests that the Bank of Canada should adopt an easy monetary policy. However, Oliver takes the position that monetary policy may have major weaknesses which would not enable it to reduce unemployment significantly. Finally, Oscar chirps up that discretionary fiscal policy, through increased government spending on social overhead capital projects, would be more successful than an easy monetary policy in quickly reducing unemployment. Required: First, through the assistance of the transmission mechanism model, show how monetary policy might work to reduce unemployment. Secondly, identify, with reasons, two different situations in which monetary policy might fail to significantly reduce unemployment. Thirdly, evaluate the alternative suggestion of Oscar. In your answer, use the three diagrams which demonstrates the transmission mechanism model. In addition, use the AD/SRAS model to demonstrate the fiscal policy option. Solid reasoning is required in your answer. 8. The behavioural equations for a hypothetical economy are set out below: C = 10,000 + adyd Id = 2,000 + by G = 3,000 + cy T = 1,000 Initially there are no transfer payment, exports and imports. In the preceding equations, ad represents the marginal propensity to consume out of Yd; b represents the marginal propensity to invest and c represents the marginal propensity for government spending. In this question, there is no requirement to solve for the equilibrium level of Y. However, an expression for the spending multiplier must be derived. Assume also that the country has price stability and too high a level of unemployment. Now, the government decides to increase taxes autonomously by 2,000 units and to spend the increased government revenue of 2,000 units in one of three ways: a. on domestically produced military uniforms; b. on imported military equipment; c. on transfer payments to low-income residents. Required: Develop expressions which represent the net impact on Y when the tax and the associated government incremental expenditure [equal to the tax] are jointly evaluated for each of the three government spending options. Three separate specific expressions are required. Show all your work. Page 11 of 18

12 PART V Section I To be answered by students in Professor Carr s section (L0401) Answer the following Questions, TRUE, FALSE, or UNCERTAIN. Give a brief explanation of your answer. Marks are given entirely for the explanation. (20 Marks) 1. The Canadian dollar has sharply increased over the last two years. As such, one should expect a sharp decrease in Canadian exports. 2. Inflation is running in the Canadian economy at about 2.2%. If inflation was significantly higher, then interest rates would be substantially lower. 3. Firm A produces shoes worth $100,000 and has a wage bill of $50,000 and Firm B also produces shoes worth $100,000, use the same capital equipment but has a wage bill of $70,000. Since wages are an important part of GDP and total wages are higher for Firm B than Firm A, Firm B will have a larger contribution to GDP. 4. In a simple model of income determination with a fixed price level, unemployed resources and no foreign sector and a system of induced taxation, it is observed that when income increases by $100 (due to an increase in autonomous investment), total taxes increase by $50 and consumption increases by $25. In this model when government expenditures increase by $100 (financed by a bond issue), consumption will also increase by $100. Section II (30 marks) 1. (15 Marks) Assume that the pubs industry in Toronto is perfectly competitive and currently in long run equilibrium. The output of this industry can be expressed in pints of beer sold. a) Illustrate, with appropriate diagrams, the situation of the industry as a whole and the situation of a representative pub. Will a representative pub be earning economic profits? Explain. b) Due to a permanent change in lifestyles, there is a large increase in the demand by individuals to drink in pubs. What will happen to the price and quantity of pints in the short-run? Will the price of pints remain at this level in the long run? Explain. c) One wealthy pub owner sees an opportunity to make money in the drinking business and buys all of the other pubs in Toronto. What will happen to the price and quantity of pints? Illustrate your answer with an appropriate diagram. Page 12 of 18

13 d) Will the level of pints sold in part (c) be allocatively efficient? Explain your answer. e) A new study finds that those who drink beer in pubs are far more likely to drink and drive and thus to have more car accidents than other members of society. In light of this study. Is the level of output in part (a) allocatively efficient? Explain your answers. 2. (8 Marks) The marginal cost and the average cost of producing a tonne of steel are both equal to $100. The steel industry is perfectly competitive. The demand curve for steel is as follows. Price Quantity a) What is the equilibrium price and quantity? b) Firms which produce steel pollute the environment. The estimated cost of this pollution is $30 per tonne. The government imposes a $20 sales tax on the suppliers of steel. What is the new equilibrium price and quantity? Illustrate with a diagram. c) After the government imposes the sales tax, is the resulting level of output too high, too low or the right amount based on the criterion of allocative efficiency? Explain. 3. (7 Marks) Canada has a comparative advantage in the production of computer software, while Mexico has a comparative advantage in the production of furniture. a) Explain what it means to say that Canada has a comparative advantage in the production of computer software. After trade barriers are removed, which good will Canada export? Which good will Canada import? b) A non-economist observes that wages in Mexico are considerably lower than wages in Canada, and concludes that there can be no gains from freer trade with Mexico. As an economist, how would you respond to this argument? Will Canada be able to export goods to Mexico? Explain. Page 13 of 18

14 PART VI To be answered by students from Professor Wolfson s section (L5101) Question 1 DO 2 QUESTIONS IN PART A AND 2 QUESTIONS IN PART B (Each question is worth 12.5 marks, for a total of 50 marks) PART A DO 2 OF 3 QUESTIONS Consider a worker, Jamie, who can freely vary the number of hours worked in a day. The wage rate (after tax) is $20 per hour. Leisure is a normal good for Jamie. Initially Jamie chooses to work 5 hours a day. 1.1 With a fully labelled diagram, use indifference theory to demonstrate Jamie s initial equilibrium position. 1.2 Jamie s father is concerned that she is spending too much time in idleness and persuades her to work harder. Jamie increases her workload to 7 hours per day. Now show on your diagram the new position when Jamie works 7 hours. State clearly what has changed to create the new equilibrium position, and why. 1.3 After Jamie has decided to work 7 hours per day, the government announces an increase in the rate of income tax. Demonstrate that Jamie could respond to a higher tax rate by working more than 7 hours or by working less than 7 hours. Use the Substitution Effect (SE) and the Income Effect (IE) to analyze the differences between these two outcomes. Ignore any further influence from her father, and focus only on the tax change. Use a separate diagram or diagrams for this part. (Do NOT add to the diagram from part 1.1 and 1.2). 1.4 Assume that Jamie decides to work more than 7 hours after the tax change. From the information in your answer to 1.3, draw Jamie s labour supply schedule. Question 2 (There are two different parts to question 2) 2.1 Indicate whether you agree or disagree with the following statement (in quotation marks) about trade. Provide a clear explanation of your answer. When we open up trade so foreigners can buy our wheat on the international market (i.e., we export wheat at a fixed price we cannot influence), some Canadians are better off, and others are worse off. Those who gain could compensate those who lose and still be better off. Use a demand-supply diagram in your answer. Page 14 of 18

15 2.2 The Mad Hatter is the sole supplier of exclusive souvenir hats at baseball games. Its Fixed Costs are zero and its Average Cost is a constant $4 per unit. The demand schedule at a typical baseball game is P = Q a) Calculate these equilibrium values: price, quantity, profits, consumers surplus, and price elasticity of demand (at the equilibrium price). b) In a fully labelled, free-hand diagram, show the equilibrium for part a). In each case, be sure that the values for price, quantity, profits, and consumers surplus are shown clearly. (You need NOT show price elasticity of demand). c) Suppose the baseball team decides to charge the Mad Hatter a fee of $1250 for the right to sell hats at its games. Mad agrees to pay this amount. As a result, what happens to the values of price, quantity, profits, consumers surplus, and price elasticity of demand? Question 3 Zippers are produced by a perfectly competitive, constant cost industry. The industry is initially in long run equilibrium. Each firm has the traditional U-shaped cost curves. In your answers below, show only short run cost curves for the representative firm. 3.1 In two fully labelled and interrelated diagrams (firm, industry), show the initial equilibrium, using subscripts P 1, Q 1, n 1 etc. What are the profits of each firm? 3.2 Quickly redraw the initial equilibrium. Suppose that an increase in one input price has caused variable costs to rise by $5 per unit of output. Show the impact on the firm and the industry in the short run only, using subscripts P 2, Q 2, etc. Show clearly whether the price changes by $5 or by more / less than $5. Show each firm s profit position clearly. State whether the number of firms rises / falls / stays the same in the short run. 3.3 Now carry on the analysis from 3.2 into the long run. Using a third set of interrelated diagrams, show the new long run equilibrium, with labels P 3, Q 3 etc. Show clearly whether the price changes by $5 or by more / less than $5 (when compared to the original P 1 ). What are the profits of each firm? State whether the number of firms rises / falls / stays the same, compared to the short run. Page 15 of 18

16 PART B DO 2 OF 3 QUESTIONS Question 4 The macro economy of Utopia can be described through the following equations: Consumption C = Y d Investment I = Y Exports X = 30 Personal Taxes T = 12 Gov t Spending G = 15 Imports M = Y Disposable Income Y d = Y T Full Employment Y F = Use the constant price, simple model to answer the following: a) What is the equation for Aggregate Expenditure (AE) in reduced form? b) What is the value of equilibrium GDP? c) What is the value of the tax multiplier? d) By how much must taxes be changed to reach the full employment equilibrium? e) Draw a free-hand diagram, fully labelled, to show the initial AE and equilibrium GDP and the new AE and equilibrium GDP after taxes have been altered. Show also the GDP Gap and the Deflationary Gap and their values. f) At the new equilibrium, what is the government s budget position? (Provide a value). 4.2 Let s add a monetary sector to the model. Assume no change in the money supply. a) What is a negative budget position for a government called (i.e., what term do economists apply to this situation)? Does the Government of Utopia have a budget position that is negative at Y F (see information in 4.1 above)? Further, state how a negative budget position can be financed by the government, if the money supply remains constant. b) What impact does an increase in a negative budget position have on the rate of interest (i.e., the budget position becomes an even larger negative number)? Use a single diagram in your explanation. Page 16 of 18

17 Question 5 (There are 2 different parts to question 5) 5.1 Below are data (in dollars) from the national accounts for the country of Oz. Assume that all relevant items you need to answer the questions have been provided. Wages and salaries 750 Capital Consumption Allowances 60 Personal Taxes 250 Undistributed Corporate Profits 80 Corporate Profits before Taxes 300 Corporate Profits Taxes 170 Imports 160 Exports 150 Rent 75 Personal Consumption Expenditure 870 Gross Investment Spending 250 Indirect Taxes minus Subsidies 40 Transfer Payments to Households 70 Interest Earned 125 Net Unincorporated Business Income 100 Use the above data to compute the following: a) Gross Domestic Product (GDP) b) Government Spending on Goods & Services (G) c) Personal Income (PI) d) Personal Disposable Income (PDI) e) Balance of Trade (BT) f) Net Investment (NI) g) Gross Domestic Expenditure (GDE) 5.2 The banking system in the country of Oz has a desired reserve ratio of 6%. Banks initially have reserves exactly equal to that required by the reserve ratio and act always to maintain that position. Individuals and firms carry out money transactions through demand deposits at banks (i.e., there is no currency drain). There are always willing borrowers to take up loans banks might offer. The national currency is the dollar. a) For each of the events below, taken separately, calculate the final change in the money supply. (You do NOT have to show balance sheets; just provide a value.) Event 1 Event 2 The central bank of Oz (The Bank of Oz) swaps $24M of the government s deposits from the Bank of Oz to the leading (private) banks in Oz. The central bank of Oz sells $60M (domestic value) of foreign exchange in order to stabilize the value of the dollar on the foreign exchange market. The buyers are business firms operating in Oz. b) Using balance sheets (T-accounts), indicate whether you agree with the following statement: A balanced budget expenditure by the government of $6M will cause an increase in the money supply of at least $100M. Page 17 of 18

18 Question The economy of Alexandria is faltering. Its central bank responds by increasing the money supply. The economy of Alexandria has no inflation, so you can assume a constant price model. Its currency is the dollar. a) State two ways in which the central bank can increase the money supply (identify each one clearly, but you need not describe them in any detail or use balance sheets). b) In a set of clearly labelled, interrelated diagrams, show the impact of an increase in the money supply on the rate of interest and equilibrium GDP. c) How does the interest elasticity of the investment demand schedule impact on your answer to b) above? Use a single diagram in your answer. 6.2 A different country, Lynnfield, does not operate under the constant price model. It has a positively-sloped Aggregate Supply (AS) schedule and negatively-sloped Aggregate Demand (AD) schedule. This economy is faltering too. But decisionmakers in Lynnfield select a different policy intervention to stimulate the economy - they choose an increase in government spending. a) In an AD-AS diagram, show the initial equilibrium and then the impact of increasing government spending. b) Is there a difference in the government spending multiplier in this situation vs. the multiplier in the simple Keynesian model with constant prices? Use the diagram from part 6.2a) to help explain your answer. REMINDERS: Be sure that your name and student number are on the front cover of every answer booklet. Indicate on the front cover that you are in the Wolfson Section. Please indicate on the front cover of the outside booklet the questions you have answered. Be sure you have your name and student number on the Scantron sheet, and all MC answers are on the Scantron sheet. Page 18 of 18