HE1002

QUESTION 1: MULTIPLE CHOICES (5 3 marks = 15 marks)

Question
1.1
1.2
1.3
1.4
1.5
Answer
Hint: There are MORE THAN ONE options correct for each question. Choose all of them.
1.1. In Lecture 4 we have derived that the tax multiplier is MPC/MPS. However, the actual size
of the tax multiplier in reality is much smaller than this in absolute value. Which of the following
facts are valid explanations to the difference?
A. Lecture 4 assumes a lump-sum tax but the tax payments in reality increase in income.
B. Lecture 4 assumes planned investment does not change with interest rate but in reality it may
decrease with an increase in interest rate, which is known as the crowding-out effect.
C. Lecture 4 assumes a balanced budget but in reality the government often runs a budget deficit.
D. Lecture 4 assumes a closed economy but in reality some domestic spending leaks into foreign
markets through imports.
(Note: The actual exam questions are slightly easier than this one.)
1.2. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX?
A. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
B. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
C. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
D. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

1.3. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX?
A. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
B. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
C. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
D. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

Note: Question No. 1 continues on page 3.

1.4. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
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XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX?
A. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
B. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
C. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
D. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

1.5. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX?
A. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
B. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
C. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
D. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
For students draft only. Contents below this line are NOT marked.

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QUESTION 2: FILL IN THE BLANK (5 3 marks = 15 marks)
2.1. Assume there is no leakage of money out of the banking system. According to Table 1, if the
required reserve ratio is decreased from 10% to 5% by the Fed, the loans of the commercial
banks will become $__________billion in the economy.
Table 1 The Balance Sheets for the Fed and Commercial Banks (billion)
Federal Reserve
Commercial Banks
Assets
Liabilities
Assets
Liabilities
Government
$250
$50
Reserves
Reserves
$50
$500
Deposits
securities
$200
Currency
Loans
$450

(Note: The actual exam questions are slightly more difficult than this one.)

2.2. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
.

2.3. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX.

2.4. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX.

2.5. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX.
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QUESTION 3: DIAGRAM (4 5 marks = 20 marks)

3.1
.

3.3
.

An increase in government expenditure 3.2

with the Fed changing money supply by .
enough to keep the interest rates
constant so that there is a large increase
in aggregate output. Illustrate this
situation using an IS-LM diagram.
(Note: The actual exam questions are of
the similar difficulty as this one.)

XXXXXXXXXXXXXXXXXXXXXXX

XXXXXXXXXXXXXXXXXXXXXX

XXXXXXXXXXXXXXXXXXXXXXX

XXXXXXXXXXXXXXXXXXXXXX

3.4
.

XXXXXXXXXXXXXXXXXXXXXX.

XXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXX.

XXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXX

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QUESTION 4: COMPREHENSIVE QUANTITATIVE QUESTION (22 marks)

(Note: The actual exam questions are of the similar difficulty as this one.)

Figure 1 Equilibrium Aggregate Output (income)

Assumption 1: There is no tax and assume the economy has fixed exchange rate. Both
consumption and import are increasing function of aggregate income. That is C = a + MPCY
and IM = f + MPM Y, where a and f are positive constants.
Assumption 2: For every 1% increase (decrease) in the interest rate, planned investment I
decreases (increases) by $0.2 billion.
Assumption 3: For every $1 billion increase (decrease) in government spending G, the interest
rate increases (decreases) by 1%.
Refer to Figure 1 and Assumptions 1-3 to answer the questions (4.1)-(4.4).
4.1.

What is the definition of equilibrium in the goods market? Using this definition, derive
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MPC and MPM mathematically according to Figure 1 and Assumption 1.

(8 marks)

Note: Question No. 4 continues on page 7.

4.2.

Holding money supply constant, according to Assumptions 2 and 3, when government

spending increases by $3 billion, what happens to the interest rate and planned
investment?
(2 marks)

4.3.

Taking this crowding-out effect into consideration, if government spending increases by $3

billion, how much will be the new equilibrium aggregate output if this is a closed
economy? And how much will it be if this is an open economy?
(8 marks)

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4.4.

Why does the same increase in government spending have a larger effect on equilibrium
output in a closed economy than in an open economy? Explain intuitively.
(4 marks)

QUESTION 5: COMPREHENSIVE QUALITATIVE QUESTION (28 marks)

(Note: The actual exam questions are much easier than this one.)

Figure 2

5.1
.

Suppose in year 2035 the President of Republic of Jubilee, a hypothetic economy,

announced a major personal income tax cut, in order to gain more popularity among the
citizens. Meanwhile, the central bank of Jubilee has been steadily increasing money
supply. The three graphs in Figure 2 represent in a simplified way the predictions of the
four popular macroeconomic theories about the likely effects of a major tax cut or an
expansionary monetary policy. Match each of the following theories with a graph and
explain the logic behind briefly.
(16 marks)
Keynesian economics corresponds to the Supply-side economics corresponds to
graph number _______and the logic behind is graph number _______and the logic behind is
as follows:
as follows:

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Note: Question No. 5 continues on page 9

New classical economics corresponds to Strict monetarism corresponds to the graph

the graph number _______and the logic number _______and the logic behind is as
behind is as follows:
follows:

5.2
.

A well-known economist told the President that, The problem with supply-side economics
is that when you cut taxes, they have both supply and demand side effects and you cannot
separate the effects. Thus even if a tax-cut leads to an increase in aggregate output, we
dont know exactly whether it is Keynesians or supply-siders that are correct. Explain his
statement. Suppose you were hired by the Present to report the effectiveness of a major
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personal income tax cut. What specific evidences would you look for to see whether it is
the mechanisms under Keynesians or under supply-siders that are working?
(4
marks)

5.3
.

5.4.

Note: Question No. 5 continues on page 10

Suppose the stock of money, price level and real GDP of Jubilee in year 2035 and 2040 are
provided as in Table 2. What is your comment on the quantity theory of money based on
the experience of Jubilee?
(4 marks)
Table 2 Data for Republic of Jubilee
year
stock of money
price level
real GDP
2035
$ 600 billion
2.0
$ 1200 billion
2040
$ 800 billion
2.2
$ 1500 billion

Suppose as a by-product of your research, you find the natural rate of unemployment has
been decreasing over the years for Jubilee. What is the definition of the natural rate of
unemployment? List three possible reasons and explain very briefly why they may lead
to a lower natural rate of unemployment.
(4 marks)

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~END OF PAPER~

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