Intermediate Economics II: Macroeconomics

ECON 512
Final Exam
Spring 2020
Name:___________________________
Purdue ID:________________________
Instructions
i. You have three hours to take this final exam between 5/6/2020 12:00 PM ET and 5/9/2020
11:59 PM ET. Please make sure that you complete the exam, scan your answers in order and
submit a single pdf file using the Blackboard interface before the end of the three-hour
window.

ii. This final exam is an open notes exam, but it is a NON-COLLABORATIVE ACTIVITY.
You may not discuss it in any way with anyone until the exam period is over. (May 9th at
11:59 pm ET).

iii. Students can use their own notes and a calculator during the exam, but are not permitted to
use other classmates for assistance or the internet. Any evidence of cheating will result in a
score of zero and the possibility of failure in the course.

iv. There are 6 problems that are worth 100 points. Allocate your time wisely.

v. Write neatly and show how you arrived at every single answer on the exam. You will receive
ZERO credit for any illegible answer or an answer where you don’t show your work.

vi. The three hours will start running automatically when you click on “begin” exam. The timer
will keep running even if you log out of blackboard. Just log back in to submit your exam.

vii. By clicking on “Begin” you agree with the following Purdue Honors Pledge: “As a
Boilermaker pursuing academic excellence, I pledge to be honest and true in all that I do.
Accountable together – We are Purdue”
1. (10 pts) In the United States, the labor force is fixed at 164 million. In March 2020 the
unemployment rate was 4.4%. In April, 18% of the workers who were employed at the
beginning of the month lost their jobs, and 3% of the workers who were unemployed at the
beginning of the month found new jobs.

a. (5 pts) For the rates of job loss and job finding given, what will the unemployment rate
be in April, 2020? What are the average durations of employment and unemployment?

b. (5 pts) In May 2020, the relaxation of lock-downs and social distancing rules to mitigate
the Novel Coronavirus Pandemic lowers the job loss rate to 5% of those employed and
increases the job finding rate to 15%. Find the unemployment rate for May. What is the
natural rate of unemployment? What is the cyclical unemployment?

2. (25 pts) Consider the following economy:

Consumption: C = 388+ 0.40 (Y − T) − 600r

Investment: I = 352 − 400r
Real money demand: L = 1750+0.75Y − 8750i
Full-employment output: Y = 1,400
Expected inflation: πe = 0.02
Taxes: T=300
Government Purchases: G = 280
Money Supply: M =12,600.
a. (5 pts) Using the goods market equilibrium condition, determine the equation for the IS curve
that gives the market clearing output, Y given the real interest rate, r.

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 b. (5 pts) Using the equilibrium condition for the money market, determine the equation for the LM
curve that gives the money market clearing output, Y, given the price level, P, and the real interest
rate, r.

c. (5 pts) Use the IS-LM model to determine the equilibrium value of the real interest rate,
consumption, investment, real money demand and prices at the full-employment level.

d. (10 pts) Starting from the equilibrium values you found in part c. Show in the graphs below
the effects of a permanent increase in government expenditure G in the classical IS-LM model
without misperceptions. The increase in government expenditure is financed by a permanent
increase in lump-sum taxes on consumers. Assume that consumer respond by reducing their
consumption each period by the full amount of the tax increase. Explicitly describe the effects
on r, w, P, Y, N, C and I.

Labor Market r Goods Market

Real wage=w

r I
,
S
r P

I,S
Effects
N IS-LM
r
Real Interest Rate: I
S
Real Wages:
-
Price: L
M
Output:

Employment:

Consumption:

Investment
Y
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3. (25 pts) For this problem you will use the same setup as in question 2 and begin at the full-
employment equilibrium that you found in part 2.c. Now consider a Keynesian IS-LM model and
suppose that the government wants to increase its government purchases to G=350 and at the
same time achieve a long run equilibrium with investment I=320 and a price level of P=$6, while
keeping the full employment level of output constant Y=1,400 and expected inflation: πe = 0.02.

a. (3 pts) Find the value of r that leads to a level of Investment I=320.

b. (4 pts) Find the value of consumption in the long run when I=320 and G=350. What value of
taxes will lead to this level of consumption?

c. (3 pts) Find the value of the nominal money supply, M, that leads to a price level of P=$6 in the
long run equilibrium.

d. (5 pts) Describe the Open Market Operation the Fed has to put in place to move from the initial
nominal money supply in problem 2 to the nominal money supply rate in part 3.c. Graphically
show the effect of this open market operation on the Federal Funds Market and the Bonds
Market.

Federal Funds Market Bonds Market

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 e. (10 pts) Identify the long-run effect of this combination of fiscal and monetary policy in the
goods market, the money market, and the Keynesian the IS-LM model.

Goods Market IS-LM

r r

I I
, ,
S S

P P

Y
I, S

r Money Market N
Effective Labor Demand

M/P Y

4. (20 pts) Consider an economy where the following statistics describe the money market. The reserve
deposit ratio is res=0.2, the currency-deposit ratio is cu=0.4, the price level is fixed at 1.0, and the
monetary base is 60. The real quantity of money demanded is: L(Y, i) = 0.5Y − 10i.
Where Y is real output and i is the nominal interest rate. Assume that the expected inflation rate is zero so that
the nominal interest rate and the real interest rate are equal.

a. (5 pts) If r=0.10, calculate the money multiplier, the money supply, the deposits, the currency,
and the reserves? For what value of real output, Y, does a real interest rate of r=0.10 clear the
money market?
Money Multiplier:______________ Money Supply:_____________ Deposits:_______________
Currency:_____________ Reserves:_________________ Output:______________
Show your work below:

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b. (5 pts) Now assume that r=0.05. calculate the money multiplier, the money supply, the
deposits, the currency, and the reserves? For what value of real output, Y, does a real interest
rate of r=0.05 clear the money market?
Money Multiplier:______________ Money Supply:_____________ Deposits:_____________
Currency:_____________ __ Reserves:_______________ Output:______________
Show your work below:

c. (5 pts) Now assume that when the real interest rate increases, banks have an incentive to lend a
greater portion of their deposits, which reduces the reserve-deposit ratio. In particular, suppose
that: res = 0.4 − 2r.
Calculate the money multiplier, the money supply and the level of output that clears the money
market when r=0.10 and r=0.05.
• r=0.10
Money Multiplier: ______________ Money Supply:____________ Output:_________________
Show your work below:

• r=0.05
Money Multiplier: ______________ Money Supply:____________ Output:_________________
Show your work below:

d. (5 pts) Based on your answer above, is the LM curve flatter or steeper when the reserve-deposit
ratio depends on the real interest rate than when is fixed? Explain your answers in economic
terms. You can use graphs if desired.

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5. (10 pts) Taxes and Incentives: Suppose that the federal income tax for single filers is set up as
follows:
Income Bracket Tax Rate
$1-$8,000 10%
$8.001-$30,000 12%
$30,001 & up 22%

a. (3 pts) Calculate the total taxes paid, the average tax rate, and marginal tax rate for the average
graduate student making $33,000.

b. (3 pts ) Suppose that there is a tax reform and the new federal income tax on individuals is set up as
follows:
Income Bracket Tax Rate
$1-$10,000 10%
$10.001-$35,000 12%
$35,001 & up 22%

Calculate the total taxes paid, the average tax rate, and marginal tax rate for the average graduate student
making $33,000.

c. (4 pts) How will the tax law change in Part (b) affect the labor supply of the person making $33,000?
Be sure to explain the potential income and substitution effects.

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6. (10 pts) The United States has an overall government budget deficit of $1,005 billion, a nominal GDP
of $21,000 billion, and total government debt equal to $16,590 billion.

a. (5 pts) Assume the nominal GDP grows at an annual rate of 1%. Find the change in the debt to GDP
ratio of the country, the new debt to GDP ratio and the overall budget deficit or surplus that the
government can run without changing the debt to GDP ratio.

b. (3 pts) Now assume that because the novel coronavirus pandemic, the nominal GDP actually
contracts at an annual rate of -4.7%. Find the change in the debt to GDP ratio of the country, the
new debt to GDP ratio and the overall budget deficit or surplus that the government can run without
changing the debt to GDP ratio.