Student Name

VERSION B
Student ID

ECO3152: MACROECONOMIC THEORY III

MIDTERM EXAM

PROFESSOR: Lilia Karnizova

15 February 2024
8:30 – 9:45 am (75 minutes)

1. There are two versions of the exam. Your responses must match the questions in your version.
2. This exam contains eight questions. All questions are compulsory.
3. You must answer all questions and demonstrate all your work in the examination booklet. You
cannot bring and use any scrap paper.
4. You can answer exam questions in any order as long as the corresponding question number is
indicated in the booklet.
5. There are no numerical computations. Consequently, calculators are not allowed.
6. This is a closed-book exam. You cannot use books, notes, mathematical tables or other study aids.
7. You must submit the examination questions along with the examination booklets.
8. Budget your time wisely!

Q1 Q2 Q3 Q4 Q5 Q6 Total Total
(%)
Student’s
grade
Maximum 10 10 10 10 10 30 80 100
possible

GOOD LUCK!!!

1
Question 1 (10 points) Macroeconomic models and microeconomic principles
Which microeconomic principles (foundations) do we use in ECO 3152? Explain why a
macroeconomic model should be built from microeconomic principles.

Question 2 (10 points) Comovements in the Canadian data

Give an example of a Canadian economic variable that is procyclical and coincident. Is your variable
more or less volatile relative to real GDP? Draw a stylized figure with time series representing the
business cycle components of the variable of your choice and real GDP. Carefully label your series.

Explain how to detect the comovement patterns in your graph.

Question 3 (10 points): Ricardian equivalence

Is the following statement true, false or uncertain?
“If government spending remains constant and Ricardian equivalence holds, an
increase in the government budget deficit is always matched by an increase in private
savings.”
Explain your reasoning in detail. Illustrate the impact of this policy in two graphs representing the
consumer’s optimal choice and the credit market. Your grade will depend on the strength of the
economic arguments.

Question 4 (10 points): Asymmetric information model

Is the following statement true, false or uncertain?
“In a model with asymmetric information, the spread between the borrowing and saving
interest rates increases and consumption declines if there are fewer bad borrowers in the
population.”

Explain your reasoning in detail and provide a graphical illustration of the consumer’s optimal
choice. Your grade will depend on the strength of the economic arguments.

Question 5 (10 points): Social security system

Is the following statement true, false or uncertain?
“If the number of old households exceeds the number of young households, all generations
benefit from an introduction of a pay-as-you-go social security system.”

Explain your reasoning in detail and provide a graphical illustration of your response. Your grade
will depend on the strength of the economic arguments.

2
Question 6 (30 points): Consumption-savings model
Consider a two-period consumption-saving model from Chapter 9. The consumer receives
exogenous income in the current and future periods, y and y’, and pays lump-sum taxes t and t’.
Assume that the credit market is perfect: the consumer can borrow and lend at the real interest rate
r. Let c and c’ denote consumption in the current and future periods, and s represent savings. Finally,
we is equal to the present value of the life-time wealth.
Answer all parts of this question based on the following consumer utility function
4 4
𝑈(𝑐, 𝑐 ′ ) = √𝑐 + 𝑏 √𝑐 ′ ,
where b>0 and the notation ∜x ≡ x0.25
a) (5 points) What is the consumer’s objective? Which variables are endogenous from the
perspective of the consumer? Which variables are exogenous?
b) (5 points) Write down and interpret the intertemporal budget constraint.
c) (5 points) Use the method of Lagrange to derive two conditions define the optimal choice of
consumption c and c’. What is the economic meaning of these conditions (equations)?
d) (5 points) Find the optimal values of c and c’* in terms of the parameter b, and the exogenous
variables of the model.
e) (5 points) What is the optimal value of saving s*? When does consumer borrow? When does
the consumer save?
f) (5 points) Consumer surveys reveal that lottery winners use their money to buy new cars and
homes, travel, give gifts to family and friends, In addition, they pay their debts and investment
for future and children. Analyze if the consumption-savings model can explain the behavior of
lottery winners. Provide a graphical illustration of your response using a figure with c on the
horizontal axis and c’ on the vertical axis. Make sure to show the endowment point, identify the
optimal consumer’s choice, and define the intercepts with the horizontal and vertical axes.

END OF THE EXAM