Student Name

DEFERRED
Student ID

ECO3152: MACROECONOMIC THEORY III

DEFERRED MIDTERM EXAM

PROFESSOR: Lilia Karnizova

27 February 2024
10:00 – 11:15 am (75 minutes)

1. This exam contains six questions. All questions are compulsory.

2. You must answer all questions and demonstrate all your work in the examination booklet. You
cannot bring and use any scrap paper.
3. You can answer exam questions in any order as long as the corresponding question number is
indicated in the booklet.
4. There are no numerical computations. Consequently, calculators are not allowed.
5. This is a closed-book exam. You cannot use books, notes, mathematical tables or other study aids.
6. You must submit the examination questions along with the examination booklets.
7. 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) Comovements in the Canadian data
Describe the key business cycle regularities in investment expenditures in Canada. How can we
discern these business cycle regularities in a time series plot? Explain and provide a graphical
illustration.

Question 2 (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 3 (10 points): Ricardian equivalence

Is the following statement true, false or uncertain?
“If government spending remains constant and Ricardian equivalence holds, a tax
reduction in the current period makes consumers better off.”
Explain your reasoning in detail. Illustrate the impact of this policy graphically. 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, a default premium declines and consumption
increases 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 fully-funded 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

𝑈(𝑐, 𝑐 ′ ) = 𝑐 0.3 + 𝑎 𝑐′0.3 ,

where a>0.
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 that 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 a, 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