MGEA06 – Introduction to Macroeconomics: A Mathematical Approach

Final Exam, Winter 2014

Version A

Last name/Family name: ___SOLUTION______________________________

First name: ___________________________________________________________

ID#: _________________________________________________________________

Date & Time: Friday, April 11, 2014, 7:00pm – 10:00pm

Instructor: Iris Au
Aids Allowed: Non-programmable calculator
Time Allowed: 180 minutes
Total number of pages (including the cover page): 17
Total Points: 100

Part 1 (Out of 70) Part 2 (Out of 30) Overall marks (out of 100)

The University of Toronto's Code of Behaviour on Academic Matters applies to all University of
Toronto Scarborough students. The Code prohibits all forms of academic dishonesty including, but not
limited to, cheating, plagiarism, and the use of unauthorized aids. Students violating the Code may be
subject to penalties up to and including suspension or expulsion from the University.

MGEA06 Final Exam Version A – Winter 2014 © Iris Au 1

Instructions – please read carefully

1) Questions related to the content of the exam will NOT be answered.

2) On the cover page of this booklet

 PRINT your family name and first name.
 Enter your student number.
If you fail to do one of the above tasks, 4 marks will be deducted from your final
score.

3) If you DO NOT write in your assigned room, 4 marks will be deducted from your
final score.

4) DO NOT UNSTAPLE the booklet. If you do it, 10 marks will be deducted from
your final score.

5) This exam consists of TWO parts.

 Part 1 consists of 35 short questions which required you to put your answers on
in the designated boxes. If answers are not written on the designated boxes,
no marks will be given for that question. For questions that required you to
show work, you must do so in order to receive full credit. We will ONLY grade
your work in the white space between the question and the designated answer
box. If you do not show your work, you will not receive full credit even your
answer is correct. However, you may receive partial credit for showing your
work even your final exam is incorrect. Each question is worth 2 marks, and there
is no deduction for wrong answers.
 Part 2 consists of 3 short-answer questions which required you to provide
sufficient explanation for full credit. Be sure to label your diagrams as clearly and
completely as possible and to explain why the curves shift and to which direction.
You can write your written explanation beside (and below if necessary) the
diagram. When providing written explanation, you can use point form, use / to
represent increase/decrease and symbols for variables that we used in class (say,
Y = output). Also, the flow of your answer matters. A clear, well-organized
answer is worth more than a long rumbling paragraph.

6) DO NOT put your answer on the blank pages of the left-hand sided of the booklet,
we WILL NOT grade any answers on those pages. However, you can use those
pages as rough/draft paper.

Good luck & have a great summer! 

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 2

PART I –70 MARKS (2 MARKS PER QUESTION)

Questions 1 – Question 2: The economy in question is a closed economy. It produces and consumes
four goods only. The following table summarizes the prices and the levels of production in 2012 and
2013. The government chooses 2013 as the base year.

2012 2013
Goods Price Quantity produced Price Quantity produced
(in thousands) (in thousands)
1 $32 50 $35 60
2 $60 45 $60 40
3 $80 30 $77 26
4 $62 30 $58 36

Additional information:
 The shares of good 1 bought by households, firms, and government are 40%, 30%, and 30%
respectively.
 Households consumed three quarters of good 2 while the remaining is bought by firms.
 The purchases of good 3 are split between the government and the firms, and the firms consume
40% of it.
 Households purchase 55% of good 4 while the government purchases the remaining amount.

Question 1
What is the consumer price index in 2012 (rounded to 2 decimal points)? Be sure to show your work.

COB2012 = $32 × 24 + $60 × 30 + $62 × 19.8 = $3795.6

COB2013 = $35 × 24 + $60 × 30 + $58 × 19.8 = $3788.4

CPI2012 = $3795.6/$3788.4 × 100 = 100.19

CPI in 2012:
100.19

Question 2
What is the GDP deflator in 2012 (rounded to 2 decimal points)? Be sure to show your work.

Nominal GDP2012 = $32 × 50 + $60 × 45 + $80 × 30 + $62 × 30 = $8560

Real GDP2012 = $35 × 50 + $60 × 45 + $77 × 30 + $58 × 30 = $8500

GDP deflator2012 = $8560/$8500 × 100 = 100.71

GDP deflator in 2012:

100.71

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 3

Question 3
Which of the following transactions will be included as investment under the expenditure approach?
Yes/No.

___NO____ Anton purchased his friend's condo.

___NO____ Tires purchased from Goodyear by General Motors for newly produced electric cars.

___NO____ ABC company purchased 10,000 shares of IBM stock.

Question 4
A survey reveals that on a small island initially 1,000 people have jobs, 200 people are looking for
jobs, and 200 people are neither working nor looking for work. Now, suppose that 100 of the 200
people who weren't looking for work now begin looking for work and that half of the new entrants
successfully find a job. Find the new unemployment rate (rounded to 1 decimal place & show your
work).

200 + 50
Unemployment rate = (1000 + 50)+ (200 + 50) × 100% = 19.2%

Unemployment rate:
19.2%

Question 5
Which of the following individual(s) will face structural unemployment? Yes/No.

__YES_____ Craig lost his job several months ago. He is reluctant to get a new job as he feels that he
can make almost as much money on social welfare.

__NO_____ Sarah is a recent economics graduate who is entering a difficult labor market, owing to a
continued recession. She is continuing to look for work but is finding it difficult.

__YES____ Juan is a miner who recently lost his job due to a permanent mine closure in his province.
He knows he could easily find work in other provinces, but is reluctant to uproot his
family.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 4

Question 6
If Macroland took 25 years to increase its real GDP per capita from $7500 to $120000, what was its
average economic growth during this period? (Hint: Use the rule of 70)

# of years for income to double = 6.25 years

Average economic growth rate = 70/6.25 = 11.2%

Average economic growth rate:

11.2%

Question 7
The following table summarizes the growth rates of total factor productivity and productive inputs for
an economy.
Annual growth rate
Total factor productivity 2%
Capital per worker 4%
Human capital per worker 5%

If the share of capital per worker is 0.3 (i.e., 30%), use the growth accounting equation to find the
growth rate of output per worker for this economy (rounded to 1 decimal place & show your work).

∆𝑦
= 0.02 + 0.3(0.04) + 0.7(0.05) = 0.067 (6.7%)
𝑦

Growth rate of output per worker:

6.7%

Question 8
Determine each of the following statements about diminishing marginal product of capital is true or
false.

__TRUE___ Diminishing marginal product of capital suggest that at some point, increasing the
amount of capital per worker is not worth the cost of the additional amount of capital.

__TRUE___ Diminishing marginal product of capital suggests that when the amount of human capital
per worker and the state of technology are fixed, successive increases in the amount of
capital per worker lead to a smaller increase in productivity.

__TRUE___ Diminishing marginal product of capital suggests that total output will increase when
there is an increase in capital, holding all else constant.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 5

Question 9 – Question 10: The market for loanable funds of a closed economy is given by:

Demand for loanable funds: DF = 400 – 600i

Supply of loanable funds: SF = 100 + 900i
where I is interest rate and is measured in decimal point (i.e., if I = 0.1, then it is equal to 10%)

The initial equilibrium levels of interest rate and quantity of funds are 20% (0.2) and 280 respectively.

Question 9
Now, firms expect sales will rise sharply in the near future, and the level of investment increases by 60
for any given level of interest rate. Find the change in the equilibrium level of investment. Be sure to
show your work.

(400 + 60) – 600i = 100 + 900i

i* = 0.24
DF* = I* = 316
I* = 36

Change in investment:
36 or + 36 or  by 36

Question 10
(Continued from the Question 9) Suppose the government finds the change in interest rate in Question
9 undesirable and wants to keep it at 15%. Find the change in government budget balance that will
achieve the goal (assume the budget balance is not affected by changes in interest rate & show your
work).

460 – 600(0.15) = (100 + GBB) + 900(0.15)

GBB = 135

Change in government budget balance:

135 or + 135 or  by 135

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 6

Question 11
Suppose you pay $982.00 today for a 2-year bond that has a face value of $1000 and a coupon rate of
3.8%, what is the yield (return) of holding this bond (rounded to 2 decimal places)? Be sure to show
your work.

38 1038
982 = 1+r + (1+r)2

r = 0.0476 (4.76%)

Yield (return) of the bond:

4.76%

Question 12 – Question 15: The economy has flexible prices and can be described by the AD-AS
model. Suppose you are given the following information:

Planned aggregate expenditure: AEPlanned = 150 – 4P + 0.6Y

W
Aggregate supply (AS): P = (– 22.5 + 0.2Y)   , where W = wage rate
 20 

Question 12
If the initial equilibrium wage is 20, final the equilibrium levels of output and price. Be sure to show
your work and keep your answer to 2 decimal places if necessary.

 20 
37.5 – 0.1Y = (– 22.5 + 0.2Y)  
 20 

Y* = 200
P* = 17.5

Output: Price:
200 17.5

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 7

Question 13 – Question 15
The economy is initially in its long-run equilibrium as shown in Question 12. Suppose there is a
reduction in housing price such that household wealth falls and autonomous expenditure changes by
15. (Hint: You need to determine whether autonomous expenditure rises or fall)

Question 13
When the economy reaches its short-run equilibrium, what is the change in the equilibrium level of
price? Keep your answer to 2 decimal places if necessary and be sure to show your work.

 20 
33.75 – 0.1Y = (– 22.5 + 0.2Y)  
 20 

Y* = 187.5 P* = 15
P* = – 2.5

Change in price:
– 2.5 or  by 2.5

Question 14
Based on your answer in Question 13, which kind of output, inflationary or recessionary, gap the
economy experienced? What is the size of the output gap (keep you answer to 2 decimal places if
necessary)?

Kind of output gap: Size of output gap (in percentage form):

Recessionary gap 6.25%

Question 15
Comparing to the initial equilibrium (i.e., the one in Question 12), find the change in the equilibrium
wage rate is when the economy reaches its (new) long-run equilibrium. Rounded to 2 decimal places
and be sure to show your work.

P* = 33.75 – 0.2(200) = 13.75

W* = (13.75 × 20)/(– 22.5 + 0.2(200)) = 15.71

W* = – 4.29

Change in wage:
– 4.29 or  by 4.29

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 8

Question 16
Determine each of the following statements about the automatic stabilizers is true or false.

__TRUE__ Automatic stabilizers have similar impacts as discretionary fiscal policy but occur
automatically, without deliberate action by the government.

__TRUE__ Automatic stabilizers are government spending and taxation changes that cause fiscal
policy to be contractionary when the economy expands.

__TRUE__ Increase in spending on employment insurance due to an increase in the number of layoffs
is an example of automatic stabilizers.

Question 17
Determine each of the following statements about the budget balance and national debt is true or false.

__TRUE__ Persistent budget deficits could lead to private investment spending being crowded out.

__FALSE_ The cyclically adjusted budget balance accounts for decreases in tax revenues that occur
during economic expansions.

__FALSE_ If the stock of national debt is growing faster than the country’s GDP, then the country
will find its debt-to-GDP ratio falls over time.

Question 18 – Question 21: Ecoland has a very simple banking system, in which there is only one
chartered bank (The ABC Bank). The central bank of Ecoland imposes a minimum required reserve
ratio of 4%. Individuals in Ecoland hold a fixed amount of $1250 in the form cash to facilitate their
daily transactions and will deposit any excess amount of money into their bank accounts. The initial
balance sheet of the ABC Bank is as follow:

Assets Liabilities & Equity

Loans $7250 Demand deposits $7500
Bank reserves $400 Equity $150
Note: Unless otherwise stated, the ABC Bank will hold the excess reserves fixed at the current level as
shown in the initial balance sheet and will lend out any surplus of reserves beyond this.

Question 18
Suppose the central bank of Ecoland conducts an open market sale of $90. What is the new
equilibrium level of MS? Keep your answer to the nearest integer and be sure to show your work.
1
DD = – $90 × 0.04 = – 2250
MS = $1250 + ($7500 – $2250) = $6500

Money supply:
$6500

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 9

Question 19
Return to the initial situation. In attempt to lower the operating cost of the ABC Bank, the central bank
lowers the minimum required reserve ratio by 1.5 percentage points. When the banking system is back
to equilibrium, the ultimate change in money supply is: (Keep your answer to the nearest integer and
be sure to show your work).

$300
MS = (0.025 + $1250) – ($7500 + $1250) = $4500

Change in money supply:

$4500 or + $4500 or  by $4500

Question 20
Return to the initial situation. Now, suppose the central bank of Ecoland provides deposit insurance to
depositors. As a result, the public reduces their cash holdings by 60. When the banking system is back
to equilibrium, find the ultimate change in the money supply. (Keep your answer to the nearest integer
and be sure to show your work).

$60
MS = – $60 + 0.04 = 1440

Change in money supply:

$1440 or + $1440 or  by $1440

Question 21
Suppose the central bank of Ecoland finds the change in money supply in Question 20 undesirable and
wants to keep the level of money supply from changing, then the central bank should:

Action taken by the central bank: Amount

Open market operations: (Circle the correct answer)
$57.6
 Open market sale
 Open market purchase
Deposit switching: (Circle the correct answer)
$57.6
 Switching government deposit from the ABC Bank to the central bank.
 Switching government deposit from the central bank to the ABC Bank.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 10

Question 22
Which of the following transaction(s) will increase the opportunity cost of holding cash? Yes/No.

__NO_____ The incidents of pick-pocketing fall significantly.

__NO_____ Inflation rate falls from 3% to 2.3%.

__NO_____ Your monthly allowance increases by $500.

Question 23
Suppose a country’s money demand function is given by:

Money demand: MD = (0.1Y – 1000i)  P

where I = interest rate and is expressed in decimal point (i.e., if I = 0.1, then I = 10%)

Suppose the central bank sets the interest rate to 15%, find the level of money supply that will achieve
the goal if the current levels of GDP and price are equal to 5000 and 2 respectively. Be sure to show
your work and keep your answer to 1 decimal place if necessary.

MS = (0.1  5000 – 1000  0.15)  2 = 700

Money supply:
700

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 11

Question 24 – Question 25: The economy is a closed economy and can be described by the income-
expenditure model. The economy is characterized by the following equations:

Consumption: C = 475 + 0.6YD; where YD = disposable income

Investment: IPlanned = 270 – 100i, where I = 0.1 (10% & it is held fixed)
Government spending: G = 360
Taxes: T = 100 + 0.125Y
Transfers: TR = 180 – 0.075Y

Question 24
If the current level of output is 2150, find the level of unplanned investment. Keep your answer to 2
decimal places if necessary and be sure to show your work.

AEPlanned = 1143 + 0.48(2150) = 2175

IUnplanned = 2150 – 2175 = – 25

Unplanned investment:
– 25

Question 25
Based on your answer in Question 24, which of the following statement(s) is(are) correct? Yes/No.

__NO____ The equilibrium level of output will be less than 2150.

__YES____ The equilibrium level of output will be greater than 2150.

__NO____ Firms will try to deplete their inventories by reducing production.

__YES____ Firm will try to replenish (i.e., to refill) their inventories by increasing production.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 12

Question 26 – Question 31: Use the income-expenditure model to answer the questions. Suppose an
open economy with fixed prices can be described by the following equations:

Consumption: C = 540 + 0.6YD; where YD = disposable income

Investment: IPlanned = 240 – 500i
Government spending: G = 280
Taxes: T = 65 + 0.15Y
Transfers: TR = 265 – 0.1Y
Exports: X = 760 – 35EFC/DC
Imports: IM = 190 + 0.075Y + 15EFC/DC

NOTE: Unless otherwise stated, interest rate, I, is held constant at 0.05 (5%) and exchange rate,
EFC/DC, is held constant at 2 (FC per DC).

Question 26
Find the equilibrium level of output (rounded to the nearest unit & be sure to show your work).

AEPlanned = 1625 + 0.375Y

Y* = 2600

Output:
2600

Question 27
When the economy reaches its equilibrium, its trade surplus is equal to (rounded to the nearest unit &
be sure to show your work):

NX = [760 – 35(2)] – [190 + 0.075(2600) + 15(2)] = 275

Trade surplus:
275

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 13

Question 28
The economy is initially in its equilibrium as shown in Question 26. Suppose the government finds the
initial budget surplus is too large and wants to lower it to 132 via a change in lump-sum (autonomous)
taxes. Find the change in lump-sum (autonomous) taxes that would achieve this goal (rounded to the
nearest unit and be sure to show your work).

AEPlanned = 1257.8 + 0.525Y

Y* = 2648

T0 = 677 – 0.25(2648) = 15
T0 = 15 – 65 = – 50

Change in lump-sum (autonomous) taxes:

– 50 or  by 50

Questions 29 – 31: The economy is initially in its long-run equilibrium as shown in Question 26.
Suppose there is a change in consumption preference in foreign households such that foreign
households consume fewer imported goods. As a result, the domestic net exports change by 110 for
any given level of output and exchange rate. In addition, this change in consumption preference in
foreign households causes interest rate to fall by 2 percentage points and domestic currency to
depreciate by 0.1 FC per DC.

Hint: You need to determine whether autonomous exports or autonomous imports change or not; if so,
whether the variable goes up or down.

Question 29
Compare to the initial equilibrium as shown in Question 26, find the change in equilibrium level of
output (rounded to the nearest unit and be sure to show your work).

1
Y* = (– 95)  1−0.375 = – 152

Change in output:
– 152 or  by 152

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 14

Question 30
Compare to the initial equilibrium as shown in Question 26, find the change in equilibrium level of net
exports (rounded to 1 decimal place and be sure to show your work).

NX = – 106.5 – (– 12.9) = – 93.6

Change in net exports:

– 93.6 or  by 93.6

Question 31
Find the cyclical budget balance as a result of this change in the consumption preference in foreign
households (rounded to the nearest unit and be sure to show your work)?

GBB = (0.15 + 0.1)  (– 152) = – 38

Cyclical budget balance:

– 38 or  by 38

Question 32
Which of the following statement(s) is(are) true about an open economy?

__FALSE _ A revaluation of a currency, holding everything else constant, leads to an increase in

aggregate demand and can therefore be expansionary.

__TRUE__ If foreign countries are increasing their demand for domestic financial assets, then we can
expect the domestic currency to appreciate and the current account balance to decrease,
all other things equal.

__FALSE _ A country with a flexible exchange rate regime reduces a country’s bias toward
inflationary policies.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 15

Question 33 – Question 34: Suppose the balance of payments accounts for Home can be summarized
by the following equations (assume there are no other international transactions):

Exports of goods and services = 0.2YF – 30EFC/DC

Imports of goods and services = 0.15YH + 20EFC/DC
Purchases of domestic assets by foreigners = 250 + 1500(iH – iF)
Purchases of foreign assets by domestic residents = 280 – 2000(iH – iF)

Note: The subscripts “H” and “F” stand for Home and Foreign respectively.
Also, interest rate is expressed in decimal points (i.e., if i = 0.05, then i = 5%).

Question 33
Suppose the current level of output in Home is 6000, which are 750 units less than the level of output
in Foreign. In addition, the interest rate at Home is equal to 4%, which is 1 percentage point higher
than the interest rate in Foreign. Find the equilibrium level of exchange rate (rounded to 1 decimal
point and be sure to show your work).

1615 – 30E = 1160 + 20E

E* = 9.1

Exchange rate:
9.1

Question 34
Based on your answer in Question 33, determine whether each of the following statements is true or
false.

__FALSE__ Home runs a current account surplus of 5.

__TRUE___ Home finds its holding of foreign wealth falls.

__TRUE___ Home is a net borrower in the world loanable funds market.

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 16

Question 35: The country is an open economy. The following table provides some entries of its
balance of payment accounts and it does not include international transactions carried by the central
bank.

Items in the balance of payments accounts Dollars

Exports of goods $355
Imports of goods $235
Receipts for services provided to foreigners $455
Payments for services received from foreigners $530
Factor income earned abroad $34
Factor income earned by foreigners $46
Sales of domestic assets to foreigners $143
Purchases of foreign assets by domestic residents $188

Find the country’s current account balance. Be sure to show your work.

CA = $355 + $455 +$34 – $235 – $530 – $46 = $33

Current account:
$33 or + $33 or a surplus of $33

PART II – SHORT-ANSWER QUESTIONS (30 MARKS – 10 MARKS PER QUESTION)

Questions 36 (10 marks)

Initially, a closed economy is in its long-run equilibrium. Suppose there are labour strikes in some of
the country’s largest oil refineries, which lead to disruptions to the oil supply and an increase in the oil
price.
a) What happens to output and price in both short run and long run? Explain in words and ONE AS-
AD diagram. (7 points)
b) Based on your answer in part (a), what happens to the government budget balance in the short run?
Explain. (3 points)

Question 37 (10 points)

An open economy is currently in an inflationary gap. In attempt to reduce the inflationary pressure, the
central bank decides to adjust the target for overnight rate to close the inflationary gap. What should
the central bank do? Also, describe how the monetary transmission mechanism works for the proposed
change in monetary policy.

Question 38 (10 points)

Consider an open economy that adopts a flexible exchange rate.
a) Suppose a recent study shows that household wealth has increased by 10%. What happens to
output and the FC/DC exchange rate in the short run? Explain in words only. (8 marks)
b) Based on your answer in part (a), what happens to country’s current account? Explain. (2 points).

MGEA06 Final Exam Version A Solution – Winter 2014 © Iris Au 17