Final Examinations from previous
terms
This
is the final from Prof. Olney's Fall 2017 offering of
Economics 1.
The exam was written and administered in two parts (Parts I & II during the final exam
period; Part III due during RRR week).
Part I. Questions based on the last
third of the course (55 points total; 49 minutes total)
Question 1 (20 points total; 17 minutes total)
This question is based on reader article #24, “Federal Funds
and Interest on Reserves,” Federal Reserve Bank of New York,
and “FAQs about Interest on Reserves and the Implementation of
Monetary Policy,” Federal Reserve Bank of New York.
A. (5 points) Define IOER.
Define FFR. When we talk about the FFR (also known as, FFER),
what is the market we are discussing? (One phrase answers to
each question are sufficient.)
B. (10 points) How does
the New York Fed traditionally use Federal Open Market
Operations (FOMO) to facilitate an increase the FFR? Be
specific about what actions are taken. Include a graph of the
FF market in your answer.
C. (5 points) After
November 2008, who became the primary sellers of federal
funds? How does this explain the fact that since 2008, the FFR
has consistently been less than the IOER?
Question 2 (8 points; 7 minutes)
Suppose the federal government passes a bill that
simultaneously does two things:
• taxes are decreased for high wealth
households, saving them a total of $100 billion per year
• transfer payments (Medicaid, Social
Security) are decreased for low income and elderly households,
with a total cut of $100 billion per year
What is the effect of this bill on aggregate demand (possible
answers: increase, decrease, stay the same)? What is the
effect of this bill on employment? Defend your answers.
Question 3 (12 points total; 11 minutes total)
The Phillips curve remains, at least for now, a useful tool
for monetary policy authorities.
A. (4 points) At the
right, draw and label a Phillips curve. Indicate on the curve
approximately where the U.S. economy is currently.
B. (8 points) The Fed (and
other central banks around the globe) now practices “forward
guidance.” What is forward guidance? How does the Fed’s use of
forward guidance decrease the likelihood of the Phillips curve
shifting?
Question 4 (15 points total; 13 minutes total)
Estimated values of the Taylor rule for the U.S. Fed are
expressed by the following equation. Subscripts “t” refer to
the time period. When all subscripts are “t” that means we are
using the values for those variables in the same time period.
For instance, if t = 2017:I, then any variable with a
subscript “t” refers to the 2017:I value of that variable. A
variable with a subscript “t+1” refers to the 2017:II value of
that variable.
Target nominal FFRt = 4.63 + 1.28*(actual
inflation ratet - 2.0) - 1.95*(actual unemployment ratet -
4.7)
A. (3 points) Using this
estimated equation, what is the neutral value of the federal
funds rate? What is the Fed’s target for the inflation rate?
What is the Fed’s target for the unemployment rate?
B. (7 points) What is an
“inflation hawk”? What is an “inflation dove”? Based on this
estimated equation, would you characterize the Fed as hawkish
or dovish? Why?
C. (5 points) When setting
the target for the FFR, the Fed is actually forward-looking.
That is, the Fed considers both current values of inflation
and also what the inflation rate would be in the near future
if the Fed were to do nothing. Does the equation above (in the
prompt) capture this forward-looking behavior? Defend your
answer.
Part II. Questions from the entire course (85 points total;
74 minutes total)
Question 5 (20 points total; 17 minutes total)
A. (8 points) Why does a
decrease in interest rates typically lead to an increase in
investment spending? In your answer, be sure to distinguish
between the interest rate(s) that are relevant for firms using
internal finance versus the interest rate(s) that are relevant
for firms using external finance.
B. (12 points) Why does a
decrease in interest rates typically lead to an increase in
net export spending? (Assume this economy is the only economy
that decreases interest rates.) Be complete.
Question 6 (7 points; 6 minutes)
The California economy, as measured by its real GDP, has been
growing about 3.5 percent per year. Analysts expect that
California’s economic growth will slow to about 2 percent per
year as the economy reaches full employment and labor
shortages appear.
Use one or more of these concepts to explain why analysts
would expect growth to slow: PPF, AD, actual real GDP,
potential real GDP.
(Inspiration:
https://mynewsla.com/business/2017/12/06/economic-uh-oh-for-california-growth-slows-employment-booms-housing-tight/)
Question 7 (15 points total; 13 minutes total)
San Francisco announced a new parking meter policy. Under the
old policy, the price for an hour of parking was fixed at
$2.50 per hour. Under the new policy, the price for an hour of
parking will vary, neighborhood by neighborhood, hour by hour,
depending upon how many parking places are available. If there
are lots of empty parking places when the price is $2.50 per
hour, the price for an hour of parking will be decreased. If
there are no empty parking places when the price is $2.50 per
hour, the price for an hour of parking will be increased.
A. (6points) At the right,
draw a supply and demand graph that captures the new policy.
Show an instance in which the price would be low. Show an
instance in which the price would be high.
B. (4 points) Analysts
working for San Francisco believe the new policy will increase
total revenue. Do we need to know the price-elasticity of
demand for parking in order to determine if the new policy
will increase revenue? Explain.
C. (5 points) Comparing
the old policy (fixed price) and the new policy (variable
price), what is the effect on consumer surplus at times when
there are lots of empty parking places at a price of $2.50 per
hour? At the right, sketch in the old and new CS. (Your graph
at the right is your defense of your answer.)
(Inspiration:
http://www.sfgate.com/bayarea/article/SF-set-to-become-first-U-S-to-price-metered-12393425.php
http://www.sfexaminer.com/transit-agency-approves-surge-pricing-lower-raise-parking-meter-costs/)
Question 8 (15 points total; 13 minutes total)
A recent study of taxes assessed on goods sold showed that
sellers will raise prices when taxes are increased, but do not
lower prices when taxes are decreased.
A. (10 points) Below, show
the effect of an increase in a tax on the price of output in
the short run and the long run, assuming the market is
perfectly competitive. Assume the tax is a constant dollar
amount. Assume the tax revenue is remitted to the government
by the seller. Use subscripts “1" to depict the initial
condition, subscripts “2" to depict the new short-run
equilibrium, and subscripts “3" to depict the new long-run
equilibrium.
B. (5 points) The result
of this recent study is surprising. One explanation the
authors offered for why businesses would not lower their
prices when taxes are lowered was that business owners are
loss averse. How might loss aversion explain the tendency of
businesses to increase prices when taxes are raised, but not
decrease prices when taxes are lowered. (No graph is required
for this part.)
(Inspiration:
https://t.co/ZvmxgG5TdG which expands to
https://www.law.ucla.edu/~/media/Assets/Tax%20Policy%20Colloquium/Documents/Spring%202017/Benzarti%20Final%20Paper.ashx)
Question 9 (13 points total; 12 minutes total)
Invention and innovation increases total factor productivity.
A recent study by Raj Chetty and co-authors found that those
people who become inventors are far more likely to have been
raised in families at the top 1 percent of the income
distribution than in median-income families. Further analysis
showed that an important underlying cause was that children in
high income families grew up meeting, knowing, and talking
with people who were themselves inventors, but that children
in median-income families had no such exposure to inventors.
Having childhood knowledge of the invention process, the
authors argued, makes someone far more likely to become an
inventor as an adult.
A. (8 points) Why should
the government be interested in a policy designed to encourage
invention and innovation? Why doesn’t the Coase Theorem apply
here?
B. (5 points) In light of
this study, suggest one policy that might be implemented to
encourage invention and innovation. Defend your suggestion.
(Inspiration:
https://www.theatlantic.com/business/archive/2017/12/innovation-income-chetty/547202/
citing
http://www.equality-of-opportunity.org/assets/documents/inventors_paper.pdf)
Question 10 (15 points; 13 minutes total)
Chain restaurants include places such as Olive Garden,
Cheesecake Factory, Kentucky Fried Chicken, Popeyes, Del Taco,
Subway, and many more.
A. (4 points) During the
2007-09 recession, sales at chain restaurants decreased. Would
you therefore characterize “meals at chain restaurants” as a
normal good or an inferior good? Defend your answer.
B. (1 point) Would you
characterize the chain restaurant industry as perfect
competition, monopolistic competition, or monopoly?
C. (5 points) Between the
end of the recession in 2009 and 2015, sales at chain
restaurants increased by 8 to 10 percent per year. That’s a
huge annual increase. Starting in about 2010, there have been
big increases each year in the number of chain restaurants.
Explain why increased sales would lead to increases in the
number of restaurants.
D. (5 points) Starting in
2016, “same store sales” have declined over time. “Same store
sales” excludes sales at stores that have entered or exited
the industry in the last year. “Same store sales” includes
only sales at stores (here, restaurants) that were in business
last year and this year. Would our usual analysis of
adjustment to long-run equilibrium have predicted this result?
Explain.
(Inspiration:
https://www.nytimes.com/2017/10/31/business/too-many-restaurants-wall-street.html)
Part III. Comprehensive Essay Question (60 points)
You are finishing up a fabulous internship at an online
news-and-opinion blog that focuses on economics issues. Your
supervisor has given you one last assignment: Write a piece
that provides some analysis of the Tax Cuts and Jobs Act
(TCJA, also known as the GOP Tax Plan). Your readers are
educated people who have an interest in and background
knowledge of economics. Your supervisor has been
impressed with the breadth and depth of your economic
knowledge and with your ability to write a clear and
compelling article. You don’t want to let your supervisor
down!
Based on conversations with your supervisor, you decided you
wanted to include the points below. You’re mostly happy with
the outline but might re-order things for better flow. You can
include visual representations of data as appropriate (a
figure can be worth a thousand words), but no “textbook
graphs” that illustrate economic concepts.
Preliminary Outline You Sketched Out for Yourself (which is
why you referred to yourself as “I”)
- Intro paragraph. Include a thesis statement here. Be
sure reader knows that the specifics of TCJA vary between
House and Senate versions (and are changing by the day),
so I’ll mostly focus on the broad outlines.
- Broad outlines that I’ll focus on: [1] lower taxes on
income (revenue - accounting costs) of corporations; [2]
eliminating taxes on wealth transfers (bequests) for
estates larger than $5 million; and [3] changes in taxes
for middle and lower income families (“change” because
it could be an income tax decrease, could be an
increase, depends on family location and circumstances)
- Provide a clear brief analysis of the effects of the tax
plan on long-run economic growth, unemployment, inflation,
and inequality. It probably will be most clear if I
separately analyze the effects of each of the three things
in my broad outline. I’ll have to think about what flows
better: grouping by what’s being affected (LR growth,
unemployment, etc) or grouping by aspect of the tax bill
(corporate taxes, wealth taxes, income taxes).
- Discuss what the Fed will likely do in response. Here I
need to focus especially on the predicted net effects on
unemployment and inflation. I should be sure to explain
(briefly anyway) what the Fed’s mandate is, and why they
consider unemployment and inflation in determining policy.
Important here to distinguish between today’s inflation,
anticipated inflation, and inflationary expectations.
- There are lots and lots of particular provisions in the
bills. To make my article more compelling, I’ll choose one
particular provision and analyze it.
- Best place to find information needed here: Joint
Committee on Taxation (https://www.jct.gov/) and
especially
https://www.jct.gov/publications.html?func=startdown&id=5031
(House bill, “Description of H.R. 1") and
https://www.jct.gov/publications.html?func=startdown&id=5032
(Senate bill, “Description of the Chairman’s Mark of
TCJA”)
- I’ll choose just one particular provision out of all
that is in those two documents. Almost everything in the
bill is the elimination (or change) of the amount of tax
credit or deductibility (a subsidy) that taxpayers
currently receive for spending on some particular
thing. After I choose what one provision I will
focus on, I want to discuss what particular (micro)
market that provision will affect, what the effect is
likely to be, and whether or not there had been a
justification for the existing (pre TCJA) provision
based on the existence of externalities. (For
instance, if the bill suggests eliminating the ability
to deduct from taxes a taxpayer’s spending on X, what
will that do to prices and quantities in the market for
X? And, is there an externality associated with spending
on X that had justified the existing ability to deduct
spending for X from one’s taxable income?)
- Offer a conclusion: Is the TCJA good or bad for the US
economy? That’s a normative question, so I better state
what I think the goal ought to be.
This
is the final from Prof. Olney's Fall 2016 offering of
Economics 1.
The exam was written and administered in two parts (Parts I & II during the final exam
period; Part III due during RRR week).
Part I.
Questions Covering the Last Third of the Course (58
points total; 45 minutes total)
Question 1 (10 points; 8 minutes)
Since the November 8 election, the dollar has
strengthened by about 10 percent against the Mexican
peso and by about 4 percent against the Euro. Explain
how the following two events can account for these
changes in the strength of the dollar.
• Event A:
Long-term interest rate in the US – but not in other
countries – have increased by about ½ percentage point
since November 8
• Event B:
President-Elect Trump's campaign comments about trade
between Mexico and the US have led to the widely-held
expectation that Mexican exports to the US will decrease
markedly in 2017
Question 2 (15 points total; 11 minutes total)
In normal times, banks hold very low levels of excess
reserves.
A. (6 points) In normal times, what do
banks typically do with their excess reserves? In
normal times, approximately what amount of excess
reserves do banks typically hold?
B. (9 points) In normal times, what is
the effect of an increase in the interest rate on excess
reserves (IOER) on the federal funds rate (FFR)?
Explain. Supplement your answer with a graph of the
federal funds market.
Question 3 (10 points; 8 minutes)
Large increases in government spending for
transportation infrastructure projects will have a
smaller effect on U.S. GDP in 2017-18 than the same size
projects would have had in 2008-09. Referring to
article #25 (“How Powerful are Fiscal Multipliers in
Recessions?” by Alan Auerbach and Yuriy Gorodnichenko),
explain why.
Question 4 (10 points total; 8 minutes total)
Suppose the Taylor rule is
interest rate target = 3 - 2*(actual unemployment
- 4 ) + 1*(actual inflation rate - 2 )
A. (3 points) According to this Taylor
rule, what are the values of the neutral interest rate,
the central bank's goal for the unemployment rate, and
the central bank's goal for the inflation rate? (No
explanation needed.)
B. (7 points) Suppose the actual
unemployment rate is 9 and the actual inflation rate is
0. What is the FFR target predicted by this Taylor
Rule? Traditionally, would the central bank have a FFR
target equal (or approximately equal) to the rate
predicted by the Taylor Rule? Explain.
Question 5 (13 points total; 10 minutes total)
Ruby, a small business owner, is considering buying
additional machinery for her company. She has been
denied a loan by the bank and is considering financing
the purchase with her credit card. The interest rate
charged by the bank for a loan is 8 percent. The credit
card interest rate is 22 percent.
A. (6 points) Should she buy the
machinery? Explain your answer.
B. (7 points) The Presidential
election results surprised Ruby. She now thinks
inflation in 2017 - 2020 will be about 5 percent rather
than the 2 percent she had been expecting. Does
her change in expectations affect her decision to buy
the machinery? Explain.
Part II. Questions Covering Any Part of the Course
(82 points total; 62 minutes total)
Question 6 (10 points; 8 minutes)
There are two groups of companies that can sell a
product. Companies in both groups face a typical
upward sloping marginal cost curve. But for group
A, their minimum average variable cost is $8 and for
group B, their minimum average variable cost is
$50. There are a large number of companies in each
group. Draw the market supply curve for this
product. Explain why you drew the Supply curve as
you did. Why will $50 be the market price for this
product over a wide range of demand curves?
Question 7 (15 points total; 11 minutes total)
Consider two economies. The sets of equations
below describe Economy A and Economy B respectively.
Economy A
C = 100 + 0.6YD
I = 200 + 0.2Y
G = 300
EX = 400
IM = 150 + 0.1Y
TA = 500
TR = 300
Economy B
C = 100 + 0.6YD
I = 200 + 0.2Y
G = 300
EX = 400
IM = 150
TA = 500
TR = 300
A. (8 points) In which economy --
Economy A or Economy B -- is the spending multiplier
larger? Explain your answer. In your answer,
be sure you describe the multiplier process.
B. (7 points) Is the formula 1 /
(1-mpc) the correct formula for the multiplier in either
Economy A or Economy B? Explain your answer.
Question 8 (6 points; 5 minutes)
A state government offers a company $7 million if it
will decrease the number of employees by 1,600 rather
than by 2,400. In 2016 the company had 3,000
employees. In 2017, the company will have 1,400
employees and receive $7 million from the state
government.
• From one
perspective, the company is being paid $7 million for
reducing its workforce by 1,600 employees.
• From another
perspective, the company is being paid $7 million for
increasing employment by 800 employees.
What is the proper counterfactual statement to use to
evaluate the effectiveness of this policy of paying this
company $7 million? Defend your answer.
Question 9 (15 points total; 11 minutes total)
Two policies are being considered to subsidize college
educations at public universities such as Berkeley.
• Policy A:
Use tax revenues to pay subsidies equal to the cost of
tuition to all students.
• Policy B:
Use tax revenues to pay subsidies equal to the cost of
tuition to students whose families earn less than
$125,000 per year.
A. (6 points) Use the concept of
externalities to explain why subsidizing college
education makes economic sense.
B. (9 points) Which policy -- Policy A
or Policy B -- is more likely to generate the socially
optimal quantity of public university graduates?
Defend your answer. In your defense consider the
price elasticity of demand for college education.
Distinguish (if appropriate) between the price
elasticities of the two groups of students -- those
whose families earn more than $125,000 per year, and
those whose families earn less than $125,000 per year.
Question 10 (36 points total; 27 minutes total)
Manufacturers of goods buy parts that are used in
production. For example, car manufacturers buy
engines that are produced by other companies, and then
put those engines into the cars they are manufacturing
and selling.
Suppose the parts that American manufacturers buy are
produced in two places: in the US, or in other
countries. You should think of those as two
separate markets: the market for US produced parts, and
the market for imported parts. Both markets for parts
are perfectly competitive. The US-produced parts and
imported parts are perfect substitutes. Currently,
American goods manufacturers buy a mix of US-produced
parts and imported parts.
President-Elect Trump has suggested implementing a 35
percent tariff (tax) on imported goods. A 35 percent
tariff (tax on imports) means an imported part that had
cost $1 to a US manufacturer would now cost $1.35, but
the American-produced part would still cost just
$1. The tariff is paid to the US federal
government by the buyer. Assume there is currently
no tariff, as is characteristic of a "free trade zone."
A. (10 points) Assume the
parts-producing firms are initially in long-run
competitive equilibrium. What is the short-run
effect of the implementation of a 35 percent tariff on
the price of parts imported from Mexico? On the
profits of a typical Mexican company that produces
parts? Explain and illustrate your answers.
B. (8 points) What is the short-run
effect of the tariff on the price of parts produced in
the US? Explain and illustrate your answer.
C. (10 points) What is the effect of
the tariff on the inflation rate in the US? On the
Phillips Curve? Explain your answers. Illustrate your
Phillips Curve answer.
D. (8 points) Given the Fed's dual
mandate, what is the Fed likely to do in response to the
implementation of a steep tariff? What is the
likely effect on the Fed's monetary policy action on
employment? Why does the mix of doves and hawks on the
FOMC affect your answer? Explain your answers.
Part III. The Comprehensive Essay Question
(60 points)
You’ve decided to submit an op-ed to a reputable
news-source read by millions of people around the world.
You are going to offer your opinion of what the Fed
should do at its December 13-14, 2016 FOMC meeting in
light of the heightened uncertainty in the US economy
post-November 8. Your readers are educated people who
have only a rudimentary knowledge of economics.
The editor who will decide whether to publish your op-ed
needs to be impressed with the breadth and depth of your
economic knowledge and with your ability to write a
clear and compelling article.
You sketched out the outline below. You can include
visual representations of data as appropriate (a figure
can be worth a thousand words), but the news source you
are writing for doesn’t allow graphs that illustrate
economic concepts. Clarity matters most. Your goal
is to have your article accepted for publication and to
persuade readers to your point of view.
Outline
• Uncertainty is greater
post-election. Things seem to change daily.
I could capture two aspects of the uncertainty:
• Fiscal policy, interest rates,
inflation. Increased infrastructure spending ,
increased military spending, and tax cuts have been
proposed. (Details may still be missing.)
I should discuss the implications of such a package of
fiscal policies for employment & inflation, while
noting the uncertainty around what will actually
happen.
• Trade policy. Again, lots of
uncertainty, but the talk has been about renegotiating
trade policies and reducing US imports. Eliminating
free trade zones would increase price of US exports to
foreigners. I should outline the possibilities here.
• Effects of
uncertainty. There are several points I want to
make here so this section will probably be long.
Effect of heightened uncertainty on aggregate investment
spending. Effects on banking and lending, perhaps
through impact on asymmetric information. Effect on the
strength of the dollar vis-à-vis foreign currencies.
Effect on aggregate consumption and saving. And
effect on inflationary expectations.
• Now, monetary policy. I should
first discuss Federal Reserve monetary policy in general
terms. What are the Fed’s goals? What data do they
examine in deciding policy? Why have they been planning
to raise rates in any case?
• Then comes my recommendation and its
defense: Should the Fed raise rates at its December
13/14 meeting. Why?
• As part of my defense, I should
explain the expected effects of a rate increase on
real GDP. Will the Fed’s actions slow growth, or
trigger recession? I need to be sure to consider
confounding factors: is anything raising expected
rates of return on investment projects? What is
happening to interest rates set by central banks in
Europe and Asia? What other factors might affect real
GDP?
• The other part of my defense (or a
caveat?) should be distribution. The US election
certainly underscored the importance of class issues,
which economists usually refer to as “distributional
issues.” I need to explicitly address how my
recommendation would affect workers in areas that used
to be centers of manufacturing.
• Conclusion
paragraph: I need a concluding paragraph that wraps up
the article and reiterates my recommendation.
This
is the final from Prof. Olney's Fall 2015 offering of
Economics 1.
The exam was written and administered in two parts (Parts I & II during the final exam
period; Part III due during RRR week).
Part I. Questions Covering the Last
Third of the Course (50 points total; 35 minutes total)
Question 1 (14 points total; 10 minutes total) This
question is based on article #21, "How Powerful are Fiscal
Multipliers in Recessions?" by UC Berkeley Professors Alan
Auerbach and Yuriy Gorodnichenko.
a. (4 points) According to the article by
Auerbach and Gorodnichenko (A&G), during what part of the
business cycle is the government spending multiplier
relatively large? When is it relatively small?
b. (10 points) Auerbach and Gorodnichenko
(A&G) estimate that the multiplier was about 0 in the
early 1960s. If the economy is on the PPF, why would an
increase in G have no effect on GDP? How is the rate of
long-run GDP growth relevant to your answer? Draw a PPF
that supports your explanation.
Question 2 (12 points total; 8 minutes total) The Phillips
curve has a downward slope because, ceteris paribus, there is
a tradeoff between unemployment and inflation.
a. (4 points) Why is a drop in
unemployment associated with a rise in the inflation rate?
b. (8 points) Offer and defend one
explanation for why the Phillips curve may be flatter today
than it was twenty years ago.
Question 3 (10 points; 7 minutes) Japan's economy has
been in or near recession for over 15 years. The
interest rate controlled by Japan's central bank, the Bank of
Japan, has been at or near the zero lower bound (ZLB) since
1998. Why is expansionary fiscal policy an important
policy tool when interest rates are at the ZLB? Explain
why and how expansionary fiscal policy will affect the
government's budget deficit.
Question 4 (14 points total; 10 minutes total) The
Taylor Rule is a simple equation that describes the connection
between macroeconomic conditions and a central bank's interest
rate target. In general the Taylor Rule is
interest rate
target = neutral interest rate + A*(actual -
target inflation) + B*(actual - target GDP growth rate)
a. (4 points) What does "neutral interest
rate" mean?
b. (10 points) New Zealand (NZ) and
Australia (AUS) each have their own central bank.
Estimates of the Taylor Rule for each country, for 1992-2008,
are (source:
http://www.rbnz.govt.nz/research_and_publications/analytical_notes/2013/an2013_04.pdf)
•
NZ: interest rate
target = 6.7 + 0.5*(actual - target inflation) + 0.5*(actual -
target GDP growth rate)
•
AUS: interest rate
target = 5.9 + 0.4*(actual - target inflation) + 0.8*(actual -
target GDP growth rate)
Define "inflation hawk" and "inflation
dove." Which country's central bank – New Zealand or
Australia – was more relatively hawkish over the 1992-2008
period? Defend your answer.
Part II. Questions Covering Any Part of the Course (90
points total; 64 minutes total)
Question 5 (10 points; 7 minutes) The local electricity
company, PG&E, wants to increase its total revenue earned
from selling electricity to residents of the Bay Area.
Should PG&E increase or decrease the price it charges for
electricity? Explain. If you need to make an
assumption in order to answer the question, do so explicitly
and defend your assumption.
Question 6 (18 points total; 13 minutes
total) Suppose interest rates decline.
a. (8 points) Explain why the decline in
interest rates raises investment spending. Does your
answer depend upon whether the business is using internal
funds (accumulated savings) or external funds (a loan)?
Explain why.
b. (10 points) Consider a business in a
perfectly competitive industry that is initially at long-run
competitive equilibrium. The business purchases
additional machinery, which increases labor
productivity. None of its competitors buy the
machinery. Under what circumstances would you expect
this business to now be earning abnormal profit? Show
the effect in a graph of the firm that includes its short-run
cost curves. Explain what you've drawn and how it
relates to your answer to the question.
Question 7 (25 points total; 18 minutes total) All U.S.
consumers have a FICO score, which is a measure of the
likelihood the individual will make regular and timely
payments on a loan or credit card. The FICO score allows
lenders to screen potential borrowers, charging higher
interest rates or denying credit to those who have bad FICO
scores.
Suppose hackers break into the computer system that produces
FICO scores. As a result of the hack, the FICO score
assigned to any individual is probably wrong. Lenders know the
system has been hacked.
a. (10 points) What is the likely
effect of the hacking on consumer credit availability?
Why? Your explanation should make reference to the
concept of asymmetric information.
b. (5 points) In general, what is the likely
effect of the hacking on consumption spending? Why?
c. (10 points) Families that can borrow or
use credit cards don't have to cut their consumption spending
as much following a lay-off or wage cut as do families that
can't borrow or use credit cards. Consumer credit
availability therefore probably matters more to consumption
during a recession than it does during an expansion.
Consider the effect of the FICO-system hack on real GDP.
Will the effect of the hack on GDP be greater in a recession
or in an expansion? Explain. Your explanation
should make reference to the concepts of marginal propensity
to consume and the multiplier.
Question 8 (20 points total; 14 minutes total) The North
America Free Trade Agreement (NAFTA) was implemented in
1994. NAFTA eliminated all trade barriers between
Canada, the U.S., and Mexico allowing for tariff-free trade
between the three countries. NAFTA was and remains quite
controversial.
a. (10 points) Arguments in favor of NAFTA
point to the gains from trade. What does it mean for
there to be "gains from trade"? What are the conditions
under which there will be gains from trade? Your answer
should make reference to the concept of comparative advantage.
b. (10 points) Arguments against NAFTA point
to the costs of trade. For instance, the Economic Policy
Institute in Washington DC argues
[NAFTA] caused the loss of some 700,000 jobs as production
moved to Mexico. Most of these losses came in California,
Texas, Michigan, and other states where manufacturing is
concentrated. To be sure, there were some job gains along the
border in service and retail sectors resulting from increased
trucking activity, but these gains are small in relation to
the losses, and are in lower paying occupations.
(http://www.epi.org/blog/naftas-impact-workers/)
Explain how increased trade could cause a
loss of U.S. manufacturing jobs. What is a negative
effect of the loss of manufacturing jobs?
Question 9 (3 points, 2 minutes)
When you purchase 100 shares of stock in General Electric (a
U.S. manufacturing company), is that investment?
Explain.
Question 10 (14 points total; 10 minutes total) Just try
finding a place to park a car in downtown Berkeley this time
of year. The price of parking is $3 per hour. You
can park for 2 hours. If you park more than 2 hours, the
price jumps: you get a $55 parking ticket. Before
the holiday season, most people park for about 90 minutes and
then move their car.
a. (5 points) Compare high-income and
low-income parkers. You can assume high-income people
have income of more than $100 per hour, while low-income
people earn minimum wage which is $11 per hour in Berkeley and
$9 per hour in the rest of the Bay Area. Which group is
receiving more consumer surplus from parking before the
holiday season? Briefly (1-2 sentences), explain why.
b. (9 points) Explain why the increased
demand for parking at this time of year will result in more
parking tickets, but only for high-income people not for
low-income people. Supplement your answer with a graph of a
person’s demand for parking places. Show separately the
demand by a high-income person and the demand by a low-income
person. Assume the increase in demand for parking at the
holidays is the same for both high-income and low-income
people. Vertical axis: price per hour of parking.
Quantity axis: # of hours a particular person wants to park.
Part III. The Comprehensive Essay Question (60
points)
Congratulations! You snagged a great job writing for one
of the country’s best newspapers. Your first feature
story is about the expected increase in interest rates that
almost everyone expects the Fed to announce on December
16. Because you are new to the paper, you want to
impress your bosses with the breadth and depth of your
economic knowledge and with your ability to write a clear and
compelling article. Your readers are educated people who
have only a rudimentary knowledge of economics.
You’ve sketched out your outline (below), which you’ll use to
guide your writing. You’ve decided you might include
visual representations of data where appropriate (a figure can
be worth a thousand words), but the newspaper you write for
doesn’t allow graphs that illustrate economic concepts.
Clarity is what matters most to your readers (and thus to your
bosses).
Outline
• Intro paragraph. It’s not a mystery
novel; I need an intro paragraph that does a good job of
letting readers know what I’ll discuss in the article
• Set the stage by discussing Federal
Reserve monetary policy in general terms. What are the
Fed’s goals as they set monetary policy? What economic data
does the Fed consider when setting interest rates? Why
does the Fed want to return the federal funds rate to its
neutral rate before the next recession begins?
• Now add some context. Why and when
did the Fed lower rates as far as they did, and why have they
kept them low for so long? Put the Great Recession in
historical context: In what ways was the 2007-2009
downturn different from most other downturns since the
1970s? How has the recovery been different from
recoveries following previous recessions?
• The Fed will probably raise rates after
its December 15/16 meeting. Why now? Why not earlier
this year? Why not wait another year?
• The Fed’s inflation target is 2
percent. Why aren’t they waiting until inflation
approaches 2% before raising rates? Start by noting what’s
actually been happening to inflation rates (best to
distinguish here between the all-items CPI inflation and
inflation for some of the expenditure sub-categories).
Then I can draw on micro principles to explain why increased
global competition limits the ability of firms to increase
prices in response to changes in demand or in costs of
production.
• Now comes the really important part of the
article: Explain the expected effects of a rate increase on
aggregate demand and real GDP. Will the Fed’s actions
slow growth, or trigger recession? I need to be sure to
consider confounding factors: is anything raising expected
rates of return on investment projects? What is happening to
interest rates set by central banks in Europe and Asia?
• Since the Occupy Movement of 2011,
distributional issues have been of interest to a lot of
people. I better take time to consider whether increased
interest rates have differential impacts on different groups
in the economy.
• Conclusion paragraph: I need a concluding
paragraph that wraps up the article and lets readers know what
to expect in coming months
This
is the final from Prof. Olney's Fall 2014 offering of
Economics 1.
The exam was written and administered in three parts.
Part I Covering not quite the entire last
third of the course (macro but not monetary theory),
administered two weeks before the last day of instruction in
Fall 2014 (60 points)
1. (12 points total; 9 minutes total)
Suppose the economy can be described by the following
equations. All amounts are billions of dollars per year.
C = 1,000 +
0.6YD
TR =
2,000
TA =
3,000
I =
5,000
G = 2,000
EX = 600
IM = 2,000 + 0.2Y
What is the equilibrium level of output and income? Show
all your work or you will receive zero (0) points on this
question. If you cannot solve this problem without a
calculator, set it up and go as far as you can to receive as
much partial credit as possible. No calculators allowed
during the exam. Please put a box around your answer.
2. (24 points total; 18 minutes total) As
the economy improves – lower unemployment, more aggregate
demand, faster GDP growth – the Fed will begin increasing
interest rates.
A. (6 points; 4 minutes) All else constant,
what effect will higher interest rates have on businesses
purchases of machinery? Explain.
B. (6 points; 4 minutes) Explain why
your answer to part (a) changes if an improving economy leads
to two events: an increase in interest rates by the Fed, and
an increase in business optimism.
C. (12 points; 9 minutes) Suppose only
the U.S. raises interest rates. What effect will higher
interest rates have on the value of the dollar vis-a-vis other
currencies? On U.S. imports? On U.S.
exports? Step-by-step, explain your answers.
3. (14 points total; 11 minutes total)
A. (8 points; 6 minutes) Explain why the
initial changes in investment and net export spending result
in an even larger total change in real GDP.
B. (6 points; 4 minutes) Consumer
spending responds more to changes in income in a downturn than
in an expansion. All else constant, when will a one
percentage point change in interest rates have a greater
effect on GDP: in a downturn, or in an expansion?
Explain.
4. (10 points total; 7 minutes total)
(6 points; 4 minutes) According to the
article “Stimulating the Economy in an Era of Debt and
Deficit,” by Joseph E. Stiglitz, in
The Economists' Voice
(March 2012), what is one of the usual two objections to using
expansionary fiscal policy? Why can this objection be
dismissed in the current economic environment? (If you
didn’t read the article, say so and we’ll give you 2 points
for honesty. If you didn’t read the article and you fill
up this space with garbage, you’ll get 0 points for wasting
your and our time.)
b. (4 points; 3 minutes) Using the
production possibilities frontier model at the right, show the
effect of increasing the production of government goods and
services. Does it matter whether you begin on, versus inside,
the production possibilities frontier? Relate this analysis to
the current economic environment.
Part II. Questions covering the entire course (80
points)
Question 5 (16 points, 14
minutes)
Consider two different economies: F and A.
Economy F: people in
economy F have family and friends with substantial wealth who
will help them out financially if they are unemployed
Economy A: people in
economy A have family and friends with little or no wealth who
therefore can’t help them out financially if they are
unemployed
Remember: the marginal propensity to consume out of disposable
income (ΔC/ΔYD) is much greater than the marginal propensity
to consume out of wealth (ΔC/ΔW).
A. (10 points) In a recession, which economy
suffers more? Explain.
B. (6 points) Suppose the government is
considering enacting this policy:
If you don’t have family
and friends who will help you out when you are unemployed, you
can receive extra government unemployment benefits.
What is the moral hazard problem with this
policy? (If you don’t know, at least define ‘moral
hazard’ for partial credit.)
Question 6 (31 points; 25 minutes)
Oil is a key input to
production of many items. Crude oil prices are falling,
as depicted in the graph (Source: FRB-St Louis).
In the United States, hydraulic fracturing (“fracking”) is a
technology developed in the 1940s and widely used to extract
oil from the earth. Technological change in 1997 made it
much cheaper for oil extraction companies to use fracking in
shale, which is a type of rock found in large parts of North
America.
A. (10 points) The oil market is a world
wide market. Suppose that individual oil extraction
companies can be depicted as perfectly competitive
firms. Explain why the 1997 technological change led to
a big boom in U.S. oil production and a decrease in the world
price of oil. Supplement your answer with graph(s).
B. (6 points) If the price of oil fell below
$80 a barrel, oil extraction companies using fracking said
they would shut down. Explain their decision using
relevant economic concepts.
C. (6 points) Draw a production
possibilities frontier for the U.S. at the right.
Production of oil goes on the vertical axis; production of all
other goods and services goes on the horizontal axis.
What is the effect of the 1997 technological change?
Briefly explain your graph.
D. (9 points) The Fed appears likely to
increase interest rates in mid-2015. Does the pattern of
oil prices depicted on page 2 make it more likely or less
likely that increasing interest rates will harm the
economy? Why are inflationary expectations an important
part of your answer? If drawing a graph makes your
answer more clear, go ahead and include a graph.
Question 7 (14 points; 11 minutes) In January 2014,
Mexico implemented a soda tax of one peso per liter, about 10
% of the purchase price. The tax revenue will be used to
fund health education programs to further discourage
consumption of obesity-enhancing goods.
A. (8 points) Sales of soda fell 10
percent. What can you say about the price elasticity of
demand for soda in Mexico?
B. (6 points) Under what condition(s) is the
soda tax in Mexico the optimal size?
Question 8 (19 points; 15 minutes)
In Europe, the unemployment rate is above 11 percent, the
inflation rate is near 0, and inflationary expectations are
falling. The central bank of Europe (ECB, European
Central Bank) lowered its target interest rate to 0.05%
earlier this year.
A. (6 points) Illustrate the information
above in a Phillips Curve. Briefly explain your graph.
B. (3 points) Some observers refer to the
German members of the ECB as “hawks.” What does it mean
for a central bank board member to be a hawk?
C. (10 points) The ECB is considering
implementing quantitative easing because it is at the zero
lower bound. What is the “zero lower bound”? What
is “quantitative easing”? Does quantitative easing
necessarily lead to an increase in economic activity?
Reference recent U.S. economic history in your answer.
Part III. Comprehensive Essay Question (60 points)
Congratulations! Based on your excellent
Cal education and your expertise in economics, you have
been hired as an economic analyst by JA Homes (JAH), a
large nationwide construction company that specializes in
residential housing. Your first task is to write a
briefing paper that discusses economic factors that will
affect JAH’s business environment over the next few
years. Your bosses will use your paper in their
deliberations about how much to expand (or contract) the
firm between now and 2017. Because you are new to
the firm, you want to impress your bosses with the breadth
and depth of your economic knowledge and with your ability
to apply your knowledge in this particular
situation. Your paper will be read by your bosses:
educated men and women who have only a rudimentary
knowledge of economics.
You’ve sketched out the following outline, which you’ll
use to guide your writing. You’ve decided you might
include visual representations of data where appropriate
(a figure can be worth a thousand words), but it doesn’t
make much sense to include graphs that illustrate economic
concepts. Clear explanations are more valuable to
your bosses than textbook/lecture style graphs.
Outline
• Intro paragraph with a recommendation:
Should JAH expand or contract in the next three years?
Give a brief defense of recommendation. (The rest of
the essay will build the detailed defense of the
recommendation.)
• Set the stage by discussing the
current state of the U.S. economy (unemployment,
inflation, growth). Put today in historical
context: In what ways is the recovery to date
different from recoveries following previous
recessions?
• Discuss Federal Reserve policy.
Interest rates are key in the housing industry, so it’s
important to try to predict what the Fed will do with
interest rates in the next year or so. Take time to
explain how the macroeconomy affects Fed policy, and how
Fed policy affects the macroeconomy.
• JAH builds houses for the middle
classes – second, third, and fourth quintiles of the
income distribution. Distribution matters. Be
sure to distinguish between trends in aggregate income and
trends for the middle classes.
• The market for houses can be captured
reasonably well with a simple supply & demand
model. Put predictions for 2014-2017 in perspective
by discussing the various forces that affected the market
for houses starting in the early 2000s.
• JAH hires thousands of workers, mostly
skilled tradespeople, and there are rumors that the
company is considering cutting wages. Include a side
note addressing asymmetric information, and how wage cuts
may affect labor markets.
• Conclude with a re-statement of the
recommendation and its defense: Should JAH expand or
contract in the next three years? Why or why not?