INSTRUCTIONS:
This part of the written, comprehensive exam in Economics is divided into two parts, micro and macro, which are given equal weight in your final Economics comprehensive grade.
Answer each part in a separate bluebook.
Be sure to put your identification number and the phrase "Econ Comps" on each bluebook. In addition, put "Micro" on the cover of the bluebook containing the micro part and "Macro" on the cover of the bluebook containing the macro part.
Your answers will be graded on the basis of the content and presentation of the economic analysis. The Macro part is an essay -- take the time to organize your ideas and present them in coherent form. Your answer should include appropriate verbal, graphical and mathematical reasoning. The Micro part is composed of a series of specific questions.
Remember, the Macro and Micro sections are equally weighted. Allocate your time efficiently!
Use the 30 minute reading period to read the entire exam. Read carefully and underline important information. You may write notes to yourself on the exam (plenty of space between questions has been provided) or the excerpt that has been provided, but we will evaluate only the answers in your blue book.
The macro exam has five equally weighted questions that you are to weave into a single essay. The micro exam contains 12 separate questions with clearly labelled point values. Spend more time and answer more completely the questions with higher point values. Each question on the micro exam is bolded and italicized .
For the micro exam, carefully number each answer in your blue book.
Remember, the Macro and Micro sections are equally weighted. Allocate your time efficiently!
According to The Wall Street Journal of 1/3/94, a survey of 51 financial and academic economists produced the following "average" forecast for 1994:
These forecasts presumably include the predicted effects of the recently-enacted tax increase, and assume that the Fed will continue to pursue the same monetary policy it has followed in the recent past.
Write a coherent, literate essay in which you answer the following questions and demonstrate your understanding of modern macroeconomics:
a. Which interest rate (short-term or long-term) is more appropriate for interpreting macroeconomic activity? Why? Which (if either) is more appropriate for interpreting the Fed's current monetary policy? Why?
b. Use the IS - LM - aggregate demand - aggregate supply framework to "rationalize" this forecast: that is, draw a set of (properly-labeled) IS - LM - AD - AS diagrams for 1993, and another set for 1994 on the same diagrams, so that output, prices, and interest rates change in the predicted directions. Obviously, your IS - LM diagram should be consistent with your AD - AS diagram.
c. Using the same analytical framework you used in Part b above, what would have been your forecast for 1994 if (1) the tax increase of 1993 had not been enacted, and if (2) the Fed were still presumed to follow the same monetary policy?
d. Suppose instead that (1) the tax increase had not been enacted, but (2) the Fed had pursued a more restrictive monetary policy. What would you forecast for output, unemployment, prices, and interest rates under these conditions? ("Higher" or "lower" than the baseline forecast above will be satisfactory. You may also answer "it depends" for some forecasts if you explain on what it depends.)
e. In the analysis of Parts b - d, what assumption have you been making about the public's expectations about inflation? Have you been assuming that inflationary expectations are constant, adaptively formed, or rationally formed? What, if any, difference does this assumption make to your answers to Parts c and d?
Introduction:
The Micro Essay part of the 1994 Economics Comprehensive Exam will test your knowledge of microeconomic theory by asking a series of questions about how economists view environmental issues.
We present an excerpt (pages 18-20) from William D. Nordhaus' "Reflections on the Economics of Climate Change" (Journal of Economic Perspectives, vol. 7 No. 4 (Fall) 1993, pp. 11-25) that discusses several of the most important concepts in economics.
[Selcuk Pultar (Class of '98) scanned the excerpt and we have provided it for you on-line for your convenience. The file is quite large and may take a some time to load. Once loaded, it can be read on-line or printed.Click here to see the reading.]
We ask that you read this excerpt carefully, then answer the questions that follow. The excerpt contains line numbers along the right-hand side for easy referencing. The questions are grouped into sections: Definitions, Explanation of Nordhaus' Model, and Extensions.
Do not hesitate to raise your hand and ask us questions if you are confused or unsure about a particular question.
The questions are designed to be answered with a graph and a few sentences of explanation. Do not spend too much time on any particular question! The definition questions require a sentence or two, while the other questions need a paragraph or two of explanation. None of the questions requires more than one page in your blue book for a perfect answer. We stress that partly answering all of the questions is much better than long-winded, comprehensive explanations of a few questions.
The micro exam seems long but that is because we have a great deal of explanatory text and lots of space between the questions. Patiently and systematically work your way through each question.
[Remember, the Macro and Micro sections are equally weighted. Allocate your time efficiently!]
Nordhaus uses many difficult, strange words. Some come from the climatologist's vocabulary, while others are used by economists. We'll define the former, you must do the latter!
Greenhouse effect -- line 1
According to Nordhaus (p. 12),
It is the process by which radiatively active gases like CO2 selectively absorb radiation at different points of the spectrum and thereby warm the surface of the earth. . . There is no debate about the importance of the greenhouse effect, without which the Earth's climate would resemble the moon's. Concern about the greenhouse effect arises because human activities are currently raising atmospheric concentrations of greenhouse gases [thus possibly leading to global warming and other climatic changes].
Greenhouse gases -- lines 3,4
According to Nordhaus (p. 12),
The greenhouse gases are transparent to incoming solar radiation but absorb significant amount of outgoing radiation [thus warming the Earth.] The major greenhouse gases are carbon dioxide (emitted primarily from the combustion of fossil fuels), methane, and chlorofluorocarbons.
CO2 emissions -- line 18
A major greenhouse gas, carbon dioxide is discharged into the atmosphere when fossil fuels (e.g., petroleum) are used.
CFCs -- line 24
Another greenhouse gas, CFCs (chlorofluorocarbons) were a widely used aerosol propellant and refrigerant.
The bottom line, according to Nordhaus (pp. 12-13) is this:
Scientific monitoring has firmly established the buildup of the major greenhouse gases over the last century. . . While the historical record is well established, there is great uncertainty about the potential for future climate change. . . Atmospheric scientists have engaged in a spirited debate about the climatic impact of increasing greenhouse gas concentrations, but it is unlikely that the uncertainties will be resolved until this vast geophysical experiment has run its course.
Now that you have a better understanding of the science involved, let's turn to some economics! We'll give a word (or phrase) and line number; you provide, in your blue book, the definition. Each question is worth 5 points.
Do not write an essay for each question -- we want a brief, concise, correct definition. That is all.
Question 1: Public goods -- line 1
Question 2: Externality -- line 3
Question 3: Marginal benefit function -- lines 8,9
Question 4: Present value -- line 10
Question 5: Efficient rate of emissions reduction -- line 45
EXPLANATION OF NORDHAUS' MODEL: (45 points)
In this section, we ask you to more carefully explain the particular pieces of the model described by Figure 2 and the conclusions that Nordhaus reaches. Budget your time wisely -- these are not essay questions. Answer each question, then move on.
Question 6: In deriving the MC curve, Nordhaus writes in lines 32-34,
"Whatever the [emissions reduction] approach, economists emphasize the importance of cost-effectiveness -- structuring policies to get the maximal reduction in harmful climatic change for a given level of expenditure."
Nordhaus has the following graphs in mind:
The graph on the left assumes that X and Y are alternative ways to reduce emissions (with prices Px and Py) and that r = Ÿ(X,Y) describes the maximum emissions reduction for given X and Y (i.e., the "production function" for emissions reduction). The straight lines are the isocost lines and the curves would be called "iso-emission reduction" lines. Finally, the points D, E, F and G are different solutions to an optimization problem with different given emissions reduction rates.
(10 points)
Question 6: What is the optimization problem depicted by the graph at the left?
(10 Points)
Question 7: Explain point H in the two graphs above.
Question 8: After setting up the model (i.e., explaining the MB and MC curves), Nordhaus quickly concludes, in lines 46 and 47, that
The pure market solution comes with emissions reductions at 0, where MB is far above the zero MC.
(10 points)
Question 8: Explain why the pure market solution generates this result.
(15 points)
Question 9: Why is the solution generated by the pure market problematical?
NOTE: This question is worth more than any other question on the micro portion of this exam. It is the heart of modern microeconomic theory.
Spend a little extra time on this one. Give a complete answer.
EXTENSIONS: (30 points)
Having defined some basic economic terms and worked out the initial solution to the model, we now turn to comparative statics and other issues not covered by Nordhaus.
Question 10: Suppose that new evidence conclusively shows much greater damages from climate changes due to greenhouse gas emissions than previously thought.
(10 points)
Question 10: Redraw Figure 2 from the Nordhaus article in your blue book. Now show the effect of the new evidence on the MB/MC curves and label the new optimal fractional reduction in emissions.
Questions 11 and 12: As mentioned in the excerpt (lines 21, 46 and 51) a carbon tax would be one way of solving the problem you discussed in the question above. A carbon tax is a tax on fossil fuels and other emittors of carbon compounds that increase greenhouse gases. However, such a tax would have effects on output in general (GNP), the production of individual goods and services, and the employment of individual factors of production.
(10 points)
Question 11: What effects will the carbon tax have on the equilibrium price and quantity of automobiles? Explain.
In Hard Heads, Soft Hearts, Alan Blinder takes the time to discuss the concerns of the environmentalists who see the whole issue differently:
To them, pollution is a moral issue that should not, indeed must not, be reduced to the crass dollars-and-cents calculus of the economist. As David Doninger, a lawyer for the National Resources Defense Council put it: "We take the view that there are rights involved here, rights to be protected from threats to your health, regardless of the cost involved. . . Indeed, 53 percent of respondents to a 1978 public-opinion poll agreed that "protecting the environment is so important that requirements and standards cannot be too high, and continuing improvements must be made regardless of cost."
(10 points)
Question 12: What would environmentalists view as the optimal fractional reduction in emissions in Figure 2? Why?