] and a markup on unit labor cost hypothesis [P = (1+z)w where
X=(1/)N and z is the markup fraction implies:
MICRO AND MACRO ESSAYS
ANSWER KEY
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 a single question that you are to answer in an essay. The micro exam contains 10 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!
At a recent meeting of the Federal Reserve Open Market Committee (charged with directing open market operations for the Federal Reserve System) "members concluded that the potential for additional inflation remained substantial and, from a monetary policy standpoint, rendered especially urgent the ongoing assessment of inflation trends. . . . most members agreed on the desirability of maintaining a steady policy course."
In pursuit of its macroeconomic objectives, the Federal Reserve has raised the discount rate (the rate it charges depository institutions when they borrow from the Fed) 6 times since 1993. These actions have contributed to the widespread belief that the Fed has followed a restrictive monetary policy that has driven interest rates upward in an attempt at taming inflation pressures in the economy.
Question: Do the data on discount rates, interest rates, and other significant macroeconomic variables, including those listed in Table 1 justify the conclusion that "since the second quarter of 1993, the Fed has followed a restrictive monetary policy that has driven interest rates upward in an attempt at taming inflation pressures in the economy "?
Your analysis should:
Your answer will be evaluated on the clarity, coherence, and completeness of your answer as well as on the conclusions and graphs.
ANSWER KEY
Germane Facts: Before and since 93.2 there has been growth in real GDP accompanied with declining unemployment rates, modest inflation and rising interest rates. Growth in the nominal money stock, whether M1 or M2, has been positive.
Supply Side Considerations: Real-time/chronological time (as opposed conceptual "shortrun" and "longrun" imposes the need to recognize that growth in potential gdp or the natural rate of output occurred. Thus the shortrun and longrun aggregate supply curves have shifted to the right during the period under question. The supply analysis should also consider possible shifts in aggregate supply due to changes in inflation expectations. The moderation of experienced inflation and modest monetary growth may be argued to have shifted shortrun supply to the right.
Given the natural rate hypothesis [
] and a markup on unit labor cost hypothesis [P = (1+z)w where
X=(1/)N and z is the markup fraction implies:
P = P- 1 [1 + ¼* - ‘] + [‘P- 1/Xf]X where Xf is the fullemployment--natural rate-- of output.
(An alternative supply theory would be acceptable and would not alter the conclusion other than the notion of a cyclical recovery interpretation. Indeed some sort of rational expectations story about monetary and fiscal policies would be a plus.)
Demand Side Considerations:
*Increased investment demand (at each interest rate), and increased government expenditures are consistent with an increase in the IS curve. Data are given only for government expenditures, although I rose as interest rates rose.
*Further, the money stock increases would be consistent with increases in the aggregate demand curve [D(P|given M, G, tax rate, exchange rate..)].
*The LM curve at each price level would also be higher given the money stock increase. Real M1 increased less, $861.75 to $908.6, and real M2 fell, $2849 to $2842. *The trade-weighted (multilateral) exchange rate first rose and then declined so that there would be a small decrease in net exports due to the exchange rate with the majority of the decrease in net exports due to income induced imports.
*If inflation expectations increased, there would in principle be some increase in D(P) through an decreased real interest rate; the effect here is likely quite small. Lagged impulses and other factors could also impact demand but are not clearly central to the explanation.
All in all, an increase in D(P) over the period.
Application to the claim: While the interest rate did rise since 93.2, it is NOT clear that this should be attributed to a "restrictive monetary policy". The interest rate increase is consistent with an expanding economy in the face of a nonaccommodating or less than fully accommodating monetary policy. With no increase in the money stock, the interest rate increase would have been greater than the 6.86% to 7.58% increase (3% to 4% for the T-bill rate). This holds whether or not the fed thought it was restrictive. The increase in the discount rate is not an accurate indicator of the stance of monetary policy any more than the nominal interest rate (although it is exogenous in principle).
1995 ECONOMICS COMPREHENSIVE EXAM: MICRO ESSAY
ANSWER KEY
Introduction:
The Micro Essay part of the 1995 Economics Comprehensive Exam will test your knowledge of microeconomic theory by asking a series of questions about how economists view traffic congestion.
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! 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!]
Instructions:
Read the excerpt, Appendix A: Graphic Analysis of Peak-Hour Road Pricing, then answer the questions below in your MICRO blue book.
We recommend active reading: underline important ideas or terms; jot down notes in the margins; ASK if you are unsure of the meaning of a word or phrase.
Questions:
(5 points)
1) What is the source of the "inefficiency of no-fee driving"?
Downs says on p. 167, "The inefficiency of no-fee driving on congested roads arises because each driver does not have to pay the total [social] costs his or her arrival adds to the overall situation." Each driver makes a decision based on private costs alone. This divergence of social and private cost is the source of the inefficiency of no-fee driving and leads to too many drivers.
(10 points)
2) Downs claims that the socially efficient level of traffic is found at level OD in Figure A-1 on p. 168:
"At that level of traffic, the average total costs imposed by each additional driver -- line MCAF -- are equal to the average total benefit received by all drivers -- line PB." (see excerpt, p. 168)
As we noted in the introduction to the excerpt, Downs made some mistakes in the language he used. Given that, How would you explain why OD is the socially efficient level of traffic flow?
By focusing clearly on MARGINAL costs and MARGINAL benefits and remembering that MARGINAL Benefit = MARGINAL cost yields the maximum difference between TOTAL Benefit and TOTAL cost (assuming appropriate second-order conditions), we can simply point out that the socially efficient (i.e., socially optimal) level of traffic is OD because that's precisely where the marginal condition for a maximum holds. Points to the left or right (lower or higher levels of traffic) are inefficient because the marginal equality is NOT met and, thus, maximum social net benefit is not attained.
To the left of OD, MB > MC means that an increase in traffic will add more to benefits than to costs, thus increasing net benefits. Therefore, points to the left of OD cannot be where the maximum net benefit solution is found.
To the right of OD, MB < MC means that a decrease in traffic will subtract less from benefits than from costs, thus increasing net benefits. Therefore, points to the right of OD cannot be where the maximum net benefit solution is found.
(10 points)
3) Use a "totals" graph (either total benefit and total cost OR total net benefit) to explain what the "shaded area lying within the triangle connecting points A, K, and G" (see excerpt, p. 168) in Figure A-1 represents.
The totals graphs above and below show that the deadweight loss described by the marginals graph in Figure A-1 as triangle AKG is exactly equal to the difference between the bold line segments which represent Max Total Social Net Benefit and Total Social Net Benefit at H.
(5 points)
4) Redraw the graph (Figure A-1) and show how much government revenue would be generated by Downs' optimal toll.
(20 points)
5) What effect would adding another lane (one each way!) to the commuter expressway have on the graph and the conclusion that no-fee driving is inefficient?
(Yes, you need to draw a graph here and provide a brief explanation of the effect of the extra lane on the graph and on the conclusion that no-fee driving is inefficient.)
That depends! Interpreting the x axis as "vehicles per highway per hour," would push the "Q" point to the right. There are two possibilities:
(1) Q doesn't reach the demand curve and so the inefficiency remains:
Possibility (2) is that the new lane eliminates the inefficiency problem:
If we stick to Downs' definition of "vehicles per lane per hour," then the new lane would shift the demand curve LEFT for each existing lane. There would still be two possible cases:
Case 1: The Inefficiency Remains:
Case 2: The Inefficiency is Eliminated:
(10 points -- 5 points each)
6)
a) Suppose the price elasticity of demand for driving on the commuter expressway is -0.2. In plain English, what does this mean?
It means that a 1% increase in price (or toll), would lead to a 0.2% DECREASE in quantity demanded.
b) What use would knowledge of the price elasticity of demand for driving on the commuter expressway be to a government which plans to charge commuters for driving on the highway?
The government would know the relationship between changes in the toll and changes in government revenue. For example, if inelastic, increases in the toll would lead to increases in government revenue.
The government would also have information concerning the magnitude of the deadweight loss. Ceteris paribus, inelastic demand means a smaller cost of inefficiency.
Either answer is acceptable.
(10 points)
7) Consider the owner of a small, private delivery service which operates delivery vans on the commuter expressway. The more miles its vans drive on the highway, the more packages can be delivered and, thus, revenues increase. However, more miles means greater expenses (salary of drivers, gasoline, etc.). The delivery service is small enough so that no matter how many miles it chooses to drive, it has no effect on overall congestion.
Let's assume that the revenue and cost functions are given by the following:
TR(Miles per day) = $5*Miles per day
TC(Miles per day) = $0.005*Miles per day2
(Yes, that's miles per day squared . . .)
So, if the delivery company decides to drive 400 miles per day on the commuter highway, it will make $2000 in total revenues, incur $800 in costs, yielding $1200 in profits.
Find the optimal number of miles per day and optimal profit.
(Show all of your work.)
Set up the problem:
max ¼ = 5M - 0.005M2
M
Find the first derivative:
d¼/dM = 5 - 0.01M
Set the first derivative equal to zero in order to find M*:
5 - 0.01M* = 0
M* = 500 miles per day
The optimal number of miles per day is 500.
Find the maximum value of the objective function:
¼* = 5(500) - 0.0005(500)2
¼* = $1250
The optimal profit is $1250.
Although Downs spends much of his time touting the "market-based approach" of government-established prices for driving, an alternative, more "market-based" in philosophy, would rely on a "marketable driving permit" scheme. Ignoring the practical complexities for the sake of argument, we could imagine a situation in which one needed a permit to drive on the commuter expressway on any given day. Such permits could, of course, be bought and sold. Economic theory could help us understand the properties of the marketable driving permit scheme.
In the Edgeworth-Bowley Box below, point E shows the initial endowment of driving permits and the hackneyed Composite Good (that represents all other goods). Individual A has more of the Composite Good than Individual B, while holding an equal amount of driving permits. (To make the story more concrete, say that A has driving permit rights on alternating workdays, while B holds driving permit rights on those days when A has to car-pool or take the bus. So, on any given month, they each have driving privileges for 10 working days.) The dark line is a price vector that represents one of the many possible terms of trade (or exchange rates) of permits for Composite Goods.
(10 points)
8) In the Edgeworth-Bowley Box above, why is point E Pareto Inferior?
Because there are allocations of Composite Goods and Driving Permits that can be made that will make one person better off without making anyone worse off.
(10 points)
9) In the Edgeworth-Bowley Box above, explain why the price vector shown is NOT the equilibrium price vector.
Because by showing the amounts of Composite Goods and Driving Permits that A and B want to sell at the given prices (as shown in the graph below), it is clear that there is a shortage of Driving Permits and a surplus of Composite Goods:
The shortage of Driving Permits will increase their price; the surplus of Composite Goods will decrease their price and, thus, the price vector will rotate around point E with a steeper slope. These changes mean that the given price vector cannot be the equilibrium price vector.
(10 points)
10) The Edgeworth-Bowley Box below shows the final, equilibrium solution of the marketable driving permit scheme.
Discuss the properties of point Z using the following terms: Pareto Optimality, Contract Curve, and Utility Possibilities Frontier.
Point Z is Pareto Optimal because there are no Pareto Superior allocations to it. In other words, it is impossible to make someone better off without making someone else worse off.
This means that point Z is on the Contract Curve. The Contract Curve represents the locus of all Pareto Optimal points (of which point Z is one).
If we redraw the Contract Curve in Utility of A and B space, we get the Utility Possibilities Frontier. Point Z is on that frontier.
The key idea is that point Z is desirable and good. It's certainly better than point E!