Written Comprehensive Exam in Economics, 1998
Instructions:
This part of the written comprehensive exam in Economics is divided into two parts, macro and micro, 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 on each bluebook. In addition, put "Micro" on the cover of the bluebook containing the micro part and "Macro" on the other bluebook.
Your answers should include appropriate verbal, graphical, and mathematical reasoning. Please number each answer in your bluebook and write coherently and legibly.
Remember, the Macro and Micro sections are equally
weighted, so you should allocate your time efficiently. Do
NOT spend too much time on one part of the exam or on one question.
If you can't get it, MOVE ON!
Use the 30 minute reading period to read the entire exam carefully,
underlining important information. You may write notes on the exam
but we will only evaluate answers in the blue book.
You have until 12:00 PM to complete the exam. Good luck.
The answer below refers to Figures that are contained in two large scanned graphics at the end of the macro answer.
C =600 + .8XD; (consumption expenditures on goods)
I = 2000 - 280r; (investment expenditures on goods)
G = 350; (government expenditures on goods)
NX = -150; (net exports of goods)
XD = X - T( disposable income; assume transfer payments (R) are zero
and that taxes are proportional to income; the income tax rate is
.1.)
T = .1X (Total taxes)
M = 1800; (supply of nominal money balances)
L = 200 + .1X - 5r; (demand for real money
balances.
Answer Key
Part I Section A
To calculate the general equilibrium, first find the interest rate
and income levels for which the product market is in equilibriu which
gives the IS curve; second find interest rate and income levels for
which the financial market is in equilibrium, which gives the LM
curve; finally, set IS=LM.
(a) Product Market
(1) Sag = X (GDP = gross income-- a NI accounting
relationship)
(2) Dag = C + I + G + NX = (600 + .8(X - .1X)) + (2000 - 280r) +
(350) + (-150)
= 2800 -280r + .72X (aggregate expenditures function)
(3) Sag = Dag (unplanned inventories = 0 equilibrium condition for
the product market)
Using (1) and (2) in (3) gives the IS curve: r = 10 - .001X
(b) Financial Market
(4) Ms/P = 1800/2 = 900 ( supply of real balances = nominal
supply÷price level)
(5) L = 200 + .1X - 5r (demand for real balances)
(6) Ms/P = l800/2 (equilibrium condition.)
Using (4) and (5) in (6) gives the LM curve: r = -140 + .02X
(c) Set IS=LM to find the general equilibrium X when prices
are constant
10 - .001X = -140 + .02X
Xeq = 7142.857
(d) Use Xeq in IS or LM to get the interest rate
r = 10 - .001 (7142.857) = -140 + .02 (7142.857) = 2.857
req = 2.857
Part I; Section B
On the demand side, if P is variable, the supply of real balances is endogenous (Ms/P = 1800/P). The greater P, the lower Ms/P and hence the lower the LM curve (LM shifts leftward as P rises), and hence the higher the interest rate. The greater the interest rate the lower aggregate expenditures. Thus aggregate demand, D[P], is negatively sloped.
On the supply side, given expected inflation equal to zero and sticky wages, we get a positively sloped supply, S[P] intersecting longrun supply at X=7500. This contrasts with the horizonatal S[P] in Part II.
The equilibrium would be at an output for which S[P] = D[P] which would lie between X= 7142.857 of Section A and X=7500 (the natural rate of output). The LM for Section B case is rightward of the LM in Section A. P=2 in Section A but since P is less than 2 in Section B, LM is higher. See Figs. 1 and 2 below.
Part II: Section A
When the demand for money is high (low), the LM curve will be low
(high). For example, in Figure 6 at an income of Xo, when money
demand is unsually high (low), the equilibrium interest rates is rc
(ra). An unusually high (low) money demand drives up (down) interest
rates which result in lower (higher) aggregate expenditures and a
lower output level.
[Note that since the IS curve gives the equilibrium output for the product market at each interest rate, the changes in interest rates caused by money demand changes do not result in shifts in the IS curve. As the interest rate increases, aggregate expenditures decrease and reduce the equilibrium output and income levels but these produce movements up the IS curve not changes in the entire schedule.]
As shown in Figure 7 the equilibrium (r,X) values are alpha, beta, and gamma depending on whether money demand is unusually low, average, or unusually high.
Part II: Section B
At high (average, low) investment demand (Figure 3) , aggregate
spending (Figure 4) will be high (average, low) resulting in high
(average, low) IS curves (Figure 5) and correspondingly high,
XIII (average- XII, low-XI) general
equilibrium income and interest rate levels.
[Unlike Section A, the IS curve does shift here. Since the shocks are
producing different investment spending at each interest rate, there
is a different aggregate demand at each interest rate and
consequently a different equilibrium income and output at each
interest rate.]
Part II: Section C
Policy #1: If the Fed keeps the money supply constant, the general equilibrium (r,X) correspond to points alpha, beta, and gamma as illustrated in Figure 9. For example, assume the Fed keeps the money supply at 100. When L is high, interest rates rise thus reducing investment spending. The rise in L causes LM to shift to the left to LMHigh and the output falls to Xlow (point gamma). Thus output would range from Xlow to Xhigh in Figure 9 as money demand ranges from Lhigh to Llow.
Policy #2: In contrast, if the Fed varies the money supply sufficiently to keep the interest rate constant at r*, output would remain at X* (as long as IS is unchanging).
For example, Lmid(X*) is average level of money demand yielding a general equilibrium at (r*,X*) when M/P=100 (point gamma in Figure 8 and beta in Figure 9). Now suppose the demand for money increased; people would sell bonds to accrue money balances and interest rates would begin to rise; without Fed response the LM shifts leftward and we start a movement towards point theta in Figure 9. In Policy #2, order to keep r=r*, the Fed increases the money supply to 120 (point theta' in Figure 8) which keeps LM passing through r* (beta in Figure 9 ). Output thus remains at X*.
If the demand for money decreased and LM increased, interest rates would fall and we would head towards point alpha. To keep r=r*, the Fed would reduce M/P below 100 and the LM curve would pass through point beta and output remains at X*.
Policy #2 thus results in smaller output variation than Policy #1 (if the IS curve is unchanged).
Part III
If a positively sloped supply curve exists, the range of output variation under constant nominal money supply policy is smaller because the real money supply variation is smaller. If money demand increases, LM and D[P] shift leftward; If prices were unchanged LM would intersect IS at point gamma. (Fig. 10) But prices decline if S is positively sloped and the decline in P results in a higher supply in real money balances than if prices were constant. As a result LM intersects IS at delta instead of gamma. (Fig. 10)
Because the Micro answers have complicated mathematical expressions that do not display well in most browsers, we have decided to create an Adobe Acrobat pdf version of the answer key.
If you have Adobe Acrobat installed, click here to get the 1998 Micro Answer Key.
If you do NOT have Acrobat installed, you need to first get it. In order to view and print the pdf formatted version of the 1998 Micro Comps Answer Key, you need to have the free Adobe Acrobat® Reader 3.0 software on your computer. If you do not have Adobe Acrobat® Reader 3.0 currently installed, you can download it from:
Once you have Adobe Acrobat installed, simply click here to get the 1998 Micro Answer Key.
If you have any problems, send me an e-mail and I'll be happy to help you out.