Public Policy and Macroeconomics Exam Solutions
Course Introduction
This course explores the intersection of public policy and macroeconomic theory, analyzing how government actions influence overall economic performance. Students will examine key macroeconomic concepts such as GDP, inflation, unemployment, fiscal and monetary policy, and assess the effectiveness and implications of various policy tools in stabilizing economies, promoting growth, and addressing economic crises. The course emphasizes critical policy debates, the roles of governmental and international institutions, and employs case studies to understand policy outcomes in different national and global contexts.
Recommended Textbook
Macroeconomics 7th Edition by Olivier Blanchard
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Page 2
Chapter 1: A Tour of the World
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Q1) Explain how the financial crisis turned into a major economic crisis.
Answer: Hit by the decrease in housing prices and the collapse in stock prices,and worried that this might be the beginning of another Great Depression,people sharply cut back consumption.Worried about sales and uncertain about the future,firms sharply cut back investment..Decreases in consumption and investment led to decrease in demand,which in turn,led to decrease in output.
Q2) Between 2010 and 2014,the annual rate of output growth in China was approximately equal to A)2%.
B)5%.
C)9%.
D)20%.
Answer: C
Q3) Explain why the U.S.crisis became a world crisis.
Answer: Other countries were affected through two channels.The first channel was trade.As U.S.consumers and firms cut spending,part of the decrease fell on imports of foreign goods.The second channel was financial.U.S.banks,badly needing funds in the United States,repatriated from other countries,creating problems for banks in those countries.The result was not just a U.S.,but a world recession.
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Chapter 2: A Tour of the Book
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Q1) Hedonic pricing is used to
A)convert nominal values to real values.
B)calculate the difference between nominal GDP and real GDP.
C)measure the rate of change in real GDP.
D)obtain chain-weight indexes.
E) none of the above
Answer: E
Q2) During the mid-1980s,we observed a significant reduction in oil prices.In the United States,we would expect that this reduction in oil prices would cause
A)a larger reduction in the CPI compared to the GDP deflator.
B)an equal reduction in the CPI and GDP deflator.
C)a larger reduction in the GDP deflator compared to the CPI.
D)no change in the CPI and a reduction in the GDP deflator.
Answer: A
Q3) According to convention,a recession is referred to if an economy goes through
A)at least two consecutive quarters of negative growth.
B)at least three consecutive quarters of negative growth.
C)at least four quarters of negative growth.
D)at least two consecutive months of negative growth.
Answer: A
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Chapter 3: The Goods Market
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Q1) If C = 2000 + .9YD,what increase in government spending must occur for equilibrium output to increase by 1000?
A)100
B)200
C)250
D)500
E) 1000
Answer: A
Q2) Disposable income equals
A)income minus saving.
B)income minus both saving and taxes.
C)consumption minus taxes.
D)the sum of consumption and saving.
E) none of the above
Answer: D
Q3) In the model discussed in Chapter 3,why do we assume G and T are exogenous?
Answer: It is based on two arguments: First,government do not behave with the same regularity as consumers or firms,so there is no reliable rule we could write for G or T.Second,treating G and T as exogenous help explore the implications of alternative spending and tax decisions.
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Chapter 4: Financial Markets
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Q1) Which of the following will cause an increase in the amount of money that one wishes to hold?
A)an increase in the interest rate increase
B)a reduction in the interest rate increase
C)a reduction in income
D)none of the above
Q2) An increase in the interest rate will cause
A)a reduction in the supply of central bank money.
B)a reduction in the demand for currency.
C)a reduction in the demand for reserves.
D)all of the above
E) both B and C
Q3) An open market sale of bonds by the central bank will cause which of the following when a liquidity trap situation exists?
A)The interest rate will increase.
B)The interest rate will not change.
C)Output will decrease.
D)The money supply, M, will not change.
E) none of the above
Q4) What is the difference between saving and savings?
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Chapter 5: Goods and Financial Marketsthe Is-Lm Model
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Q1) Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve.Which of the following is true for this economy?
A)Production does not equal demand.
B)The money supply does not equal money demand.
C)The quantity supplied of bonds does not equal the quantity demanded of bonds.
D)Financial markets are not in equilibrium.
E) all of the above
Q2) An increase in government spending will likely have which of the following effects?
A)a rightward shift in the IS curve
B)a leftward shift in the IS curve
C)an upward shift in the LM curve
D)a downward shift in the LM curve
Q3) If government spending and taxes increase by the same amount,
A)the IS curve does not shift
B)the IS curve shift leftward
C)the IS curve shifts rightward
D)the LM curve shifts downward
Q4) First,define the LM curve.Second,explain why it has its particular shape.
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Chapter 6: Financial Markets Ii: the Extended Is-Lm Model
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Q1) If the expected real interest rate 5% and expected inflation 3%,the nominal interest rate in year t is approximately
A)2%.
B)3%.
C)5%.
D)8%.
E) 11%.
Q2) Holding large amounts of bank capital helps prevent bank failures because A)it means that the bank has a higher income.
B)it makes loans easier to sell.
C)it can be used to absorb the losses resulting from bad loans.
D)it makes it easier to call in loans.
Q3) With a nominal interest rate of 5%,the present discounted value of $100 to be received in two year is
A)$90.00.
B)$90.70.
C)$95.23.
D)$110.00.
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Chapter 7: The Labor Market
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Q1) Suppose we wish to examine the determinants of the equilibrium real wage and equilibrium level of employment (N).In a graph with the real wage on the vertical axis,and the level of employment on the horizontal axis,the wage-setting relation will now be
A)a vertical line.
B)a horizontal line.
C)an upward sloping line.
D)a downward sloping line.
E) a curve that first slopes upward, then downward.
Q2) A reduction in the unemployment rate will tend to cause which of the following?
A)an increase in the separation rate
B)a reduction in the nominal wage
C)a reduction in the duration that one is unemployed
D)none of the above
Q3) The natural rate of unemployment is the rate of unemployment
A)that occurs when the money market is in equilibrium.
B)that occurs when the markup of prices over costs is zero.
C)where the markup of prices over costs is equal to its historical value.
D)that occurs when both the goods and financial markets are in equilibrium.
E) none of the above
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Chapter 8: The Phillips Curve, the Natural Rate of Unemployment, and Inflation
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Q1) A number of factors are believed to have caused changes in the natural rate of unemployment in the United States during the 1990s.Briefly comment on each of these factors.
Q2) During which decade did the original Phillips curve break down? Also,briefly explain why the original Phillips curve broke during this period.
Q3) During the Great Depression,the actual unemployment rate in the U.S.________,and the natural rate apparently ________.
A)increased; decreased B)increased; remain unchanged C)increased; increased as well D)decreased; increased E) decreased; remained unchanged
Q4) Explain what is meant by the "wage-price" spiral.
Q5) What is the difference between deflation and disinflation?
Q6) Briefly comment on the predictions of economists Milton Friedman and Edmund Phelps about the ability to exploit a trade-off between inflation and unemployment.
Q7) Why has the U.S.natural rate of unemployment fallen since the early 1990s?
Q8) Explain the natural unemployment rate and its relationship to inflation rate.
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Q1) The natural rate of interest is not A)zero.
B)the neutral rate of interest.
C)Wicksellian rate of interest.
D)associated with the natural rate of unemployment.
Q2) Okun's law shows that when the unemployment rate is below the natural rate,
A)inflation is higher than expected.
B)inflation is lower than expected.
C)output is below potential.
D)output is above potential.
Q3) Okun's law shows that when the unemployment rate is above the natural rate, A)inflation is higher than expected.
B)inflation is lower than expected.
C)output is below potential.
D)output is above potential.
Q4) When a government reduces its deficits by increasing taxes,in the medium run, A)output returns to potential.
B)output increases.
C)interest rate is higher.
D)IS curve shifts inward to the left.
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Chapter 10: The Facts of Growth
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Q1) Briefly explain what effect a reduction in the saving rate will have on growth.
Q2) Assume that constant returns to scale exists and that N and K both decrease by 3%.Given this information,we know that
A)output (Y)will decrease 6%.
B)Y will decrease by 3%.
C)Y will decrease by less than 3%.
D)the capital-labor ratio (K / N)will decrease.
Q3) Which of the following must occur to sustain economic growth in the long run?
A)technological progress
B)capital accumulation
C)a higher saving rate
D)all of the above
Q4) Is it possible for a country to experience a permanent increase in output per worker over time? If so,how can this occur?
Q5) Decreasing returns to capital (N)implies that a 4% increase in N will cause
A)Y to increase by more than 4%.
B)Y to increase by exactly 4%.
C)Y to increase by less than 4%.
D)no change in Y / N.
Q6) Briefly explain what effect an increase in the saving rate will have on growth.
Page 12
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Chapter 11: Saving, capital Accumulation, and Output
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Q1) Graphically illustrate and explain the effects of an increase in the rate of depreciation ( )on the Solow growth model.In your graph,clearly label all curves and equilibria.
Q2) Suppose the following situation exists for an economy: Kt / N < Kt / N.Given this information,we know that
A)saving per worker equals depreciation per worker in period t.
B)consumption per worker will tend to fall as the economy adjusts to this situation.
C)saving per worker is greater than depreciation per worker in period t.
D)the saving rate increased in period t.
E) none of the above
Q3) Explain what human capital is and discuss how changes in human capital can affect output per worker.
Q4) During the latter half of the 1990s,the U.S.saving rate decreased.Will this reduction in the saving rate have a permanent effect on the rate of growth of output per worker? Explain.
Q5) For an economy in which there is no technological progress,explain what must occur for the steady state to occur.Also explain what this implies about the rate of growth of output,output per worker,and the capital stock.
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Chapter 12: Technological Progress and Growth
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Q1) In the following production function,Y = f(K,NA),suppose A increases by 20%.This 20% increase in A implies that
A)the same output can be produced with 20% less labor.
B)the effective quantity of labor has increased by 20%.
C)output will increase by less than 20%.
D)all of the above
E) both A and C.
Q2) Assume that an economy experiences both positive population growth and technological progress.Once the economy has achieved balanced growth,we know that output (Y)is
A)constant.
B)growing at a rate of gA + gN.
C)growing at a rate of gN.
D)growing at a rate of gA.
E) growing at a rate of gA - gN.
Q3) Suppose there is an increase in the saving rate.Explain what effect this increase in the saving rate will have on the rate of growth of output per worker.
Q4) Explain the different dimensions of technological progress.
Q5) What factors determine technological progress?
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Chapter 13: Technological Progress: the Short, the Medium, and
the Long Run
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Q1) Based on price setting behavior,which of the following will cause a reduction in the price level?
A)an increase in productivity
B)a reduction in the nominal wage
C)a reduction in the markup
D)all of the above
E) none of the above
Q2) First,explain each of the following: hysterisis and Eurosclerosis.Second,explain how each of them can be used to explain the relatively high natural rate of unemployment in Europe.
Q3) Suppose an economy experiences a reduction in productivity.Explain both the short-run and medium-run effects of this reduction in productivity on output,employment,and the unemployment rate.
Q4) For this question,assume that expectations of P and A are correct.Now suppose that there is a 4% increase in A.Given this information,which of the following will occur?
A)The PS relation will shift up by 4%.
B)The WS relation will shift up by less than 4%.
C)The WS relation will shift down by 4%.
D)The PS relation will shift down by 4%.
Page 15
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Chapter 14: Financial Markets and Expectations
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Q1) For this question,assume that the Fed is expected to respond to any event by keeping the interest rate constant (i.e.,equal to its initial level).An unexpected tax increase will cause
A)stock prices to fall.
B)stock prices to rise.
C)no change in stock prices.
D)an ambiguous effect on stock prices.
Q2) Which of the following bonds (of equal maturity)would have the largest risk premium?
A)U)S. government bonds
B)German government bonds
C)the bonds of a financially stable corporation, like IBM
D)Bondsbrated Aaa by Moody's
E) junk bonds
Q3) A discount bond is a bond
A)with no coupon payments.
B)where the price of the bond is greater than its face value.
C)where the interest rate is zero.
D)where the face value is zero.
E) that never matures.
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Chapter 15: Expectations, consumption, and Investment
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Q1) Consumption is most likely to respond one-for-one with changes in current income when
A)the change in current income results from a one-time bonus.
B)people believe the change in their current income is temporary.
C)people are able to borrow as much as they wish, as long as they pay it back.
D)the change in current income is caused by the business cycle.
E) none of the above
Q2) Human wealth is
A)the present discounted value of expected future after-tax labor income.
B)the sum of financial and housing wealth.
C)the discounted present value of all financial assets.
D)financial wealth minus housing wealth.
E) total wealth minus housing wealth.
Q3) Explain how expectations affect consumption.
Q4) Discuss the various components of wealth.
Q5) Explain how a change in expected future output could affect current output.
Q6) What is Tobin's q? How tight is the relation between Tobin's q and investment?
Q7) Suppose firms expect future output to be higher and future interest rates to be higher.Given this information,how will firms alter investment in the current period? Explain.
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Chapter 16: Expectations, output, and Policy
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Q1) Suppose individuals now believe that there will be a future tax cut.This reduction in expected future taxes will cause which of the following to occur in the current period?
A)the LM curve to shift down
B)the LM curve to shift up
C)the IS curve to shift rightward
D)the IS curve to shift leftward
E) none of the above
Q2) Suppose the central bank reduces the money supply.This monetary contraction will always cause a greater reduction in output when it is accompanied by
A)an increase in expected future taxes.
B)an increase in expected future interest rates.
C)a reduction in expected future output.
D)all of the above
E) none of the above
Q3) Explain whether a policy that results in a larger budget deficit in the current period can lead to a reduction in current output.
Q4) Explain the determinants of aggregate private spending.
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Chapter 17: Openness in Goods and Financial Markets
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Q1) Which of the following expressions represents the real exchange rate ( )?
A)E / P.
B)EP* / P.
C)EP*.
D)EP / P*.
E) none of the above
Q2) Suppose you are considering the purchase of a bond issued in another country.What calculations must you do to calculate the expected return on a foreign bond? Explain.
Q3) Assume that the nominal exchange rate decreases by 4%.If prices (both domestic and foreign do not change),we know that
A)foreign goods are now relatively cheaper.
B)foreign goods are now relatively more expensive.
C)domestic goods are now relatively more expensive.
D)both A and C
Q4) Which of the following will cause a real appreciation?
A)a reduction in E
B)a decrease in P
C)an increase in P*
D)none of the above
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Chapter 18: The Goods Market in an Open Economy
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Q1) Suppose a country is experiencing a situation where output is above the full employment level of output and a trade deficit.Further assume that the policy makers' goals are to achieve full employment output and balanced trade.Given this information,what type of exchange rate and / or fiscal policy can be used to achieve simultaneously these two goals? Explain.
Q2) Which of the following is true when a county is experiencing a trade deficit (NX < 0)?
A)Demand for domestic goods is equal to the domestic demand for goods.
B)Demand for domestic goods is greater than the domestic demand for goods.
C)Demand for domestic goods is less than the domestic demand for goods.
D)A budget deficit exists.
Q3) Suppose a country's output is below the policy makers' desired level of output and is experiencing a trade surplus.Assume that the policy makers' goals are to achieve the desired level of output (i.e.,full employment output)and balanced trade.Given this information,what type of exchange rate and / or fiscal policy can be used to achieve simultaneously these two goals? Explain.
Q4) Explain what the J-curve is and why it occurs.
Q5) Explain why the demand for domestic goods curve (ZZ)has a different shape than the domestic demand curve (DD).
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Chapter
19: Output, the Interest Rate, and the Exchange Rate
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Q1) A real depreciation will tend to cause
A)a reduction in exports.
B)an increase in imports.
C)a reduction in net exports.
D)an increase in demand for domestic goods.
E) none of the above
Q2) Suppose a country switches from a fixed to a flexible exchange rate.Which of the following will occur as a result of this change?
A)Monetary policy will become a less effective tool for changing output.
B)A given change in government spending will now have a greater effect on output.
C)Both fiscal and monetary policy will become more effective in changing GDP.
D)Both fiscal and monetary policy will become completely ineffective in changing GDP.
E) none of the above
Q3) To what extent can monetary policy be used to affect output in a fixed exchange rate regime? Explain.
Q4) For a country pursuing a fixed exchange rate regime,what does the interest parity condition imply about domestic and foreign interest rates? Explain.
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Chapter 20: Exchange Rate Regimes
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Q1) Explain why exchange rates are more volatile than is suggested by the relatively simply interest parity condition presented earlier in the course.
Q2) Which of the following is an advantage of a common currency in Europe?
A)Each country could conduct its own, independent monetary policy.
B)Exchange rate uncertainty within the common currency area would be eliminated.
C)Each country could conduct its own, independent fiscal policy.
D)all of the above
E) none of the above
Q3) European currencies taken out of circulation and replaced with the Euro in A)1992.
B)1997.
C)1999.
D)2004. E) none of the above
Q4) Assume a country is in a fixed exchange rate regime.Explain what factors might cause individuals to expect that a country will devalue its currency.
Q5) Suppose output is above the natural level of output.In a fixed exchange rate regime,explain the two ways the economy can return to the natural level of output.
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Chapter 21: Should Policy Makers Be Restrained
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Q1) Which of the following was one of the main rules in the 1990 "Budget Enforcement Act"?
A)flat tax rate
B)PAYGO rule
C)indexation of income tax brackets
D)consumption tax
E) none of the above
Q2) Suppose an elected official wishes to introduce a new government program.Under a PAYGO rule,this new program would be adopted only if
A)the budget deficit is reduced by the same amount as the costs of the new program.
B)the budget deficit is reduced by half the amount of the costs of the new program.
C)the new program does not result in an increase in the current or future budget deficit.
D)none of the above
Q3) What were some of the key features in terms of fiscal policy of the Stability and Growth Pact signed in 1997 by would-be members of the Euro?
Q4) Explain spending caps set by the Budget Enforcement Act.
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Chapter 22: Fiscal Policy: a Summing up
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Q1) The "official measure" of the deficit (the one reported by the government)
A)tells us the change in government nominal debt.
B)is equal to nominal interest payments on the debt plus the primary deficit.
C)overestimates the real budget deficit whenever the inflation rate is positive.
D)all of the above
E) none of the above
Q2) Explain the economic costs of hyperinflation.
Q3) If the Ricardian equivalence proposition is correct,then
A)deficits harm future generations.
B)deficits reduce investment spending.
C)deficits stimulate the economy in the short run.
D)all of the above
E) none of the above
Q4) The debt-ratio is the ratio of the debt to A)government spending.
B)saving.
C)taxes.
D)personal disposable income.
E) GDP.
Q5) What are the primary causes of hyperinflations? Explain.
Page 24
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Chapter 23: Monetary Policy: a Summing up
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Q1) M2 is also referred to as which of the following?
A)currency
B)narrow money
C)near money
D)high powered money
E) none of the above
Q2) Discuss the change of the design of monetary policy over time.
Q3) For this question,assume that the Fed sets monetary policy according to the Taylor rule.Suppose current U.S.macroeconomic conditions are represented by the following: > ?* and u = un.Given this information,we would expect that the Fed will
A)implement a monetary contraction.
B)implement a monetary expansion.
C)maintain its current stance of monetary policy.
D)more information is need to answer this question.
Q4) What are some of the questions about the macro prudential tools?
Q5) Suppose an economy experiences an increase in inflation.Explain the possible macroeconomic benefits of this increase in inflation.
Q6) What are the lessons from the crisis for monetary policy?
Q7) Discuss and explain each of the instruments of monetary policy.
Page 25
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Chapter 24: Epilogue: the Story of Macroeconomics
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Q1) The flatter is the IS curve,
A)the more effective is monetary policy.
B)the less effective is monetary policy.
C)the effectiveness of monetary policy does not change.
D)a given change in the money supply will have a smaller effect on output.
Q2) The less staggered are labor contracts,
A)the more rapidly the economy will adjust to changes in aggregate demand.
B)the less rapidly the economy will adjust to changes in aggregate demand.
C)the greater the inflationary effects of a given change in money growth in the medium run.
D)the less inflationary effects of a given change in money growth in the medium run.
Q3) The theories of investment were developed by
A)Friedman and Phelps.
B)Hicks and Hansen.
C)Modigliani and Friedman.
D)Lucas and Sargent.
E) Tobin and Jorgenson.
Q4) Discuss research on the role of banks and other financial institutions in the intermediation of funds between lenders and borrowers.
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Chapter 25: Appendix
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Q1) If GDP is more than GNP,we know with certainty that
A)a budget deficit exists.
B)a trade surplus exists.
C)a trade deficit exists.
D)none of the above
Q2) Which of the following is included in National Income?
A)indirect taxes
B)consumption of fixed capital
C)proprietors' income
D)all of the above
Q3) Which of the following problems would lead an economist to use instrument variable methods?
A)The dependent variable has an impact on the independent variable.
B)There are too few quarters of data.
C)There are too many independent variables.
D)The R² is too high.
E) The residuals are too small.
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