Time Limit:2 Hours and 45 Minutes Total Points: 200
Econ 332: Intermediate Macroeconomics
SP 2021: Midterm Exam
March 10th, 2021
Grade Table (for Teacher use only)
Question: 1 2 3 4 5 6 Total
Points: 32 40 39 35 30 24 200
Score:
1. Suppose you have the following data for the United Kindom for 2020:
Quarter Real GDP Nominal GDP Working age population Employeds LFP CPI
2020-Q2 372.77 476.39 41.88 32.50 64.2 108.7
2020-Q3 432.42 538.87 41.94 32.43 63.7 109.1
Here, both GDP numbers are in billions of British pound sterling. Working age popukation and number
of employeds are in millions of people. Laborforce participation (LFP) is in percent and CPI is an index.
Use data in the table above to answer the following questions. For each part you must show your work
for receiving any credit.
(a) (4 points) Compute the annualized real GDP growth between Q2 and Q3 of 2020. What is the
interpretation of this number. Explain.
(b) (4 points) Compute the GDP deflator for each quarter.
(c) (10 points) Compute the rate of inflation between Q2 and Q3 using CPI. Now compute the rate
of inflation between Q2 and Q3 using the GDP deflator. Why are these two numbers different?
Explain.
(d) (4 points) If employment ratio is the number people employed as a fraction of working age popu-
lation, compute this ratio for each quarter.
(e) (10 points) Compute the size of the UK labor force for each quarter.
2. Suppose the U.S. good’s market can be represented by the following set of equations:
C = 2000 + 0.75 · (Y − T )
I = 350
G = 200
T = 100
Econ 332 Midterm - Page 2 of 3 March 10th
(a) (10 points) Solve for goods market equilibrium output (Y). Show your work for credit.
(b) (15 points) Now suppose there is a crash in the stock market that lowers investment from 350 to
300 and the exogenous part of consumption from 2000 to 1900. Compute the new equilibrium value
of Y. Show your work for credit.
(c) (15 points) Now suppose the government plans to cut taxes T as well as increase G to take the
economy back to the output level in part (a). Suppose it can only cut taxes by 20. How much does
it need to increase G to achieve this goal? Show your work for credit.
3. Consider the following model of the economy
C = 300 + 0.5 · (Y − T )
I = 200− 1500 · i+ 0.4 · Y
G = 400
T = 200
(a) (9 points) Derive the equation for the IS curve. Show your work for credit.
(b) (15 points) Suppose the Fed sets the interest rate at i = 2.5% This is your LM curve. Compute
the short run equilibrium output (Y), consumption (C), and investment (I). Verify that C+I+G is
indeed equal to the equilibrium value of Y you obtained. Show your work for credit.
(c) (15 points) Now suppose the Fed increases interest rate to 3.5%. Compute the new short run equi-
librium output (Y), consumption (C), and investment (I). Why would this policy be implemented
in a real world setting? Explain.
4. During the first four quarters of 2017 the US economy grew at an average rate of more than 2 percent.
At the end of 2017, backed by the Trump administration, the Congress and the Senate, a large decrease
in corporate taxes as well as personal income taxes were implemented. Around the same time, concerned
about the potential for inflation that these tax cuts could generate in a growing economy, the Federal
Reserve Bank started increasing the federal funds rate.
(a) (15 points) Using the short run economy and the IS-LM framework we covered in class, which of
the above two policies (tax cut and increase in FFR) can be considered consistent with the policy
recommendations of this model based on the state of the economy. What other economic reasons
can be used to justify such tax cuts in a growing economy? Explain.
(b) (20 points) Using the IS-LM diagram, explain how these two policies when implemented simulta-
neously would affect the equilibrium output in the short run. Is it possible for the output to fall
after this policy mix is implemented? Explain.
5. Consider the following set of equations that represent an economy:
IS : Y = C(Y − T ) + I(r + x, Y ) +G
LM : r = r
Answer the following questions using this model.
(a) (15 points) Suppose inflation expectations increase due a shock to the economy and the Fed does
not respond to this shock immediately. Using the IS-LM diagram explain how this shock will
affect the equilibrium in the short run. Explain how we can restore the pre-shock equilibrium with
a combination of monetary and fiscal policy. Show the effect of these policies using the IS-LM
diagram.
(b) (15 points) Suppose due to a string of bankruptcies there is increased uncertainty in the economy.
Using the IS-LM diagram explain how this shock will affect the equlibrium in the short run. Explain
how the Fed can respond to this shock to restore the pre-shock equilibrium. Here you should use
our discussion on the financial crisis of 2008 to support your arguments.
Econ 332 Midterm - Page 3 of 3 March 10th
6. True or False? You need to explain your choice. Keep your explanations brief and to the point. Credit
will only be awarded for stating the right reason for the correct choice.
(a) (6 points) Only comparing real GDP between two time periods is sufficient to measure economic
performance as nominal GDP changes can play no role in determining how well an economy is doing
over time.
(b) (6 points) Suppose mpc is 0.75. If both government spending and taxes are increased by the
same amount then there will be no shift in the IS curve leaving the short run equilibrium output
unchanged.
(c) (6 points) Higher leverage implies greater profits from investment. Consequently, an increase in the
leverage in the financial system will boost investment spending and shift the IS curve to the right.
(d) (6 points) The assumption of monopolistic competition alone is sufficient to explain why prices are
fixed in the short run. 