MGEB06 Sample Final Questions ¤ Iris Au 1
MGEB06 Sample Final Questions

These are some of the past Final exam questions. These questions are collections from
different exams (the total marks do not add up to 100) and are for your reference only.
You should also practice the review and assignment questions again assigned throughout
the term.

Instructions:
x Answer all questions.
x Point form is acceptable.
x You must submit the questions along with your answer booklet; otherwise, you will
receive a grade of ZERO for the whole exam.
x No credit will be given if you do not show your work.
x Label your graph; otherwise, marks will be subtracted.
x If the question has more than one part, label each part of your answer. Latter part(s) of
the question will not be graded if you failed to label your answer.
x Do not write exchange rate increases/decreases, you should state whether the currency
appreciates or depreciates.
x Your answer should be structured in a way that even those with limited knowledge in
economics will understand your argument/answer

Question 1 (15 points)
The economy is currently in its long-run equilibrium. However, there are evidences indicating
that there is an increase in (autonomous) consumption.
a) According to the long-run classical model of a closed economy, what would happen to the
HFRQRP\¶VRXWSXWUHDOLQWHUHVWUDWHDQGLQYHVWPHQW"6XSSRUW\RXUDQVZHUE\DQDSSURSULDWH
diagram. (6 points)
b) Suppose the government finds the change in real interest rate in part (a) undesirable and
wants to maintain the real interest rate at the initial level, what policy would you recommend
the government to pursue? Explain how the recommended policy could achieve the goal of
WKHJRYHUQPHQW $OVRKRZGRHVWKLVUHFRPPHQGHGSROLF\DIIHFW WKHFRXQWU\¶VRXWSXWUHDO
interest rate, and investment? Use the diagram your drew in part (a) to support your answer
and discuss the magnitudes of changes of the above macroeconomic variables after your
recommended policy is implemented (compare your answer in part (b) to your answer in part
(a)) (9 points)

Question 2 (10 points)
Consider an economy described by the production function: Y = F(K, EL) = 3K1/3(EL)2/3.
a) Find the steady-state capital per effective worker and output per effective worker if the
depreciation rate is 7%, the population growth rate is 5%, the growth rate of efficiency of
worker is 3%, and the saving rate is 20%. (4 points)
b) Redo part (a) if the production function becomes Y = F(K, EL) = 12K1/3(EL)2/3. (2 points)
c) Explain your results in parts (a) and (b) in words and an appropriate diagram (4 points).



MGEB06 Sample Final Questions ¤ Iris Au 2
Question 3 (15 points)
³:KHQ WKH HFRQRP\ LV LQLWLDOO\ DERYH LWV JROGHQ UXOH FKDQJLQJ WKH VDYLQJ UDWH WR UHDFK WKH
golden rule involves no trade-off between current (or initial) consumption and future
FRQVXPSWLRQ´ 7UXHFalse/Uncertain, explain in the context of the Solow Growth Model
(support your answer by a Solow Model diagram and the time path of consumption per worker).

Question 4 (10 points)
³7KH 6RORZPRGHO SUHGLFWV D IDOO LQ GHSUHFLDWLRQ UDWHZLOO LQFUHDVH WKH FDSLWDO-labour ratio in
transition and in the new steady-state; but this will lead to a lower steady-state growth rate of
WRWDORXWSXW´7UXH)DOVH8QFHUWDLQH[SODLQDQGVXSSRUW\RXU answer in an appropriate diagram
(you can assume there is a population growth of n% a year and there is no technological
progress).

Question 5 (15 points)
³7KH TXDQWLW\ WKHRU\ RI PRQH\ VWDWHV WKDW JLYHQ D FRQVWDQW YHORFLW\ WKHUH LV D RQH-to-one
relationship between monetary growth rate and inflation rate, even if the growth rate of labour
UHPDLQVFRQVWDQW´7UXH)DOVH8QFHUWDLQH[SODLQ

Question 6 (15 points)
Consider an economy with 5000 people in the labour force. At the beginning of every month, 50
people lose their jobs and remained unemployed for exactly one month; one month later, they
find new jobs and become employed. On January 1 of each year, 200 people lose their jobs and
remained unemployed for 6 months before finding new jobs. Finally, on July 1 of each year, 200
people lose their jobs and remain unemployed for six months before finding new jobs.
a) What is the unemployment rate in this economy in a typical month? (3 points)

Now, a study shows that in the long run the job finding rate and the job separation are 18% and
2% respectively.
b) What is the natural rate of unemployment? If the unemployment rate in part (a) were the
current unemployment rate, what would you expect to happen in the unemployment rate over
the long run? Briefly explain. (5 points)
c) Suppose, in order to help those who suffer from the unemployment spell, the government of
this economy decides to provide unemployment insurance to the unemployed. How does the
provision of unemployment insurance affect the natural rate of unemployment in this
economy? Explain and you should relate your answer to the job finding and job separation
rates. (7 points)

Question 7 (10 points)
a) Between December 2002 and December 2003, total employment increased by 427,400
workers, but the number of unemployed declined by only 182,600. How are these numbers
consistent with each other? Why might one expect a reduction in the number of people
counted as unemployed to be smaller than the increase in the number of people employed?
Explain. (5 points)
b) Statistics Canada announced that in December 2000, of all adult Canadians, 14,974,500 were
employed, 1,015,300 were unemployed, and 8,459,400 were not in the labour force. What
MGEB06 Sample Final Questions ¤ Iris Au 3
was the labour-force participation rate? What was the unemployment rate? (Keep your
answer in percentage terms and keep 1 decimal point) (5 points)

Question 8 (25 points)
Suppose there are only two countries in the world, Foreign and Home. Foreign is a large country
while Home is small country. Currently, Home runs a huge trade deficit. Concerning about the
FRXQWU\¶V WUDGHEDODQFH WKHJRYHUQPHQWRI+RPHEHJLQV WR ORRNIRUSROLF\ WKDWFDQFRUUHFW LWV
trade deficit. The Home government asks you for recommendation. In addition, the Home
government wants you to use the long-run classical model of a small open economy to evaluate
the long-UXQHIIHFWVRI\RXUUHFRPPHQGHGSROLF\RQWKH+RPH¶VNH\PDFURHFRQRPLFVYDULDEOHV
(output, national saving, investment, real interest rate, net foreign investment, net exports, real
exchange rate, nominal exchange rate, price level, and unemployment rate).

What policy would you recommend? What happens to the key macroeconomic variables in the
long run? Explain and support your answer by a set of appropriate diagrams.

Note: You must provide explanation on how your recommended policy affects the key variables
(explain why the variables change or remain unchanged).

Question 9 (10 points)
³7RPLQLPL]H IOXFWXDWLRQV LQ RXWSXW in a closed economy, the central bank should target the
PRQH\ VXSSO\ QRW WKH UHDO LQWHUHVW UDWH LI VKRFNV RULJLQDWHG IURP WKH JRRGV PDUNHW´
True/False, explain and use ONE IS-LM diagram to support your argument (Only the first
diagram will be graded)

Question 10 (10 points)
Suppose a closed economy is currently producing above its full capacity. Knowing that you are
an expert in macroeconomic, policy makers want you to suggest a policy that would bring the
economy back to its full-employment equilibrium and, at the same time, prevent the level of
investment from falling. What kind of policy, fiscal or monetary, would you suggest? Explain
with the help of ONE IS-LM diagram.

Question 11 (20 points)
Answer the following questions using the IS-LM model and support your explanation by ONE
diagram for all parts. Also, compare your answer to initial equilibrium. Each part is worth 5
points.

Suppose a closed economy experiences a fall in money demand.
a) What happens WRWKHHFRQRP\¶VRXWSXWSULFHUHDOPRQH\EDODQFHDQGXQHPSOR\PHQWUDWe in
the short run? Explain.
b) In the absence of intervention from policy makers, what happens WR WKHHFRQRP\¶VRXWSXW
price, the real money balance and unemployment rate in the long run? Explain.
c) Suppose the government finds the change in output in part (a) undesirable and wants to keep
output from changing, what kind of policy should the government pursue? What happens to
the real money balance?
MGEB06 Sample Final Questions ¤ Iris Au 4
d) Suppose the central bank finds the change in output in part (a) undesirable and wants to keep
output constant, what kind of policy should the central bank pursue? What happens to the
real money balance?

Question 12 (15 points)
Answer the following questions using the AS-AD model and support your explanation by ONE
diagram for all parts. You should compare your answer to the initial equilibrium.

A closed economy experiences a favorable shock in the demand for goods and services.
a) What happens to the HFRQRP\¶VRXWSXWSULFHUHDOPRQH\EDODQFHDQGXQHPSOR\PHQWUate in
the short run? In the long run? Explain. (10 points)
b) Suppose the government finds the short-run change in output undesirable and wants to keep
it from changing, what kind of policy should the government adopt? What is the effect of
this change in policy on the real money balance? Explain. (5 points)

Question 13 (20 points)
Consider the following closed economy:
Consumption: C = 325 + 0.5(Y ± T) ± 500r
Investment: I = 200 ± 500r
Real money demand: L(i, Y) = 0.5Y ± 1000i
Expected inflation: Se = 0
Money supply: MS = 6000
Full-employment level of output = 1000
Note: In this economy, consumption is not only depending on disposable income (as we
normally assumed) but also on the real interest rate. Interest rates, i and r, are expressed in
decimal points, i.e., if r = 0.5, then r = 50%.
a) Derive the IS and LM equations as functions of exogenous variables. (4 points)
b) The government runs a balanced budget; government purchases (G) and taxes (T) are both
equal to 150. Calculate the full-employment values of the real interest rate, price level,
consumption, and investment. (6 points)
c) Now suppose that government purchases increase to 250 and there is no change in taxes.
Assuming that the economy was initially at full employment, what are the new values of
output, the real interest rate, price level, consumption, and investment in the short run? In the
long run? (10 points)

Question 14 (20 points)
Consider the following closed economy:
Consumption: C = 300 + 0.5(Y ± T) ± 50r
Investment: I = 250 ± 200r
Government spending: G = 300
Taxes: T = 300
Real money demand: L(i, Y) = 0.5Y ± 250i
Expected inflation: Se = 0
Money supply: MS = 5000
Production function: Y = 6K0.5L0.5
Note: Interest rates, i and r, are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
MGEB06 Sample Final Questions ¤ Iris Au 5
a) Derive the AD equation for this economy. (6 points)
b) The supply of capital and labour in this economy are 400 and 100 respectively. Calculate the
full-employment values of the output, real interest rate, price level, and real money balance.
(4 points)
c) Now suppose that there is an increase in autonomous investment such that the investment
function become:
I = 350 ± 200r
Assuming that the economy was initially at full employment, what are the new values of
output, real interest rate, price level, and real money balance in the short run and the long
run? (10 points)

Question 15 (10 points)
A principal method used by the Bank of Canada to change money supply is open-market
operations. Use the AS-AD model to illustrate graphically and state in words the impacts, in
ERWKVKRUWUXQDQGORQJUXQRID%DQNRI&DQDGD¶VGHFLVLRQWRLQFUHDVHRSHQ-market purchases
on output and price.

Question 16 (30 points)
Macroland is a closed economy and is characterized by the following equations:
Consumption: C = 200 + 0.8(Y ± T) ± 500r
Investment: I = 200 ± 500r
Government spending: G = 196
Taxes: T = 20 + 0.25Y
Real money demand: L = 0.5Y ± 250i
Expected inflation: Se = 0.1
Production function: Y = K1/3L2/3
Note: Interest rates, i and r, are expressed in decimal points, i.e., if r = 0.5, then r = 50%.

Suppose the IS-LM model can used be to describe Macro-land, and answer the following
questions. Keep your answers to a minimum of TWO decimal points (for fractions).
a) Derive the IS and LM equations for this economy. (4 marks)
b) The supply of capital and labour in this economy are both equal to 1000; and the level of
money supply is 9890. Calculate the long-run or full-employment values of the output,
consumption, investment, real interest rate, public saving, private saving, national saving,
and price level. (5 marks)
c) Now suppose the central bank of Macro-land undertakes open market sales (of assets). As a
result, the level of money supply falls to 9200. Assuming that the economy was initially at
full employment, what are the new values of output, consumption, investment, real interest
rate, public saving, private saving, national saving, and price level in the short run and the
long run? (5 marks)

Now, instead of using the IS-LM model, the AS-AD model is used to describe Macro-land.
Note: DO NOT convert aggressively round your decimal places when you are solving for the
answers, please keep them in fractions with a reasonable number (two or three) of decimal
places. You can report your final answer in decimal form and with a minimum of TWO
decimal places.
MGEB06 Sample Final Questions ¤ Iris Au 6
d) Derive the AD equation. (5 marks)
e) Redo part (b) using the AS-AD model. (3 marks)
f) Redo part (c) using the AS-AD model. (3 marks)

Now compare your answers in the previous parts (part A to part F).
g) Do you get the same answer by using IS-LM model and AS-AD model to solve for the
equilibriums? Explain (in words and support by ONE IS-LM and ONE AS-AD diagram)
your findings on output, consumption, investment, real interest rate, public saving, private
saving, national saving, and price level in the short run and the long run when the central
bank of Macro-land carries open market sales. (5 marks)

Question 17 (10 points)
Consider a small open economy that has a flexible exchange rate regime, and it can be described
by the following set of equations:
Consumption: C = 1000 + 0.75(Y ± T)
Investment: I = 800 ± 10r
G = 200
T = 200
NX = 750 ± 100e
Real money demand: L(i, Y) = Y ± 50i
Expected inflation: Se = 0
Note: Both nominal and real interest rates are expressed in percentage points. For example, if r =
10, then r = 10%.
a) Derive the IS* and LM* equations in terms of exogenous variables if the world interest rate
is 10%. (4 points)
b) Suppose the level of money supply is 7000, the domestic price level is 2 and the foreign price
level is 6. Find the equilibrium values of output, net exports, nominal exchange rate, and real
exchange rate. (6 points)

Question 18 (15 points)
Consider a small open economy and it can be described by the following set of equations:
Consumption: C = 2500 + 0.75(Y ± T) ± 2500r
Investment: I = 3500 ± 2500r
G = 1500
T = G + 500
NX = 2000 ± 75e
Real money demand: L = 0.4Y ± 500r
Note: Real interest rates are expressed in decimal points, i.e., if r = 0.5, then r = 50%.
a) Derive the IS* and LM* equations in terms of exogenous variables if the world interest rate
is 20%. (4 points)
b) Suppose the level of money supply is 22500 and the domestic price level is 5. Use the IS*
and LM* equations from part (a), find the short-run equilibrium levels of output, nominal
exchange rate, private saving, and net foreign investment if the economy has a flexible
exchange rate regime. (6 points)
MGEB06 Sample Final Questions ¤ Iris Au 7
c) Now, suppose the economy fixes the nominal exchange rate to 40 and the price level is 5.
Use the IS* and LM* equations from part (a), find the short-run equilibrium levels of output
and money supply that are consistent with the fixed exchange rate. (5 points)

Question 19 (15 points)
³$FFRUGLQJ WR WKH 0XQGHOO-Fleming model (Y-e diagram), fiscal policy is effective under a
IOH[LEOHH[FKDQJH UDWH UHJLPHEXW LV LQHIIHFWLYHXQGHUD IL[HGH[FKDQJH UDWH V\VWHP´ 'LVFXVV
and support your answer with ONE diagram (only the first diagram will be graded).

Question 20 (20 points)
The economy in question is a small open economy with perfect capital mobility. Due to the
collapse of the real estate market, households find their wealth drop by 20%. In attempt to make
up of this loss of wealth, households save more and consume less.
(Hint: Compare your answers in both parts to the initial equilibrium)
a) Use the Mundell-Fleming/IS-LM model (Y-r diagram) model to show (both in graph and
ZRUGVWKHHIIHFWVRIWKLVFKDQJHRQWKHFRXQWU\¶s output, real interest rate, nominal exchange
rate, real exchange rate, and net exports in the short run if the economy has a flexible
exchange rate. (10 points)
b) Redo part (a) if the economy has a fixed exchange rate. (10 points)

Question 21 (15 points)
³$ IDOO LQ WKH UHDOPRQH\ GHPDQGZLOO OHDG WR FKDQJHV LQ RXWSXW DQG XQHPSOR\PHQW UDWH LQ D
closed economy but no changes in these variables in a small open economy that has a fixed
H[FKDQJHUDWHLQWKHVKRUWUXQ´7UXH)DOVH8QFHUWDLQH[SODLQZLWKWKHaid of ONE Y-r diagram
(only the first diagram will be graded).

Question 22 (20 points)
Home is a small open economy while Foreign is a large open economy, and Home has a flexible
exchange rate. Besides, both countries are in their long-run equilibrium. Now, to lower its
budget deficit, the Foreign government lowers its spending.

Note: For both parts, you must provide explanations why the variables of interest change or
remain unchanged in order to receive any credit.

a) Use the Mundell-Fleming model (Y-r graph) to illustrate graphically and explain in words
the short-UXQ HIIHFWV RI WKLV FKDQJH RQ +RPH¶V RXWSXW QHW H[SRUWV UHDO H[FKDQJH UDWH
nominal exchange rate, and real money balance. Only the first diagram will be graded. (10
points)
b) Use the long-run classical model of a small open economy to show, in graphs and words, the
long-UXQ HIIHFWV WKLV FKDQJH RQ +RPH¶V RXWSXW QHW H[SRUWV UHDO H[FKDQJH UDWH QRPLQDO
exchange rate, and real money balance. (10 points)

Question 23 (20 points)
Consider a small open economy with perfect capital mobility that adopts a flexible exchange rate
system. Also, the economy is initially in its long-run equilibrium. Suppose a computer virus has
MGEB06 Sample Final Questions ¤ Iris Au 8
GHVWUR\HGPRVWRI WKHFRXQWU\¶VSD\PHQW V\VWHPDQGDVD UHVult, money becomes the primary
method to facilitate transactions.
a) Use the Mundell-)OHPLQJ WR VKRZ WKH HIIHFW RI WKLV FKDQJH RQ WKH FRXQWU\¶V RXWSXW UHDO
interest rate, nominal exchange rate, real exchange rate, price level, and net exports in the
short run. Support your answer in words and TWO diagrams (Y-e diagram and Y-r diagram)
(12 points)
b) Now use the long-run model of a small open economy (with appropriate diagrams) to show
the long-UXQ HIIHFW RI WKLV FKDQJH RQ WKH FRXQWU\¶V RXWSXW UHDO LQWHUHVW UDWe, nominal
exchange rate, real exchange rate, price level, and net exports. (8 points)

Question 24 (20 points)
Home is a small open economy that has a fixed exchange rate and perfect capital mobility. It is
also producing at its long-run production capacity. Recently, a trade dispute between Home and
Foreign has been resolved, and the government of Foreign removed its 27.5% tariff on Home
products.

Note: For both parts of the question, you must provide explanations why the variables of interest
change or remain unchanged in order to receive full credit.

a) Use the Mundell-Fleming model (Y-e graph) to illustrate graphically and explain in words
the short-UXQ HIIHFWV RI WKLV FKDQJH RQ +RPH¶V QHW H[SRUWV UHDO H[FKDQJH UDWH QRPLQDO
exchange rate, national saving, and real money balance. Only the first diagram will be
graded. (10 points)
b) Use the long-run classical model of a small open economy to show, in graphs and words, the
long-UXQHIIHFWVRIWKLVFKDQJHRQ+RPH¶VQHWH[SRUWVUHDOH[FKDQJHUDWHQRPLQDl exchange
rate, national saving, and real money balance. (10 points)

Question 25 (10 points)
The economy in question is a closed economy and can be described by the IS-LM model.
Different proposals have been submitted to the government on how fiscal policy should be
conducted and these proposals are:

Proposal 1: Use fiscal policy to target real interest rate
Proposal 2: Use fiscal policy to target real output

Which of the above proposal(s) would minimize short-run fluctuations in investment if there
were a reduction in autonomous consumption? Explain and support your answer by ONE IS-