EC201-6-FY
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UNIVERSITY OF ESSEX
FINAL YEAR EXAMINATIONS 2021

MACROECONOMICS (INTERMEDIATE)

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The paper consists of 8 questions divided in two Sections, A and B.
Candidates must answer 4 questions, at least one from each Section.
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Section A. You must answer at least ONE question from this section.
1. Answer all parts (a) – (c) of this question.
(a) [8 marks] According to empirical evidence, countries with high money supply growth rates
tend to have high rates of inflation and high nominal interest rates. Provide an economic
explanation for that empirical fact.
(b) [9 marks] In the context of the money multiplier explain how lending activity of banks is
related to the money supply of an economy. How can the central bank of a given economy
control the money supply?
(c) [8 marks] Suppose that the central bank announces a new quantitative easing programme for
the future, where money supply will be permanently increased. What should happen to the
money market equilibrium in the short and in the long-run as a result of that announcement?
Explain.

2. Answer all parts (a) – (c) of this question
(a) [8 marks] Consider an economy where the government has a balanced budget ( GT = ).
Suppose that the government decides to increase taxes and government expenditure by the
same amount to keep its budget balanced. In the context of the Keynesian Cross model,
explain the main effects of that policy.
(b) [8 marks] In the context of the Keynesian Cross, assume that taxation depends on the level of
income. What are the main economic implications of such a tax system in the Keynesian
Cross model compared to the case where taxes are lump-sum?
(c) [9 marks] Suppose there is an excess of money supply in the money market. What are the
main implications of that fact on the equilibrium of the money market in the short-run? Use a
diagram to illustrate your answer.

3. Answer all parts (a) – (c) of this question.
(a) [9 marks] Explain the main features of a Liquidity Trap and comment on the effectiveness of
fiscal and monetary policies in such a case. Use a diagram to illustrate your answer.
(b) [9 marks] Suppose that the economy can be hit by a real shock (i.e. a shock on the IS curve).
Using a diagram to illustrate your answer, explain which policy should the central bank
commit to in order to offset the effects of such a shock.
(c) [7 marks] Deflation hurts borrowers. How would you model the effects of deflation in the IS-
LM model? What policies can be used to offset the effects of deflation? Use a diagram to
illustrate your answer.

4. Answer all parts (a) – (c) of this question.
(a) [8 marks] Empirical evidence shows that real wages are pro-cyclical (they increase in booms
and decrease in recessions). Is this empirical fact consistent with the “sticky wages” model?
Explain.
(b) [9 marks] In the context of the DAD-DAS model explain what the implications for the
cyclicality of the nominal interest rate are (i.e. how nominal interest rate moves during a
business cycle). Use a diagram to illustrate your answer.
(c) [8 marks] In the context of the DAD-DAS model explain why the Central Bank may face a
trade-off between output stability and inflation stability in conducting monetary policy. Use a
diagram to illustrate your answer.
END OF SECTION A
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Section B. You must answer at least ONE question from this section.
5. Answer all parts (a) – (c) of this question.
(a) [5 marks] Define the trade balance for an open economy and explain the relationship between
the trade balance and the real exchange rate.
(b) [8 marks] Consider a small open economy with perfect capital mobility. Describe the main
features of the Mundell-Fleming model for such an economy and provide a graphical
representation of its equilibrium.
(c) [12 marks] Using diagrams to illustrate your answer, analyse the effectiveness of monetary
and fiscal policy in the Mundell-Fleming model.

6. Answer all parts (a) – (c) of this question.
(a) [10 marks] Explain the main features of the Solow growth model. Explain how the steady
state level of capital is determined. Use a diagram in your explanation.
(b) [8 marks] Suppose that an economy is hit by an earthquake that reduces the level of capital.
Explain how the reduction in capital affects the convergence to the steady state implied by the
Solow growth model. Use a diagram to illustrate your answer.
(c) [7 marks] The Solow growth model predicts that richer and poorer countries should reach the
same living standards in the long run. Critically assess that statement.

7. Answer all parts (a) – (c) of this question.
(a) [10 marks] In the context of search theory explain the main determinants of the natural
unemployment rate. Use a diagram to illustrate your answer.
(b) [7 marks] One important difference between the US and European countries in terms of their
labour market performance is the average duration of unemployment. Some economists have
argued that laws restricting the ability to lay off workers are responsible for the longer
average duration of unemployment in Europe as compared to the US. Discuss this statement
in the context of the search theory you explained in (a).
(c) [8 marks] Outline the basic features of the efficiency wage theory and discuss how this theory
can explain structural unemployment.

8. Answer all parts (a) – (c) of this question.
(a) [10 marks] Outline the main features of the Keynesian consumption function. Explain the
concept of “consumption puzzle”?
(b) [8 marks] Using a two period model explain the consumption behaviour of consumers that
face liquidity constraints. Use a diagram to illustrate your answer. Is the Keynes consumption
function you outlined in (a) consistent with the predictions of the model?
(c) [7 marks] Outline the main features of the Permanent Income Hypothesis. Do you think this
hypothesis explains consumption behaviour more satisfactorily than the Keynes consumption
function? Explain.


END OF SECTION B
(END OF PAPER)