PART A:
1. In a closed economy where consumption is function of income and investment depends on the
interest rate, autonomous spending is given as:
(a) c0 + I + G + c1T
(b) c0 − G + c1T
(c) c0 − c1T
(d) c0 + I + G − c1T
(e) c0 + G − c1T
2. With the reserve ratio being 25%, a new deposit of $1000 in a single private bank will leave
that bank in a position to lend out at most:
(a) $4000
(b) $3000
(c) $1000
(d) $750
(e) $250
3. Which of the following is likely to increase the natural rate of unemployment?
(a) a decrease in the minimum wage
(b) a decrease in unemployment benefits
(c) a decrease in firms’ market power
(d) an increase in the number of retired workers
(e) an increase in unemployment benefits
4. In a graph with saving on the vertical axis and output on the horizontal axis, the saving
schedule intersects the vertical axis at -100 and intersects the horizontal axis at 500. In this
case, the propensity to consume equals:
(a) -100
(b) 100
(c) 0.8
(d) 0.2
(e) 0.5
5. In a closed economy with no government, if investment —— the level of income, the slope of
the demand schedule —— the marginal propensity to consume.
The University of Sydney
School of Economics
Practice Final Exam
The format of this exam is different from the actual exam.
See the "Final Exam Info Sheet" on Canvas for the format of actual exam.
(a) varies with; equals
(b) is unrelated to; is greater than
(c) in unrelated to; is less than
(d) is unrelated to; equals
(e) varies with; is unrelated to
6. At the current level of output, suppose that the actual price level is less than the price level
that individuals expect. We know that:
(a) any subsequent decrease in the aggregate price level will cause an increase in the real
money supply and a rightward shift in the aggregate demand curve
(b) output is currently less than the natural level of output
(c) the interest rate will tend to rise as the economy adjusts to this situation
(d) the nominal wage will tend to increase as individuals revise their expectations of the
price level
(e) the AS curve will tend to shift up over time
7. Assume that the Phillips curve equation is represented by pit − pit−1 = (m + z) − αut. An
increase in the unemployment rate will cause:
(a) an increase in the markup over labour costs
(b) a decrease in the inflation rate over time
(c) an increase in expected inflation
(d) a decrease in the markup over labour costs
(e) an increase in the inflation rate over time
8. Suppose policy makers underestimate the natural rate of unemployment. In such situations,
policy makers will likely implement policies that result in:
(a) a steadily decreasing inflation rate
(b) overly restrictive monetary and fiscal policy
(c) an unemployment rate that is too high
(d) more unemployment than necessary
(e) a higher inflation rate than necessary
9. Which of the following will likely result in a decrease in the steady-state level of capital per
effective worker?
(a) an increase in the saving rate
(b) a decrease in the depreciation rate of capital
(c) an increase in the population growth rate
(d) a decrease in technological growth rate
(e) an increase in total factor productivity
10. In the Solow model, a simultaneous increase in the saving rate and an increase in the depre-
ciation rate will result in:
(a) an increase in capital per effective worker
(b) a decrease in capital per effective worker
(c) a decrease in the steady state growth of output per worker
(d) an increase in the steady state growth of output per worker
(e) an ambiguous effect on capital per effective worker
11. In an economy with population growth rate at gN , technology growth rate at gA and depre-
ciation rate at δ. The change in capital per effective worker k is given by the equation:
(a) sf(k) + (δ + gA + gN )k
(b) sf(k)− (δ + gA + gN)k
(c) f(k)− (δ + gN )k
(d) f(k)− (δ + gA + gN )k
(e) f(k) + (δ + gA + gN )k
12. If policymakers pass a budget that reduces the budget deficit. A deficit reduction package
has a greater chance of increasing current output when:
(a) the policy features larger cuts today and smaller cuts in the future
(b) financial markets believe that the central bank will raise interest rates in the future
(c) financial markets believe that taxes will not increase in the future
(d) financial markets believe that output will not increase in the future
(e) financial markets believe the central bank will lower interest rates in the
future
13. If the exchange rate between the U.S. dollar and the euro is $1.20 = ¿1 and the exchange
rate between the U.S. dollar and the yen is $0.0125/¥, then the exchange rate between the
euro and the yen is
(a) ¿1 = ¥80
(b) ¿1 = ¥96
(c) ¿1 = ¥0.0104
(d) ¥1 = ¿80
(e) ¥1 = ¿96
14. Suppose there is a real appreciation in favour of Australia. Which of the following must have
occurred?
(a) foreign currency has become less expensive in Australian dollars
(b) foreign currency has become more expensive in Australian dollars
(c) foreign goods have become less expensive to Australians
(d) foreign goods have become more expensive to Australians
(e) the foreign price level has increased relative to the Australian price level
15. Which of the following events will cause the largest real depreciation for the domestic econ-
omy?
(a) a 7% increase in P and a 7% decrease in P ∗
(b) a 3% increase in E and a 3% increase in P
(c) a 4% increase in E
(d) a 7% decrease in P and a 7% increase in P ∗
(e) a 7% decrease in E and a 7% decrease in P ∗
16. According to the interest parity condition, if the US interest rate is 4% and the Australian
interest rate is 9%, then it must be that:
(a) the U.S. dollar is expected to depreciate by 4% against the Australian dollar
(b) the Australian dollar is expected to depreciate by 9% against the U.S. dollar
(c) the Australian dollar is expected to appreciate by 5% against the U.S. dollar
(d) the U.S. dollar is expected to appreciate by 4% against the Australian dollar
(e) the Australian dollar is expected to depreciate by 5% against the U.S. dollar
17. Assume the Marshall-Lerner condition holds. Which of the following will cause an increase
in net exports?
(a) a decrease in foreign output
(b) a real exchange rate depreciation
(c) an increase in investment
(d) an increase in government spending
(e) a real exchange rate appreciation
18. In a flexible exchange rate regime, an expansionary monetary policy will cause:
(a) an appreciation of the domestic currency
(b) a downward shift in the IP curve
(c) a depreciation of domestic currency
(d) the IP curve to become horizontal
(e) no change in the exchange rate
PART B: Short-Answer Questions
1. Why do economists say inflation is bad? High inflation abroad and high expected inflation at
home, both increase output. Please discuss.
2. ∆k = sf(k) − (δ + n)k . Explain in words what you understand by this equation.
3. Explain hysteresis.
4. Explain the notion of non-accelerating inflation rate of unemployment (NAIRU).
5. Explain how the exchange rate acts as an automatic stabilizer in flexible exchange rate regime.
6. What is the Marshall-Lerner condition?
7. Why is the IS-curve steeper when expectations are included in the model?
8. Why is fiscal coordination difficult for two identical countries operating as open economies.
9. Explain the transition dynamics of an increase in rate of technological progress in Solow-Swan
model. You may use a diagram to support your answer.
10. The saving rate has no effect on long run growth rate of output per capita. Please discuss.
PART C:
1. Consider an open economy with a fixed exchange rate E¯ that is described by the following
equations:
IS relation: Y = 300− 500i− 200E¯
LM relation:
M∗
P
= 5Y − 2000i
Assume that the economy is small relative to the rest of the world such that the equilibrium
interest rate is always fixed and is equal to the foreign interest rate i = i∗ = 4%. The fixed
exchange rate is E¯ = 1.
(a) Solve for the equilibrium output Y and the equilibrium level of real money supply M
∗
P .
(b) Suppose that the government changes the fixed exchange rate to E¯ = 1.1. Compute the
new level of equilibrium output Y . Provide an intuitive explanation of the change in
output.
(c) The government decides to offset the impact of the change in the exchange rate on out-
put. Assume that the propensity to consume of 0.5 and a propensity to invest of 0.3
and that net exports do not respond to changes in output. Compute the change in
government spending that can reverse the effect of the change exchange rate on output.
(d) What does the change in the exchange rate and the response of the government imply
for the trade balance and the fiscal balance?
2. Consider the production function for a closed economy:
Y = 8K0.5(AN)0.5
where Y is aggregate output, A is technology, K is capital stock and N is labour. Capital
evolves according to Kt+1 = sYt + (1 − δ)Kt. Also, assume s = 0.3, labour force growth
gN = 4%, technology growth gA = 5%, and depreciation δ0 = 3%.
(a) Compute the steady-state values of (i) capital stock per effective worker, (ii) output per
effective worker and (iii) consumption per effective worker.
(b) Compute the steady-state values (i) the growth rate of output per effective worker, (ii)
the growth rate of output per worker, and (iii) the growth rate of output.
(c) Compute the new steady-state values of (i) capital stock per effective worker, (ii) output
per effective worker and ( iii) consumption per effective worker.
(d) Draw a carefully-labelled diagram to illustrate the effect of the change in the deprecia-
tion rate on the economy in the long run.
(e) Explain how the change in the depreciation rate affects capital and output per unit of
effective worker i n the short run and l ong run.
3. Consider an open economy IS-LM model. Assume that that the interest parity condition
holds and that the expected future exchange rate and the foreign interest rate are fixed.
(a) Explain the differences between the short term effects of an expansionary monetary policy
and an expansionary fiscal policy under a flexible exchange rate regime.
(b) Explain the differences between the short term effects of domestic contractionary monetary
policy and foreign contractionary monetary policy under a flexible exchange rate regime.
(c) Explain the differences between the short term effects of an expansionary monetary policy
and an expansionary fiscal policy under a fixed exchange rate regime.
(d) Explain the differences between the short term effects of a contractionary monetary policy
and a contractionary fiscal policy under a fixed exchange rate regime.
(e) Explain the differences between the short term effects of domestic contractionary fiscal policy
and foreign contractionary fiscal policy under a fixed exchange rate regime.
(f) Explain the differences between the short term effects of an expected appreciation of the
domestic currency under fixed exchange rate regime versus an expected appreciation of the
domestic currency a fixed exchange rate regime.
With the help of diagrams:
4. The formation of expected inflation
The text proposes the following model of expected
inflation
7Tf = ( 1 - 0) 1T + 01Tt-1
a. Describe the process of the formation of expected inflation
when0 = 0
b. Describe the process of the formation of expected inflation
when0 = 0.
c. How do you form your own expectation of inflation-more
like part a, or more like part b?
7. Exploring the ,urt11ral mte of m1emplo!1me11t
a. The equation of the Phillips curve from 19 70 to 199 5 is
'", - 11"1-1 = 7.4% - 1.211,.
Calculate and define the natural rate of unemployment
using this curve.
b. The equation of the Phillips curve from 1996 to 2018 is
1r1 = 1. 8'¾1 - U. H,111 .
Here the natural rate of unemployment cannot immedi­
ately be calculated from this Phillips curve. Explain why.
c. Graph the Phillips relation 1r, = 2.8% - U.lh111 with
inflation on the vertical axis and unemployment on the
horizontal axis. Calculate and interpret the intercept on
the vertical axis. Why might this be an undesirable eco­
nomic outcome? Calculate and interpret the intercept on
the horizontal axis. Why might this be an undesirable
eco­nomic outcome? What is the unemployment rate if
infla­tion is 2'¼1?
d. What is the natural rate or unemployment using the
rela­tion 11i = 2.8'¼, - U.1 bu, under the assumption that
the value of Ti= 2.0%. Explain the logic of the