|SAMPLE QUESTION 1 (from Quiz in week 5, Fall 2011)
Discuss whether the following statement is true, false, or uncertain. No credit will be given if you say true and the answer is true. Your explanation determines your entire grade. Be short. (4 points)
The amount of loans made by US banks to firms has decreased substantially at the end of 2008. This necessarily means that investment dropped because of the banking crises.
SAMPLE QUESTION 2 (from Midterm, Fall 2011)
Recent economic debates—PART I
The US has recently experienced a structural reduction in the manufacturing sector, due to a massive offshoring to China, where unskilled labor is cheaper. This has reduced the demand for unskilled workers (who are mainly used in the manufacturing sector).
Think about two labor markets as the one we developed in class: one for low skill workers and one for high skill workers. Assume that the income effects are weak.
a. Suppose nothing changes in the labor market for skilled workers. How the structural change described above affects the labor market for unskilled workers? What is going to happen to the equilibrium level of employment in the US market for unskilled workers? What is going to happen to the wage premium (the difference between the real wage of skilled workers and the one of unskilled workers)? (4 points)
b. Suppose that US residents change their education decision to respond to the wage premium. What will happen to the equilibrium level of skilled and unskilled employment? And to the wage premium? (4 points)
Recent economic debates—PART II (4 points + 4 EXTRA points)
On October 21st 2011, The Financial Times reports that Mr Tarullo (one of the five governors of the Federal Reserve board) dismissed concerns that most unemployment was structural. “He said that the economy’s main problem was lack of demand.”
Consider the Keynesian view: output is purely determined by aggregate demand in the short run, that is, by the intersection of the IS curve and the interest rate r set by the Fed. Imagine that the Fed is keeping r fixed and that the current IS curve intersects with r at Y
c. Imagine that the government decides to increase G to help the economy to recover. Represent graphically how an increase in G can increase Y. (4 points)
d. Imagine that the Government wants to increase Y by $700bn. If the economic consultant of the government is neoclassical, will he recommend increasing G by more or less than $700bn? Why? (EXTRA 4 points)
SAMPLE QUESTION 3 (from Final, Fall 2011)
In this question, we analyze the recent 2007-2008 US recession through the lens of our model. Assume we can represent the recent recession as driven by a negative demand shock both to investment and consumption due to reduced borrowing access, drop in households and business confidence, losses in financial wealth. (20 points total + 4 extra)
Throughout the question, assume that
1) both prices and wages are fixed in the short run,
2) there is no income effect on the labor supply.
a. Imagine that we start at Y = Y* (long run equilibrium) and the economy is hit by a reduction in I and C for the reasons mentioned above. Consider the IS-LM framework. What happens in the short run to output and interest rate? Which curves move in the short run and why? (4 points)
b. Assume there is no policy, and the economy is left to the self-correcting mechanism. Starting from the short run equilibrium in point (a), represent graphically what happens in the long run in the IS-LM framework. What would happen to Y, P and r in comparison to the short run? Which curves would move and why? (4 points)
c. In the fall of 2007, Bernanke started cutting interest rates. Starting from the short run equilibrium depicted in point (a), represent graphically an expansionary monetary policy strong enough to bring output back to potential. What happens to output and interest rate in comparison to the short run? Explain which curves will move and why. (4 points)
d. In 2008, the US entered a liquidity trap. What does it mean? Represent graphically with the “modified IS-LM framework” a situation where the demand shock is so large that the economy enters a liquidity trap. Is a standard expansionary monetary policy effective in this situation? (HINT: recall that there is a zero lower bound for the nominal interest rate.) (4 points)
e. In response to the recession, The Obama administration passed a large stimulus package. Starting from the short run equilibrium depicted in point (a), consider now the effects of a permanent increase in G strong enough to bring output back to potential Y*. Assume that G does not affect A. Represent graphically what happens using the IS-LM framework. What happens in the short run to output and interest rate? Which curves move in the short run and why? Is there going to be some crowding out of private investment? (4 points)
f. BONUS QUESTION (4 extra points!) Consider the current situation where we are in a liquidity trap (see point 6.f). In this case, can an increase in G bring the economy back to Y*? For a given increase in G, does aggregate demand increase more or less than if we were not in a liquidity trap? (No need of graphical representation, but you are welcome to use it if it is helpful) (4 points)