Name: ______________________________ Practice Final Exam

Part I (13 points): Multiple Choice Questions – Circle the right answer

1. Suppose there are two countries that are identical with the following exception. The saving rate in
country A is greater than the saving rate in country B. Given this information, we know that in the long
run:
a. the capital-labor ratio (K/N) will be greater in B than in A
b. the capital-labor ratio (K/N) will be greater in A than in B
c. the capital-labor ratio (K/N) will be the same in the two countries
d. economic growth will be higher in A than in B

2. Suppose the economy is initially in the steady state. An increase in the depreciation rate (𝛿𝛿) will cause:
a. a reduction in K/N
b. a reduction in Y/N
c. a reduction in C/N
d. all of the above
e. none of the above

3. Suppose the following situation exists for an economy: Kt+1/N > Kt/N. Given this information, we know
that:
a. saving per worker equals depreciation per worker in period t
b. saving per worker is less than depreciation per worker in period t
c. saving per worker is greater than depreciation per worker in period t
d. the saving rate fell in period t
e. none of the above

4. Under a fixed exchange rate regime, the central bank must act to keep
a. P = P*.
b. the real exchange rate fixed.
c. i = i*.
d. E = 1.
e. none of the above

5. Suppose a country is perceived to have an overvalued fixed exchange rate and does not devalue. As a
result the country is producing below its natural level of output. Which of the following would we expect
to occur over time?
a. a reduction in its inflation rate
b. a real depreciation of its currency
c. an increase in net exports
d. all of the above
e. none of the above
6. Which of the following is an advantage of a common currency in Europe?
a. Each country could conduct its own, independent monetary policy.
b. Exchange rate uncertainty within the common currency area would be eliminated.
c. Each country could conduct its own, independent fiscal policy.
d. The risk of a currency crisis in the Euro member countries would be eliminated.

7. The rate of growth of output per capita in the United States between 1960 and 2020 was approximately
equal to which of the following?
a. 2.0%
b. 3.8%
c. 4.8%
d. 5.8%

8. Suppose there is an increase in the saving rate. This increase in the saving rate will cause an increase in
which of the following once the economy reaches its new steady state equilibrium?
a. growth rate of output
b. growth rate of capital
c. growth rate of capital per worker
d. all of the above
e. none of the above

9. For this question, assume that the domestic interest rate is 8% and that the foreign interest rate is 6%.
And finally, assume that the domestic currency is expected to depreciate by 3% during the coming
year. Given this information, we know that:
a. individuals will only hold domestic bonds
b. individuals will only hold foreign bonds
c. individuals will be indifferent about holding domestic or foreign bonds
d. the interest parity condition holds

10. High growth in the rich countries after 1950 was most likely due to
a. a high savings rate.
b. high capital accumulation.
c. technological progress.
d. high consumption rates.
e. monetary policy.

11. We would expect which of the following to occur when the central bank pursues contractionary
monetary policy?
a. an increase in bond prices and an increase in the interest rate (i)
b. a reduction in bond prices and an increase in i
c. an increase in bond prices and a reduction in i
d. a reduction in bond prices and a reduction in i
12. For this question, assume that policy makers are pursuing a fixed exchange rate regime and that output is
initially less than the natural level of output. The economy will tend to move toward the natural level of
output when which of the following occur?
a. an increase in the price level
b. a devaluation of the currency
c. an increase in the domestic interest rate
d. a reduction in the foreign price level
e. none of these

13. Changes in GDP in the short run are caused primarily by

1. (4 points) Consider the case of an open economy with a flexible exchange rate regime. Suppose the
foreign interest rate decreases. Using the IS-LM-UIP model from Chapter 19, explain how this change
will affect the exchange rate and output in the domestic economy. Explain your reasoning.

2. (3 points) GDP per capita is generally considered to be a good proxy of living standards in a country.
Nonetheless, the measure suffers from some imperfections. List and explain three weaknesses of GDP
per capita as welfare proxy.
3. (7 points) Consider the case of the United States, an open economy with a flexible exchange rate regime,
which runs both a trade and a government budget deficit. Suppose the Council of Economic Advisers
suggests to the President that the US can lower its trade deficit by eliminating the government budget
deficit. Assume that the US economy starts out initially at its natural level of output.
a. Using the IS-LM-UIP model from Chapter 19, check whether this claim is correct. Explain your
reasoning. In your answer, you should illustrate the effects of this policy change on US output, the
interest rate and the Dollar exchange rate, and discuss its impact on the US trade balance.

b. In the medium run, demand shocks should not affect the output level in the US economy. Describe in
detail how the US economy will return to its natural level of output.
 c. If the US had a fixed exchange rate, would your answers in parts a. and b. change? Why or why not?
Explain your reasoning.

4. (10 points) Suppose the economy’s aggregate production function is 𝑌𝑌 = 𝐾𝐾 2/5 𝑁𝑁 3/5 . In each period the
capital stock of the economy depreciates by 4 percent. The economy currently saves 40 percent of its
output every period. The government is initially running a balanced budget. In addition, the number of
workers increases by 1 percent each year.
a. Solve for the economy’s steady-state levels of capital per worker and output per worker. Show your
work.
b. Solve for the economy’s steady-state level of consumption per worker.

c. It can be shown (you do not have to do this here) that the saving rate of the economy described above
corresponds to its golden rule saving rate. Describe in your own words what this means.

d. Given your answer in part c., if the government would go from a balanced budget to a budget surplus,
would consumption per worker increase or decrease in the new steady state? Explain your reasoning.
5. (3 points) Suppose Brazil and Argentina consider forming a monetary union. Under what conditions
would that be a good idea? Explain.

6. (5 points) Suppose the US economy is suffering from a financial crisis and several commercial banks are
on the verge of bankruptcy. One of the advisors to Fed chairman Jerome Powell suggests to mandate an
increase in the reserve ratio to lower the risk of bank runs to avoid a complete meltdown of the financial
system.
a. What would be the effect of an increase in the reserve ratio on the overall supply of money in the
economy, MS? Explain.

b. Based on your answer in part a., what would be the effect of the increase in the reserve ratio on the
equilibrium interest rate in the economy? Explain.
c. The equilibrium interest rate is crucial for commercial banks because it represents the cost of short-
term interbank loans. Based on your analysis, is then the increase in the reserve ratio a good strategy
to avoid a meltdown of the financial system? Explain.

-The End-
Total points: /45