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Econ 204 Practice Midterm Exam II

Part I1.Suppose that the economy experiences a negative aggregate demand shock due to reduced consumer confidence. Use a graph of the AD/AS model and explain the short-run and long-run effects of this shock if: i) the government chooses not to use stabilization policy, and ii) the Bank of Canada uses monetary policy with the goal of keeping output stable.2.Demonstrate the effect of high domestic inflation on the nominal exchange rate of the domestic currency.3.“Expansionary fiscal policy causes both budget deficits and trade deficits.”Is this statement true or false? Explain briefly.4.Can an increase in the rate of saving cause continuous economic growth in the context of the Solow model? Can an increase in the saving rate cause continuous economic growth in the context of the two-sector endogenous growth model? Why, or why not? Explain briefly.5.Suppose that the economy is at a steady state unemployment rate with a separation rate of 0.02 per month and a job-finding rate of 0.10 per month. If the labour force is 100 million, how many individuals will lose their jobs every month? What is the natural rate of unemployment? Show all of your work.6.In the context of the Solow model (with population growth and technological progress), what factors cause total output and the total capital stock to grow (even) when the economy is in a steady state? Explain briefly.Part II1. Suppose that the large industrial countries are concerned about the depreciating currencies of a number of small open economies.What type of fiscal policies must the large industrial countries undertake in order to promote currency appreciation in the small open economies? Illustrate graphically and explain the impact of the industrial countries’ policies on the exchange rate and the trade balance of the small open economies. (5 marks)Now suppose that the governments of the small open economies wanted to promote trade policies that would result in currency appreciation. What type of trade of policy (protectionism or free trade) will achieve this result? Illustrate graphically and explain the impact of this trade policy on the trade balance and the quantity of exports and imports. (5 marks)2.Assume that the per worker production function is given by1/2. The rate of depreciation is 10 percent.Find the Golden Rule level of capital accumulation. Show all of your work. (4 marks)Illustrate the Golden Rule level of capital accumulation on a diagram of the Solow model. (2 marks)Find the saving rate consistent with the Golden Rule level of capital accumulation. Show all of your work. (4 marks) 3.The IS curve represents combinations of income and interest rates that characterize the equilibrium in the goods market.Explain how you can derive the IS curve using the Keynesian cross (aggregate expenditure) model. (4 marks)In the Keynesian cross model, suppose that the consumption function is given by +0.8(Y – T) and planned investment is 100, government purchases are 200 and taxes are 150. What is the level of investment needed to achieve an equilibrium income to 2,000? What is the multiplier in this economy? Use a graph and show all of your work. (4 marks)The LM curve represents the equilibrium in the money market. Use the quantity theory of money to derive the LM curve. (2 marks)

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