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ECN 136 Midterm #2 spring 2021 – Dr

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ECN 136 Midterm #2 spring 2021 – Dr. Frenkel Economics 136 Midterm #2 Spring 2021 Dr. Emanuel A. Frenkel Instructions: This exam has seven (7) questions. Please answer as many as you can. Up to 70 points possible. 1 ECN 136 Midterm #2 spring 2021 – Dr. Frenkel 2 (1) (12 points possible) A sudden rise in business confidence causes an overall increase in the demand for investment in the closed domestic economy. At every real interest rate, investors and businesses are more willing to expanding expenditure on new plant and equipment. a) Using the model of real saving and real investment we have developed thus far, trace through the impact of this rise in investment demand on – the real interest rate, the level of domestic national savings, the level of domestic public savings, and the level of domestic investment. b) What would you expect to happen to the yield curve, domestic price level and explain why? (2) (10 points possible) What is a “normal” shape for the Yield Curve for USA Treasury Bills? What does “normal” mean in this case? What is meant by an “inverted” Treasury Bill Yield Curve? Why is the yield curve usually “inverted” just before an economic downturn or recession begins? e) If the Yield Curve suddenly rises at an increasing rate, what would that likely indicate. a) b) c) d) (3) (10 points possible) An economy that suffers from a HYPERINFLATION has prices ("P") rising at least at the rate of 50% per month. a) Given what we have discussed in lecture, list the typical origins of a hyperinflation. b) Then, use the expression MV = PY to analyze the transmission mechanism of the hyperinflation, from a large government budget deficit and EXPLAIN the impact of the hyperinflation on the real and nominal interest rates, and, make a suggestion as to how the hyperinflation can be stopped. (4) (6 points possible) In your economy, the demand and supply of real balances are equal. Now there is a fall in the supply of real balances (due to a FALL in the nominal money supply). ECN 136 Midterm #2 spring 2021 – Dr. Frenkel a) In order for equilibrium to be restored, what might occur in the demand for money function (there is a combination of things that could happen)? b) If nothing occurs in the money demand function what must occur in the macroeconomy to equate real money balance supply with real money balance demand? (5) (6 points possible) In your economy, the demand and supply of real balances are equal. Now there is a rise in the supply of real balances (due to a RISE in the nominal money supply). a) In order for equilibrium to be restored, what might occur in the demand for money function (there is a combination of things that could happen)? b) If nothing occurs in the money demand function what must occur in the macroeconomy to equate real money balance supply with real money balance demand? (6) (20 points possible) From the discussion in lecture, explain why and in what direction a rise in the public’s inflation expectations (and a rise in the level of the yield curve) could affect the: a) b) c) d) e) Demand for real balances, Income velocity of money The level of real investment (I) Actual price level The level of real income, Y (7) (6) points possible) a) What are the three main ways a government can finance a budget deficit? b) Of the three ways a government can finance its budget deficit, which one MIGHT depend upon a good international credit rating and why? 3