EC201-5-FY

UNIVERSITY OF ESSEX
SECOND YEAR EXAMINATIONS 2020

MACROECONOMICS (INTERMEDIATE)

Time allowed: 3 hours

Candidates must answer FOUR questions (at least ONE from each section).

This paper consists of TEN questions, divided into two sections each of FIVE questions.

Candidates are permitted to bring into the examination room:

Please do not leave your seat unless you are given permission by an Invigilator.
Do not communicate in any way with any other candidate in the examination room.
Do not open the question paper until told to do so.
All answers must be written in the answer book(s) provided.
All rough work must be written in the answer books provided. A line should be drawn through
any rough work to indicate to the examiner that it is not part of the work to be marked.
At the end of the examination, remain seated until your answer book(s) have been collected and
you have been told you may leave.
 EC201-5-FY
2

Section A. You must answer at least ONE question from this section.

1. Answer all parts (a) – (c) of this question.

(a) [8 marks] In the context of the money multiplier explain how lending activity of banks is
related to the money supply of an economy. How can the central bank of a given economy
control the money supply?
(b) [9 marks] “Inflation is always and everywhere a monetary phenomenon”. Provide an
economic explanation for that statement. Is the statement more likely to be true in the long-
run, in the short-run, or in both? Explain.
(c) [8 marks] Suppose that the central bank announces a new quantitative easing programme for
the future, where money supply will be permanently increased. What should happen to the
price level today as a result of that announcement? Explain.

2. Answer all parts (a) – (c) of this question

(a) [9 marks] Explain how output is determined in the Keynesian Cross model. Use a diagram to
illustrate your answer. Why saving reduces the equilibrium level of output in the Keynesian
Cross model? Explain.
(b) [6 marks] In the context of the Keynesian Cross model why the government expenditure
multiplier is larger than the tax multiplier? Explain.
(c) [10 marks] In the context of the “theory of liquidity preference”, explain how changes in
money supply affect the equilibrium interest rate in the “money market” in the short-run. Use
a diagram to illustrate your answer. What are the effects of changes in the money supply on
the interest rate in the long-run?

3. Answer all parts (a) – (c) of this question.

(a) [9 marks] According to Milton Friedman money is not a close substitute of interest bearing
assets only but it is a substitute of all possible assets. This implies that money demand is not
very sensitive to the interest rate. Moreover according to Friedman investments are believed
to be very sensitive to the interest rate. Using diagrams to illustrate your answer discuss the
effectiveness of fiscal and monetary policy in the IS-LM model in such a case.
(b) [9 marks] Using diagrams to illustrate your answer, explain what is meant by a ‘liquidity
trap’. How monetary policy can affect the level of output in a liquidity trap? Explain.
(c) [7 marks] Suppose prices are flexible in the IS-LM model. Explain under which conditions
the economy may be unable to reach the full employment equilibrium even though prices are
fully flexible. Use a diagram to illustrate your answer.
 EC201-5-FY
3

4. Answer all parts (a) – (c) of this question.

(a) [10 marks] Consider an economy where output is at its natural level and inflation is positive.
In the context of the DAD-DAS model with adaptive expectations explain the effects on
equilibrium of a negative demand shock that lasts for two periods. Use a diagram to illustrate
your answer. How economic policies can be used to offset the effects of such a shock?
Explain.
(b) [8 marks] In the context of the DAD-DAS model explain what the implications for the
cyclicality of the nominal interest rate are (i.e. how nominal interest rate moves during a
business cycle). Use a diagram to illustrate your answer.
(c) [7 marks] What is the Taylor principle in conducting monetary policy? Why it matters for
monetary policy? Explain.

5. Answer all parts (a) – (c) of this question.

(a) [8 marks] Explain how the Sticky Prices model can give rise to a Short-Run Aggregate
Supply (SRAS) that is positively sloped. What is the relationship between a SRAS and the
Phillips curve? Explain.
(b) [9 marks] Suppose that in country A the Phillips curve is: 𝜋𝜋 𝐴𝐴 = 0.04 − 0.5(𝑢𝑢 𝐴𝐴 − 0.05). In
country B the Phillips curve is 𝜋𝜋 𝐵𝐵 = 0.08 − 0.5(𝑢𝑢𝐵𝐵 − 0.05). Suppose that 𝑢𝑢 𝐴𝐴 = 𝑢𝑢𝐵𝐵 . What
are the main differences between the two Phillips curves? In which country the policy makers
face a bigger trade-off in decreasing unemployment in the short run? Explain.
(c) [8 marks] Can policy makers permanently reduce the unemployment rate below the natural
level? Explain and use a diagram to illustrate your answer.

END OF SECTION A
 EC201-5-FY
4

Section B. You must answer at least ONE question from this section.

6. Answer all parts (a) – (c) of this question.

(a) [5 marks] Define the trade balance for an open economy and explain the relationship between
the trade balance and the real exchange rate.
(b) [8 marks] Consider a small open economy with perfect capital mobility. Describe the main
features of the Mundell-Fleming model for such an economy and provide a graphical
representation of its equilibrium.
(c) [12 marks] Using diagrams to illustrate your answer analyse the effectiveness of monetary
and fiscal policy in the Mundell-Fleming model.

7. Answer all parts (a) – (c) of this question.

(a) [10 marks] Outline a basic model of the natural rate of unemployment. Suppose that the
government wants to introduce the following policy: on top of unemployment benefits the
unemployed receive a bonus for finding new jobs; the amount of the bonus declines with the
duration of search. In the context of the model you have outlined explain the main effects of
the proposed policy.
(b) [8 marks] Explain the difference between frictional and structural unemployment. In the
context of search theory explain why a certain amount of frictional unemployment is probably
necessary in a well-functioning economy.
(c) [7 marks] Some economists argue that efficiency wages theory provides a useful explanation
why economy’s wages are sticky. Critically assess that statement.

8. Answer all parts (a) – (c) of this question.

(a) [11 marks] Explain the main features of the Solow growth model. How is the steady state
level of capital determined in that model? Why is the steady state stable? Explain using a
diagram to illustrate your answer.
(b) [8 marks] Explain the main features of the balanced growth path implied by the Solow growth
model.
(c) [6 marks] Austerity policies can have a positive effect on growth. Critically assess that
statement in the context of the Solow growth model.

9. Answer all parts (a) – (c) of this question.

(a) [10 marks] Using a diagram to illustrate your answer explain why the debt to GDP ratio in an
economy may explode over time when the real interest rate is higher than the growth rate of
real GDP. Explain what a government can do in such a case to keep under control the debt to
GDP ratio.
(b) [9 marks] Outline the main differences between the traditional and the Ricardian Equivalence
view of government deficits. What are the main assumptions behind the Ricardian
Equivalence view?
(c) [6 marks] A progressive tax system can help in reducing output fluctuations in the presence of
shocks. Assess that statement using a diagram to illustrate your answer.
 EC201-5-FY
5

10. Answer both parts (a) and (b) of this question.

(a) [9 marks] Explain Keynes’ three conjectures about the consumption function. Describe the
evidence that is consistent with these conjectures and the evidence that is inconsistent with
them.
(b) [16 marks] Compare and contrast the Life Cycle Hypothesis with the Permanent Income
Hypothesis. Which of these two hypotheses do you think deals more satisfactorily with the
well known “consumption puzzle”? Explain.

END OF SECTION B

(END OF PAPER)