Unit Title: Introduction to Macroeconomics University of Bristol

Unit Code: ECON10011

Unit Director: Dr. Katerina Raoukka
Lecturers: Dr. Luis Correia (3E1), Dr. Katerina Raoukka (2E8)
Problem Set 2
To be submitted on Monday 28th October 2013 at 10:00. Make sure that your work is
submitted to the right tutor.
Week 5 Starting: 28 October, 2013 Covering: Lectures 3-4

Section A: Multiple Choice
Total Marks: 10, 1 mark each
For questions 1-10, choose your answer and write the letter that represents it in the box
provided below. Where necessary choose the answer that fills in the blanks. No explanation is
needed for your answer.
Multiple
Choice
Answers
1 2 3 4 5 6 7 8 9 10


1. In a closed economy, if , the government is running a
a. budget surplus
b. budget deficit
c. balanced budget
d. none of the above
2. The formula

, where is marginal propensity to consume, is called:

a. the multiplier
b. the consumption function
c. the average propensity to consume
d. the marginal propensity to consume
3. Which of the following will not cause a shift in the investment function of the
Keynesian model?
a. A change in investors confidence and expectations of the future
b. A change in the interest rate
c. A change in the willingness of lenders to lend
d. A change in the price of investment goods
10 marks
4. Assume a simple closed economy with a consumption function

where

are defined as in the lectures. Government and investment spending

are considered autonomous (in other words, they are not a function of income). The
marginal propensity to consume () is given to be 0.60. In such a setup, the value
of the multiplier is:
a. 1.34
b. 0.57
c. 4
d. 2.5
5. Assume that in a closed economy, investment spending falls by 100 million. By how
much will output fall if the ?
a. 20 million
b. 80 million
c. 166.6 million
d. 250 million
6. The consumption can be affected and shifted by:
a. A change in the interest rate
b. A change in wealth
c. A change in expected future income
d. All of the above
7. In the model of the goods market presented in Lecture 4, which of the following
variables is exogenous?
a. Disposable income
b. Investment
c. Consumption
d. All of the above are endogenous variables
8. If the countrys nominal interest rate is 5% and its inflation rate is 15% then the real
interest rate is approximately:
a. 20%
b. 0%
c. -10%
d. 10%
9. A reduction in the MPC from 0.6 to 0.5 will cause the line to become:
a. steeper and a given change in the autonomous consumption to have a smaller
effect on output
b. flatter and a given change in the autonomous consumption to have a smaller
effect on output
c. steeper and a given change in the autonomous consumption to have a larger
effect on output
d. flatter and a given change in the autonomous consumption to have a larger effect
on output
10. According to the Fisher equation:
a.
b.
c.

d.

Section B: Numerical Questions
For the following mathematical questions provide your workings and the result. Show all
your workings.
11. Goods Market, 20 marks
Suppose a closed economy is characterised by the following equation

Planned investment is 100; government expenditure and taxes are both 100.
i. Find planned expenditure ( as a function of income . (1)
ii. What is the equilibrium level of income? (2)
iii. Graph planned expenditure () as a function of income (. Show the equilibrium
level of income. (5)
iv. What is the equilibrium level of disposable income? (2)
v. Suppose the government expenditure increases to 125. How will the equilibrium
income change? Show clearly on the graph from part (i) any movements in (5)
vi. What level of government expenditure is needed to achieve an income of 1,800? (5)
12. Present Value, 30 marks
A firm with 2000 of cash has two choices
a) It can place the money in a savings account where it will earn a nominal interest rate of
5% per annum
b) It can buy a machine which will potentially add 65 to its profits in a year, 800 in two
years time and 250 in three years time. The machine becomes worthless afterward.
The firm believes that inflation will be 2% in each of the next three years.
i. What should the firm do? Invest in buying the machine or put the 2000 in the
savings account? (10)
ii. How would your answer in (i) change if the expected inflation were instead 3%? (10)
iii. If the firm did not have the initial 2000 but had to borrow 2000 instead at the rate
of 5% per annum should it buy the machine? (10)
Section C: Short Answers
13. Explain in approximately 200 words, using a mathematical example, the difference
between nominal and real interest rates. If you were to plot this relationship, how would
it look like?
14. Describe/explain the following (use a graph or mathematical formulas wherever needed):
i. Consumption Puzzle
ii. Permanent Income Hypothesis
50 marks
25 marks
iii. The multiplier
15. Show graphically and explain how an increase in taxation alters equilibrium in the goods
market.
Section D: Going On-Line
Collect data on Consumption, Investment, Government Spending, Exports and Imports for the
UK or the US. Use Excel to help you graph the data found. Briefly explain what you observe.
Here are some more sites you could use:
OECD: www.oecd.org/statistics
FRED: http://research.stlousfed.org/fred2
Do not forget:
World Bank:
http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=world-
development-indicators
Here are some hints:
Websites might define variables differently so here are some titles you should be looking for:
Consumption: Household final consumption expenditure (constant 2005 US$)
Investment: Gross fixed capital formation (constant 2005 US$)
Government: General government final consumption expenditure (constant 2005 US$)
Exports: Exports of goods and services (constant 2005 US$)
Imports: Imports of goods and services (constant 2005 US$)

End of Problem Set 2



15 marks