Term Test 2: 2019 Version 2

University of Toronto ECO102: Principles of Macroeconomics
Department of Economics Robert Gazzale, PhD
Term Test 2: 2019 Version 2

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20190317 Term Test 2

General Instructions
1. 105 minutes. 106 marks. Allocate your time wisely!
2. OTHER test booklet: Multiple choice questions. 53 marks.
3. THIS test booklet: Short answer and calculation questions. 53 marks.
4. THIS test booklet: Record multiple-choice answers on last page.
5. Aids allowed: a non-graphing, non-programmable calculator; a straight edge (i.e., ruler).
6. For True, False or Uncertain questions, all marks are earned for the explanation.
7. Show your work. No work, no partial marks.
8. When explanations are needed, be clear, accurate, and concise.
Avoid the temptation to write too much.
9. The final page is blank. If you need to continue an answer on this page, you must write
“Continued on final page” in the question’s answer space.
I. [15 Marks] TFU means “True, False or Uncertain?”. All marks are earned for the explanation.
(1) [5 Marks] In 2026, real GDP was equal to potential GDP and inflation was at the target level.
In 2027, real GDP was greater than potential GDP. TFU: The AS-AD model predicts higher
than target inflation in 2027.

(2) [5 Marks] In Boblandia, while every $10 increase in government expenditures increases imports
by $4, every $10 increase in consumption expenditures increases imports by $2. TFU: Sending
$100 to each of its 1 million residents will increase real GDP by more than increasing government
expenditures by $100 million.
(3) [5 Marks] Bob is a resident of Boblandia. He is currently working. He owns bonds. When he
retires, he will live off of his pension as well as the money he receives when his bonds mature.
Both his pension and his current earnings are indexed to inflation. TFU: If the government will
pay off its debt at the beginning of Bob’s retirement, he prefers high inflation before that time.

II. [5 Marks] Explain. An explanation earning full marks will be understandable by a uni-
versity student who has never taken economics.
(1) [5 Marks] Assume an economy currently at potential GDP and a central bank committed to
returning the economy to potential GDP as quickly as possible.
i. Explain what can we infer if the yield on one-year government bonds is 3% and the yield on
two-year government bonds is 2%.
ii. Given these yields, are people predicting that next year’s GDP will be above or below
potential GDP? Explain.

III. [9 Marks] Assume a commercial bank with a target reserve ratio of 5%. Here is its current T-
account. IMPORTANT: In the T-accounts you need to complete, I have included an extra line for
both assets and liabilities. You might, or might not, need to use these extra lines.
Assets Liabilities
$5 Currency $1000 Customer Deposits
$35 Central Bank Deposits
$60 Government Bonds
$900 Loans
(1) [4 Marks] Assume the commercial bank chooses to return to its target reserve ratio by either
buying or selling government bonds. Complete the bank’s resulting T-account.
Assets Liabilities
$ Currency $ Customer Deposits
$ Central Bank Deposits $
$ Government Bonds
$ Loans
$
(2) [5 Marks] Assume the commercial bank refuses to buy or sell government bonds.
• Identify one other action the bank can take to return to its target reserve ratio.
• Explain (make clear) how the action returns to bank to equilibrium.
• Complete the T-account after the bank returns to its target reserve ratio.
Assets Liabilities
$ Currency $ Customer Deposits
$ Central Bank Deposits $
$ Government Bonds
$ Loans
$

IV. [10 Marks] If Janet runs Boblandia’s Central Bank, her goal will be to return the economy to full-
employment (i.e., potential GDP) as quickly as possible. If Petr runs Boblandia’s Central Bank, his
goal will be price stability. That is, he will follow an inflation-targeting rule. (Think Janet cares
about Jobs and Petr cares about Prices.) In each of the scenarios:
• Assume the economy starts at potential GDP and actual inflation equals target inflation.
• Draw any needed new curves, and label the following:
A The AD and SRAS curves resulting the shock identified in the Scenario.
J The AD and SRAS resulting from Janet’s policy response.
P The AD and SRAS resulting from Petr’s policy response.
• Yes, this means that in each graph, each label will be used twice: once for AD, once for SRAS.
• Yes, this means that in each graph, a curve may have multiple labels.
(1) [5 Marks] Scenario 1 Boblandia’s major trading partner has a large decrease in real GDP.
(2) [5 Marks] Scenario 2 Vibranium, a commodity only available by import and used in Boblan-
dia’s production processes, has a large increase in price.

V. [14 Marks] Consider the following economy. In all questions, assume prices are fixed (i.e., a horizontal
SRAS).
8 D
Consumption C = 10 + 10 Y
Investment I = 90
Government Expenditures G = 140
1
After-Tax Transfers T R = 100 − 10 Y
4
Taxes T = 10 Y
Exports X = 80
2
Imports M = 10 Y
(1) [4 Marks] What are private savings if real GDP equals 400?
(2) [4 Marks] IF autonomous government expenditures increased by $1, what would be the change
in real GDP?

Copied from previous page:
8
Consumption C = 10 + 10 YD
Investment I = 90
Government Expenditures G = 140
1
After-Tax Transfers T R = 100 − 10 Y
4
Taxes T = 10
Exports X = 80
2
Imports M = 10 Y
(3) [6 Marks] What are government savings, in equilibrium?

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University of Toronto ECO102: Principles of Macroeconomics

Department of Economics Robert Gazzale, PhD

Term Test 2: 2019 Version 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

20190317 Term Test 2

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