Macroeconomics. Seminar 2.

Practice on Chapters 4 (IS-LM model), 5 (Extended IS-LM

model), 6 (Labor Market) and 7 (Phillips Curve). December 11th 2018

First question (3.5 points): Let us consider the following representative data for an
economy (in billions of Euros): Public Spending (G) = 2500; Net Taxes (T) = 2000;
Autonomous consumption (c0) =1200; Marginal propensity to consume (c1) = 0.6. In addition,
assume the following equation for investment: I = 2000 + 0.2∙Y – 1000∙(r+0.01). The real
policy interest rate is 1% and the expected inflation rate is 1%.
1. In the context of the extended IS-LM model, determine the equilibrium value for the
following variables: output, private consumption, investment, private saving and
public deficit. Represent graphically the equilibrium.

Assume that the banks’ leverage ratio increases:

2. Discuss the impact on the risk premium of this shock. Explain in detail the adjustment
process towards the new equilibrium. Support your explanation on the graphic
analysis (IS-LM and money market).
3. Discuss the impact on the variables of the model.

If the government intends to restore the level of output previous to the shock:
4. Which policies should implement? Represent graphically (IS-LM and money market).
5. Discuss the joint effect on the variables of the model of both factors (the initial shock
and the implemented policies).

Assume that, starting from the equilibrium in point 5, the expected inflation rate increases to
2%. If the Central Bank intends to maintain fixed the real policy interest rate:
6. Which policies should implement? Represent graphically (IS-LM and money market).
7. Discuss the joint effect on the variables of the model of both factors (the initial shock
and the implemented policies).

Second question (2 points) In the context of the expectations-augmented Phillips Curve,

assuming adaptative expectations for inflation and perfect expectations for productivity,
consider two economies which share the following data: F ( u, z ) =1 − α ⋅ ut + z ,
m= 0 2%, α
0 z= = 0.5 .
a. Represent graphically the Phillips curve resulting from the data.
In the first country, the effective rate of unemployment is u0 = 6% , while in the second
1
b.
country it is u0 = 10% . Compute the change in the inflation rate between period 1 and
2

period 0 in each country.

c. Assuming that the m parameter can change because of a new Competition law, which new
value for m would be necessary in each country in order to stabilize the inflation rate?

Multiple choice questions (4.5 points): you must support your answer on graphical
analysis, mathematical computations or economic discussion

1. In the context of the IS – LM model, as a result of one or several shocks, in the final
equilibrium the three of consumption, income and investment remain constant. These effects
could be the result of:
A) a decrease in autonomous consumption.
B) a decrease in autonomous consumption jointly with an increase in public spending.
C) a decrease in autonomous consumption jointly with a decrease in taxes.
D) a decrease in both autonomous consumption and the interest rate.
2. For a given economy, the annual nominal return (riskless) on government bonds is 1%.
A firm plans an investment project with a probability of failure equal to 15%. If the firm
issues one-year bonds to finance that project, how much should the firm pay back after one
year to a risk-neutral investor who buys today 5 000 € worth of bonds?
A) 5 750 €
B) 5 050 €
C) 5 225.3 €
D) 5 941.2 €

3. At an aggregate level, the Balance Sheet of Commercial Banks in a given country have
assets of 10 000, 2 000 of which correspond to toxic assets, and deposits of 8 000. Starting
from this initial equilibrium, because of a financial crisis, the market value of toxic assets
decrease by 50%. Then:
A) The bank leverage ratio increases from 5 to 10.
B) If the government injects capital by an amount of 2000, the leverage ratio does not
change.
C) The bank leverage ratio increases from 5 to 8.
D) If the bank pursues to restore its initial leverage ratio, should decrease
loans by 4 000.

4. In the context of the extended IS-LM model (assuming constant expected inflation), the
Central Bank decreases the nominal interest rate and simultaneously the liquidity of banks’
liabilities increases. Which is the joint effect of these two shocks on income and the real
interest rate? (choose the right answer).
A) Income remains constant and the real interest rate increases.
B) The effect on income is indeterminate.
C) Income decreases and the effect on the real interest rate is indeterminate.
D) The real interest rate increases.

5. The National Accounts data for a given country in year t show that real GDP decreased by
3.1%, real domestic demand decreased by 5.3%, employment decreased by 6.1% and GDP
deflator decreased by 0.2% (all of them are year on year data). Consequently:
A) Labor productivity increased
B) Labor productivity decreased
C) Labor productivity remained constant
D) With the available data, it is not possible assessing whether productivity increased,
decreased or remained constant

6. Consider the graph below, which depicts the labor market of an economy initially placed in a
situation where the unemployment rate is equal to the natural rate of unemployment (point
0):

𝑊𝑊/𝑃𝑃
A
0 C
B
D

un
𝑢𝑢
A) If layoff costs decrease in a remarkable way, the economy could move to point A
B) If the degree of competition in the product market decreases, the economy could move
to point B
C) If unemployment benefits increase in a remarkable way, the economy could move
to point C
D) A more stringent enforcement of antitrust legislation in the product market, could move
the economy to point D
7. In the context of the expectations-augmented Phillips Curve, assume that the expected
inflation rate is negative while the effective inflation rate is zero. This means that the
economy is placed at:
A) Unemployment, with a constant rate of unemployment
B) Unemployment and the unemployment rate is decreasing
C) Over-employment
D) It is not possible that the expected inflation rate be negative and simultaneously the
effective inflation rate be zero
8. Assume an economy characterized by the Price-setting equation P = (1+m)(W/A) and the
wage-setting equation W = AePeF(u,z) = AePe(1 – αu + z). Taking into account that (m+z)=6%
and α=1, and the unemployment rate in year t is 4%, the change in the inflation rate
between years t and t-1 is:
A) 2%
B) -2%
C) 3%
D) -1%

9. In the context of the Phillips curve (with πet = πt-1), consider an economy where the actual
(or effective) unemployment rate is larger than the natural rate of unemployment, while the
inflation rate remains constant. In this case, it can be concluded that:
a) Actual (or effective) productivity exceeds expected productivity.
b) Government has implemented a law that reduces severance payments.
c) Expected productivity is larger than actual (or effective) productivity.
d) The nominal salaries demanded by workers become more sensitive to the
unemployment rate.