DIRECTIONS: This exam has two (2) sections; be sure to follow the directions for each section. Allocate your time carefully.

1. Short Answer Questions (15 points each)

DIRECTIONS: M.A. students must do the first question. Every student must do a total of two (2) short answer questions. If a question has multiple parts, indicate exactly where you answer each part.

1. An economy has a representative consumer with preferences over consumption in two periods: U = C1 × C2. Real income in the two periods is Y1 =$10, 000 and Y2 =$11, 000, the nominal interest rate is 15% per year, and expected inflation is 5% per year. Set up and solve the consumer optimization problem, explaining each step. What is the optimal level of saving for this consumer? Now suppose first period income doubles to Y1 =$20, 000: what happens to savings? In what sense does this consumer engage in “consumption smoothing”?

2. Write a fully commented EViews program that i. uses the Hodrick-Prescott filter to decompose GDP and unemployment into their flexible trends and flexible cycles and ii. produces recursive least squares estimates of the evolution of the Okun coefficient over time.

3. Graphically, show the derivation of the labor demand curve, the labor supply curve, and equilibrium in the labor market. Include a full discussion of your derivations, and explain the link between your discussion of the labor market and the classical aggregate supply curve.

4. Graphically, show the complete derivation of the saving supply curve, the investment demand curve, and equilibrium in the market for loanable funds. Include a full discussion of your derivations, including a discussion of the role of present value calculations in the derivation of the saving supply curve.

5. Discuss the trade-offs that underpin the demand for money. Then derive the LM curve under the assumption that the money supply is exogenous.

2. Multiple Choice Questions (1 point each)

DIRECTIONS: Answer all 82 multiple choice questions. Pick a single answer for each question: there is one best answer.

1. In the U.S., consumption has tended to be about
(a) twice as volatile as GDP
(b) half as volatile as investment
(c) three-quarters as volatile as GDP
(d) as volatile as GDP
(e) none of the above

2. The main difference between the classical and Keynesian explanations of what causes investment to fluctuate is that
(a) the classical economists believe that productivity shocks affect investment demand while Keynesian economists believe investment shifts because of interest rate fluctuations
(b) the classical economists believe that productivity shocks affect investment demand while Keynesian economists believe investment shifts because of animal spirits
(c) the classical economists believe that investment fluctuates because of changes in market psychology while Keynesian economists believe investment fluctuates because of shocks to the production function
(d) the classical economists believe that productivity shocks affect the supply of saving schedule while Key-nesian economists believe that they affect demand for investment curve
(e) none of the above

3. Let the interest rate be 6% per year. The present value in June 2001 of $100 received now and $159 received in June 2002 is
(a) $250
(b) $259
(c) $235
(d) $268.54
(e) none of the above

4. An increase in the rate of interest tends to increase household saving because
(a) it will shift the saving supply curve to the right
(b) investment demand will decrease
(c) the investment demand curve will shift up and hence saving will go up in equilibrium
(d) it makes future consumption cheaper relative to present consumption
(e) none of the above

5. If the investment demand curve is I(r)=1/(1 + r) and the saving supply curve is perfectly inelastic at 4/5 units of commodities, then the equilibrium interest rate will be
(a) -20%
(b) 25%
(c) 25 units of commodities
(d) 0.25%
(e) none of the above