Université d'Orléans - Année universitaire 2008-2009 Faculté de Droit, Économie et Gestion

Licence Economie Gestion (Mention Européenne) – semestre 2 Macroeconomics 26th March 2012

Exam #2

Aucun document autorisé Calculatrice autorisée

I. The Goods market (9 points) An economy has the following characteristics: C = 200 + 0.8 Yd I = 200 G = 200 T = 200 1) In the consumption function, what do the values 200 and 0.8 represents? (1 point) 200 is the level of fixed consumption (subsistence level). 0.8 is the marginal propensity to consume. 2) Give the marginal propensity to save. (0.5 points) MPS=1-MPC=0.2 3) Solve for equilibrium output (2 points) Y=C+I+G Y= 200 + 0.8 Y – 0.8*200 + 200 + 200 0.2Y= 440 Y=2200

4) Give the value of the multiplier. Comment. (1.5 points) m = 1/0.2= 5 (1/1-c). The higher is c, the stronger is the multiplier. 5) Due the financial crisis, businessmen are much less optimistic. They decide to cut their investments. I is now equal to 100. Solve for new equilibrium output. Comment. (2 points). \delta Y = m \delta I = 5 * -100 = - 500 Y= 1700 The negative effect on the output is much stronger that investment cuts, due to the multiplier effect.

1

6) In order to minimize the effect of the financial crisis, the government decides to cut taxes, by the same amount that investment was reduced. T is thus now equal to 100. Solve for new equilibrium output. Compare with the one you obtained in question 3. Comment. (2 points). Tax multiplier: -c/1-c \delta Y= [-0.8*100]/ 0.2 = 400 New level of Y= 2100. We do not come back to the initial value of Y. Tax multiplier is lower than other autonomous spending multiplier because its effect goes through the disposable income. There is an initial crowding out effect explained by savings. Remark (1 point bonus): we find the result of the balanced budget multiplier. When a government simultaneously increases level of G and T by the same amount, the level of GDP is increased by this amount. Here, the fall is equal to 100, which is the initial fall of investment levels.

II. Savings and investment (6 points)

1) Show that S=I + (G-T). Explain. (2 points) S=Y-T-C And Y=C+I+G S+T+C=C+I+G S= I + (G-T)

2) M. X argues that an increase in private saving is good for the economy because it will foster private investment. M. Y argues that M. X is wrong and that an increase in private saving may actually lead to a decrease of private investment. Explain why. (2 points) M. X is right if the only determinant of investment is the level of saving available in the economy. The indirect link between those variables is the interest rate which makes the equilibrium between I and S. However, M. Y is right when considering that an increase in private saving leads to a decrease in consumption which has negative effects on the output. The negative effect on the output would have two negative impacts on private investments: - It will reduce level of savings is saving is a function of income (with marginal propensity to save included between 0 and 1) - It will also reduce level of investment if it appears that investment is also a function of income. 3) According to the Keynesian model, is a reduction of public deficit a good way to increase private investment? Why? (2 points). Same type of answer than in the previous question. If there is a trade-off between private investment and public investment (or public deficit), a decrease in public deficit will automatically leads to an increase of private investment. However, if we consider that a reduction of public deficit will have negative effects on the output Y, it will also lead to a decrease of private saving S (function of Y). Tht may lead to a decrease of private investments. III. Financial markets (5 points)

2

The money demand is given by Md=$Y (0.20-i). Money supply is $100. And Y=$1000 1) Find the equilibrium interest rate. (1 point) At the equilibrium: Md=Ms 100= 1000 (0.20-i) 100/1000 = 0.2-i i=0.1=10%

2) This year, the country has a 10% growth rate. Give the new level of GDP, the new level of demand for money and the new interest rate. Explain. (2 points) Y=1100 Md= 1100(0.2-i) 100=1100(0.2-i) i=0.2-0.09=11% An increase in GDP leads to an increase of money demand and for a given level of money supply to an increase in interest rate. 3) The central bank decides to reduce the money supply to $80. How do we call such policy? What is the effect on the interest rate? (2 points). 80=1100(0.2-i) I=0.2-0.07=13%
Monetary contraction. It will have negative effects on the output.

3