1
Final Exam: 2015
QUESTION-1: TRUE/FALSE with explanation.
1) Fiscal policy affects income more rapidly than monetary policy, this means fiscal
policy has shorter lag.
2) The term intertia is defined when agents expect for tomorrow the same inflation as
today i.e.
3) If marginal product of labor is larger than the unit cost of capital which drives up the
replacement cost of installed capital, which implies higher the value of Tobin-q.
4) In the two period consumption model if
borrowing constraint is binding then Keynesian
consumption function is micro-founded. (diagram is required)
QUESTION-2:
Consider the equilibrium dynamic model for given values for the exogenous and parameters of
the model. Use the following values to solve for the impulse response function of output (Y) for
period t and t+1 i.e. Y
t
and Y
t+1
.
100,
∗
2, 1, 1,
0.5,
0.5. Also assume the demand shock
increases by 1 in period t and shock ends at the end of period t i.e. shock is zero at
period t+1 whereas, supply shock is zero.
A. Use the model of dynamic aggregate demand and aggregate supply to graphically illustrate the
impact on output and inflation of an exceptional weather pattern that results in a one-period glut
of food worldwide that reduces food prices (a one-period positive supply shock) when the
economy is initially at long-run equilibrium. Explain the time path of output and inflation in
words.
*
A( ) B ,
= − − +
t t t t t
Y Y
π π ε
1
A 0, B 0
1 1
= > = >
+ +
Y Y
π
αθ
αθ αθ
QUESTION-3:
A) State main results of cross-sectional studies and time-series studies. Which of the studies show
consistent results with Keynesian consumption function? What consumption puzzle arises from
the findings of the two studies?
C) Fisher’s two period, inter-temporal, consumption function investigates whether Keynesian
consumption function is microfounded. The two period consumption theory draws results that
Keynesian consumption function is not microfounded when rise in interest rate creates income
and substitution effect. Explain the reason that in micro-foundation consumption function timing
of income is irrelevant.
D) The average propensity of consumption in the long-run is considered to be stable under the Life
Cycle Hypothesis (LHC) and Permanent Income Hypothesis (PIH). Explain why?
QUESTION-4:
A. In order to maximize profits a neoclassical firm rents capital when MPK = R/P. where MPK is
the marginal productivity of capital, R is the nominal rental rate and P is the price of firm’s
product it sells in the competitive market. Given the production function as:
,
