• If government increases government spending by $100 million and increases tax by $100 million so that the fiscal deficit does not increase, what happens to GDP? (Hint: the conclusion is the same regardless the value of marginal propensity to consumer.)

4. AEM and AD/AS (8 MARKS TOTAL). A temporary economic boom in China pushes up that country's demand for Australian minerals. The boom ends quickly however and Chinese demand for Australian minerals falls back to normal levels. Assume that the Australian macro-economy begins in equilibrium for both the short-run and long-run. a. Use the AE-45 degree line graph and the AE equation to depict the way the Australian economy moves out of equilibrium as a result of the China boom. Then depict equilibrium being naturally restored after that boom ends. Briefly explain the economic intuition behind your answer. (4 MARKS) (Maximum length: one page) b. Use the AD-AS graph to depict the way the Australian economy moves out of equilibrium and back into equilibrium as a result of the sudden China boom. Then depict equilibrium being naturally restored after that boom ends. Briefly explain the economic intuition behind your answer. (4 MARKS)

5 Figure 1: Research and Development (R&D) expenditures as a percentage of Gross National Product (GNP) Given the data above, how would you rank the countries above in terms of predicted future real GDP per capita growth? Explain your answer.

6. Real and nominal interest rates (2 MARKS) (Maximum length: half-page) Figure 1 shows the trend in real rates for the Federal Funds rate in the US (equivalent to the short- run money market interest rate) from 1956-2010. Why are the real rates sometimes negative? Use the Fisher Equation and speculate about how short-run output gaps over that period might have led to temporarily negative real interest rates.

For each of following, use an AD-AS diagram to show the short-run and long-run effects on output and inflation. Assume the economy starts in long-run equilibrium. a) An easing of monetary policy by the Reserve Bank (a downward shift in the policy re- action function)

Assume three Solow economies without technological progress and pro- duction function Y = √K-L. Each economy starts with capital per worker equal 9. Population growth equals 4% and savings rate equals 30% in each economy. Economies differ only in the depreciation rate: in country A it equals 1%, in country B it equals 2%, and in country C it equals 6%-

3. During the late 19th and early 20th centuries, the U.S. and many other nations adhered to the gold standard. Under the gold standard, a country aimed to sustain a target value of currency in terms of gold. In other words, the gold standard is simply a fixed exchange rate regime, except for pegging the domestic currency to a foreign currency, the domestic currency is pegged to a unit of gold. For instance, the U.S. may have pegged the dollar to gold at, say, $35 per ounce. If market forces put upward pressure on the dollar price of gold, the U.S. would need to intervene by selling gold reserves in order to increase the supply of gold and reduce the supply of dollars in order to drive the value of the dollar up the the dollar price of gold down. Thus, the government needs to have sufficient gold held in reserves in order to maintain the peg. When many countries simultaneously adhere to the gold standard, then their foreign-currency exchange rates are also fixed. (a) By the beginning of World War I the United States had accumulated a majority of the world's gold reserves. Explain in a few sentences why this forced foreign countries to abandon the gold standard. (b) After the gold standard dissolved, many countries instead pegged their currency to the U.S. dollar. By the end of World War II, most advanced countries, including the U.S., entered the Bretton Woods system whereby their exchange rates were fixed and the dollar was convertible to gold. During the 1960s the U.S. economy was booming above full employment. Through the lense of the IS-LM (Mundell- Fleming) model we can think of this as a temporary positive demand shock. Was it possible for the Federal Reserve to cool down the economy and bring it back to full employment? Justify your answer using a diagram like that in Figure 1. (c) Based on your answer in part (b), what would be the implications for the relative inflation rate of the U.S., relative to the rest of the world? Is this consistent with the data? (Hint: You will also need to make use of relative PPP.) To answer the last part, look up inflation data from Federal Reserve Economic Data (FRED) to examine inflation rates in the U.S., Japan, France, and the United Kingdom.

3. Dalal consumes only two goods for lunch and dinner: risotto (R) and lamb machboos (M). Dalal's utility function is given by U(R, M) = R + 4M. Suppose that a risotto dish costs 3 KD and that a dish of lamb machboos costs 6 KD. Dalal has 300 KD a month to spend on her lunch and dinner meals. a. How many risotto and lamb machboos dishes will Dalal buy each month if she maximizes utility? Dalal's brother, Jassem, wants to make her happier and is considering two options: giving her a 60 KD gift card that can only be spent on risotto from one of the Italian restaurants or giving her some cash money. If Jassem chooses to give Dalal the 60 KD risotto gift card: b. How many risotto meals can Dalal add to her optimal basket? c. What utility level will Dalal get given her income and the risotto gift card? Suppose that Jassem instead chooses the second option and promises Dalal to raise her income to the level that ensures making her as happy as the first option (getting the utility level found in part c). d. What would Dalal's optimal basket be given that her utility will equal the level found in part (c)? e. How much would the basket found in part (d) cost? f. How much cash does Jassem need to offer to fulfill his promise? Although both of Jassem's offers will make Dalal just as happy, their costs will not be the same. g. What is the cheaper option for Jassem: offering a 60 KD risotto gift card or offering the amount of cash found in part (f)?

a. Using the point elasticity method, derive an equation for the income elasticity of demand for toys. b. Using the point elasticity method, derive an equation for the cross elasticity of demand for toys relative to bike's price. c. Are toys normal or inferior goods? Why? d. Are toys and bikes substitutes or complements? Why? e. Calculate the income elasticity of demand for toys for a consumer that purchases 20 toys and has an income of 400 KD. f. Calculate the cross elasticity of demand for toys relative to bike's price for a consumer that purchases 20 toys when the price of a bike is 12 KD. g. Using the arc elasticity method, calculate the price elasticity of demand for toys for a consumer that has an income of 400 KD if the price of a bike is 12 KD and the price of a toy changes from 1 KD to 2 KD. h. Determine whether demand is elastic, inelastic, or unit elastic based on your calculation in part (g). i. Using the point elasticity method, calculate the price elasticity of demand for toys for a consumer that has an income of 400 KD if the price of a bike is 12 KD and the price of a toy is 2 KD. j. Determine whether demand is elastic, inelastic, or unit elastic based on your calculation in part (i). k. Write down the total revenue function as a function of P, when income is 500 KD and the price of a bike is 8 KD. l. Use the total revenue test to determine the range of prices where the demand for toys is elastic and the range where it becomes inelastic.

1. Farah is a Mocha Latte lover. Her demand function for Mocha Lattes is given by: Q = 20-3P Where Q and P denote the quantity and price of Mocha Lattes, respectively. Let the market equilibrium price for a cup of Mocha Latte be 4 KD. Answer the following questions: a. Calculate the price elasticity of Farah's demand for Mocha Lattes using the point elasticity method at a price of 1 KD. b. Derive Farah's marginal benefit function from drinking Mocha Latte. c. What is the equilibrium quantity of Mocha Lattes will Farah end up buying? d. Draw a rough sketch of Farah's demand curve and show all intersections with the horizontal and vertical axes. e. Label the consumer surplus area and the total expenditures area on your graph in part (d). f. Calculate Farah's total expenditure on Mocha Lattes. g. Calculate Farah's consumer surplus from consuming Mocha Lattes using the following approaches: i. Geometric area based on your sketch in part (d). ii. Integration h. Calculate the extra gain that Farah gets in her consumer surplus when the Mocha Latte price reduces to 2 KD. i. Label the area associated with the gain found on part (h) on a new rough sketch. Label the critical points that define the location and size of that area on the vertical and horizontal axes.