Econ 712 Midterm Examination
Fall 2001

DIRECTIONS:
Obey page limits. If a question has multiple parts, indicate exactly where you answer each part. This exam has three (3) sections; be sure to follow the directions for each section. Allocate your time carefully: many students spend too much time on the short answer questions.

1. VERY SHORT ANSWERS:

ANSWER ALL OF THESE. Carefully define and briefly discuss the following terms. Whenever possible, supplement your verbal definition with both a mathematical definition and an example. Allocated time: 3 minutes each.

Page limit: one page per definition.

gross substitutes ``Walras' Law of Stocks''
unit root spurious regression
Government budget constraint NAIRU

2. SHORT ANSWERS:

DO ANY TWO (2) OF THE FOLLOWING QUESTIONS. ALL QUESTIONS ARE EQUALLY WEIGHTED. Allocated time: 30 minutes each.
Suggested page limit: three pages per question.

  1. Consider the differential equation system
    M/P=L(if+DE/E,Y)
    DP=φ(Y,E/P,F)
    with the partial derivatives defined in class. Here P is a predetermined endogenous variable, and E is a ``jump'' variable. (Y is exogenously fixed.) Use the adjoint matrix technique to find a solution for the dynamic path of this system, given an initial value of P. Note that this is primarily an algebraic exercise: you are not asked to discuss the model.
  2. What was Sargent's (1971) critique of estimates of the long-run tradeoff between inflation and unemployment?
  3. Consider our simple modification of the Friedman(1948) deficit finance model to rely on 100% bond finance. What is the necessary and sufficient condition for stable adjustment dynamics? Is this condition likely to be satisfied?
  4. What is Okun's Law and what is its significance? Does the empirical evidence support the stability of this ``law''? Be detailed and specific in your discussion.

3. LONGER ANSWERS:

ALL STUDENTS MUST ANSWER ONE (1) OF THE FOLLOWING QUESTIONS. Allocated time: 1 hour.

  1. Consider the following ``term-structure'' model of a simple fix-price economy.
    M=L(i,R,Y)
    Y=φ(Y,Yss,R,F)
    i=R-DR/R
    Here D is the differential operator, i is the short-rate, R is the coupon rate of return on a perpetuity, Y is real income, Yss is the steady-state level of real income, M is the exogenous money supply, and F is a ``fiscal stance'' variable. Give an intuitive explanation of each of the ``structural'' equations, including and explanation of the sign of each of the partial derivatives. Then consider the effects of anticipated tax cut in the short run, intermediate run (i.e., dynamic adjustment), and long run. Include a complete intuitive discussion supported by detailed graphs. Also include the complete algebra for the long-run comparative statics. You should assume that the combined marginal propensity to spend out of current (Y) plus ``permanent'' (Yss) income is less than unity.
  2. Consider the Tobin (1969) disaggregated model of the assets market, as summarized by
    M=L(rB,1/q,Y,M+B+qK)
    B=b(rB,1/q,Y,M+B+qK)
    qK=k(rB,1/q,Y,M+B+qK)
    Here rB is the short-rate, q is Tobin's q, Y is real income, M is the exogenous money supply, B is the exogenous bond supply, and K is the exogenous supply of real capital. Comment on the assumptions of the model, including any assumptions that allow us to write the model in this simplified form. Consider the effects of an open market purchase of equity shares. Provide a detailed verbal analysis, along with supporting graphs, and the explicit comparative statics algebra.

END OF EXAM