ECON 305: Intermediate Macroeconomic Theory
University of Southern California
EXAM 2
Please answer all 11 questions below in a separate document and clearly indicate the
problem number for which you are providing the answer.
You have 12 hours to turn in your answers (i.e., until 10pm Pacific Standard Time).
Please upload your documents in Word or PDF format to Blackboard in the section from which
you downloaded the exam. You are responsible for making sure that all your answers, including
graphs, are readable.
1. [4 points] Let’s say that depreciation per worker is less than saving per worker. If this is
the case, explain what will happen to each of the following variables over time: (a)
capital per worker, (b) output per worker, (c) saving per worker, and (d) consumption per
worker.
2. [6 points] Suppose an economy has a production function given by y = f(k) = 2k0.5 where
k is capital per worker. There is no technological progress in the economy. The
depreciation rate is 7%, the saving rate is 10%, and the population growth rate is 3%.
Using the Solow growth model, calculate the steady state values of (a) capital per worker,
(b) output per worker, and (c) the real rental rate on capital.
3. [8 points] Consider a situation where expectations of productivity growth adjust slowly.
Assume that there is a 3% reduction in productivity. Explain, using an appropriate graph,
how this reduction in productivity can cause changes in the unemployment rate.
4. [7 points] Show graphically and explain what effect a reduction in taxes will have on
output, exports, imports, and net exports (Use the ZZ/Y and NX graphs). Clearly label all
curves and clearly label the initial and final equilibria.
5. [5 points] A policymaker desires a full-employment level of output but the country’s
current output is lower. The country is also experiencing a trade surplus. The policy
maker’s objective is to achieve the desired level of output and balanced trade. What type
of exchange rate and/or fiscal policy can be used to achieve these two goals
simultaneously? Explain.
6. [5 points] Why might the IS curve be downward sloping in an economy operating under
flexible exchange rates? Explain clearly.
7. [2 points] Assume that the U.S. interest rate is 8% while the U.K. interest rate is 6% and
that the interest parity condition holds. Would financial markets expect the pound to
appreciate or depreciate? By how much?
8. [5 points] Consider an open economy with flexible exchange rates. Using the openeconomy
IS-LM framework, answer the following: (a) What is the impact on domestic
output of an increase in foreign output? (b) What is the impact on domestic output of a
decrease in the foreign interest rate?
9. [6 points] With the aid of an appropriate framework (i.e., graph(s)), explain the impact on
the nominal exchange rate of a simultaneous tax increase and monetary expansion in an
open economy on a flexible exchange rate regime.
10. [7 points] Assume the Covid-19 crisis leads to a significant decline in consumer
confidence. Using the IS-LM model, explain what effect this will have on the domestic
economy of a country on a fixed exchange rate regime.
11. [5 points] The exchange rate between the British pound and the U.S. dollar is 2 pounds/$.
In England, the price level is 1.0 and the one-year interest rate is 20%. In the United
States, the price level is .8 and the one-year interest rate is 8%. The inflation rate in both
countries is zero.
a. What is the real exchange rate from the US perspective?
b. What is the price of US goods measured in pounds?
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