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ECONOMICS 3K03 (SUMMER 2020)

Instructor: Krishnakali SenGupta

 This online exam will be available for 24 hours between 11.30pm on August
7 to 11.30pm on August 8 (EDT) on A2L. YOU MUST SUBMIT YOUR
ANSWERS WITHIN THIS TIME FRAME.
 Any late submission will be graded zero.
 Submit your answers in the space provided. You may add additional
space(s) if required.
 YOUR ANSWERS MUST DEMONSTRATE YOUR OWN WORK. ANY
INDICATION OF ACADEMIC DISHONESTY (for example, collaborative
work and etc.) SHALL BE GRADED ZERO FOR ALL PARTIES
CONCERNED.

Answer all 4 questions in the answer space provided at the end. Total worth is 40 marks.
Show all your steps, wherever required for every question and explain your answers to avoid grade
penalty.

QUESTION 1 (Total: 10 marks)

Chapter 7: Suppose that fiat money stock changes according to the numerical magnitude of z= 2 and
number of young people born in each generation evolves according to the numerical magnitude of n =
1.5. In this economy, gross real interest is 1.3.
a. Calculate the gross and net inflation rates.
b. Calculate the gross and net real rates of return on fiat money.
c. Calculate the gross and net nominal interest rates.
In each of above your answers indicate clearly the equations you have made use of and show your steps.
(2 x3 = 6 marks).
d. Suppose people in our overlapping generations model have the opportunity to either hold fiat
money with complete safety or lend it to someone with the risk of loan default of 20%. Assume a
stationary equilibrium where population grows at a net rate of 8% and z = 1. What real rate of
interest will be charged to the borrower if people are i) risk neutral and ii) risk averse. Explain
your answers. (4 marks).

QUESTION 2 Chapter 8 (Total: 10 marks)

Consider an economy of two-period-lived people in overlapping generations. Each
person produces from labour y goods when young but nothing when old. The number of people
born doubles every period. There is the following capital technology: if kt goods per young
person are turned into capital at time t, the capital produces f(kt) goods at t + 1. The
diminishing marginal product of capital is f′(kt). After production takes place, d units of
capital are lost to depreciation. However, the remaining units of capital can be consumed.
a. Find an equation that represents the set of feasible stationary allocations and
explain it in words. (5 marks)

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 b. Find the equation that describes the golden rule capital stock for this economy. (You may use
either calculus or a marginal cost and marginal benefit analysis.) (5 marks)

QUESTION 3 (10 marks)

i. This is a question from Chapter 9. Consider an economy in which the reserve requirement is
increased from 10% to 20%.
a. Explain why the increase in the reserve requirement ratio causes overall welfare to
decline. (2 marks)
b. Construct a graph in c1-c2 space (the axes) showing how the increase in the reserve
requirement ratio will affect an individual’s lifetime budget constraint. (3 marks)

ii. Consider the economy explained in Chapter 6, where there are 2 islands. Total population on
2 islands is 500 people. The initial stock of fiat money is $500. Money grows in this economy
at z = 1.1. The probability that a person is on Island 1 is ¼ and on Island 2 is ¾. Let l(pit) = 4.
a. Write down the money market clearing condition for each island. (2 marks)
b. What is the per- person transfer the government gives to each old person? (2 marks)
c. What is the equilibrium price level? (1 mark)

|SHOW YOUR STEPS AND WELL-DEFINED EQUATIONS TO AVOID GRADE PENALTY.

QUESTION 4 (10 marks)

i. Consider an economy as explained in Chapter 10, in which people wish to hold bank checking
deposits worth a total of 10 million goods and currency worth 4 million goods in every period. In
addition, there is a stock of unintermediated capital worth 20 million goods. Fiat money is the
only asset used as currency. Deposits at banks are subject to a reserve requirement of 10 percent.
After meeting the reserve requirement, banks invest the remainder of all deposits into capital. The
monetary base is $2 million. (Hint: The key to this exercise is to understand the difference
between inside and outside money.)
a. Find the value (in goods) of a dollar. (1 marks).
b. Find the total nominal money stock as measured by the definition of M1. (1 marks).
c. Find the money multiplier. (1 marks).
d. Find the total capital stock. (1 marks).
e. Find the currency-deposit ratio, (1 marks)
SHOW YOUR STEPS AND WELL-DEFINED EQUATIONS TO AVOID GRADE PENALTY.

iii. Draw a well labeled graph showing the rate of return on deposits and si which corresponds to
purchase size of old age consumption from Chapter 10. Assume the rate of return on fiat
money is n/z.
a. On your graph, indicate clearly the zone where the old age consumption is purchased by
currency and the same is purchased by deposits. (1 marks)
b. On your graph show the impact of a rise in n on the split between the use of deposit and
currency to purchase old age consumption. Explain your answer in few sentences. (4
marks).

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 ANSWER SPACE
PLEASE INDICATE THE QUESTION NUMBER AND SUBPARTS CLEARLY IN YOUR
ANSWERS. FOLLOW THE ABOVE SEQUENCE OF THE QUESTIONS WHILE ANSWERING
(do not mix and combine questions in your answers).
KEEP EXPANDING THE ANSWER SPACE AS PER YOUR REQUIREMENT