ECON 528 Midterm | 180 Questions & Answers
with Accurate Solution | Advanced Economics
Guide
Question 1: In a two-period consumption model with no uncertainty, a rise in the real interest rate
(r) causes the representative household to
A) always increase C₁
B) always decrease C₁
C) increase C₁ if the substitution effect dominates the income effect
D) leave C₁ unchanged because PV income is unchanged
Correct Answer: C) increase C₁ if the substitution effect dominates the income effect
Explanation: A higher r makes future consumption cheaper in present-value terms (substitution
effect tends to reduce C₁), but it also raises the return on saving, increasing lifetime resources
(income effect tends to raise C₁). The net change in C₁ depends on which effect is stronger;
nothing in the baseline model fixes the sign a priori.
Question 2: Under Ricardian equivalence, a one-time lump-sum tax cut today financed by higher
taxes next period
A) raises current aggregate demand
B) lowers the real interest rate
C) leaves current consumption unchanged
,D) increases the current-account deficit
Correct Answer: C) leaves current consumption unchanged
Explanation: Ricardian equivalence says households view the tax cut as merely a re-timing of
liabilities; they save the entire windfall to pay next period’s higher taxes, so current consumption
does not change.
Question 3: The Ramsey planner’s optimal capital-income tax rate in the long run (Chamley-Judd
result) is
A) equal to the labour-income tax rate
B) zero
C) slightly positive to correct for depreciation
D) negative to subsidise capital
Correct Answer: B) zero
Explanation: Chamley-Judd shows that in a Ramsey growth model with infinitely lived agents, the
optimal steady-state tax on capital income is zero to avoid intertemporal distortions; labour income
can still be taxed.
Question 4: In the New Keynesian Phillips Curve (NKPC), a higher coefficient on real marginal cost
(κ) implies
A) a flatter Phillips curve
B) a steeper Phillips curve
C) no change in slope
,D) a vertical Phillips curve
Correct Answer: B) a steeper Phillips curve
Explanation: NKPC: π = βE π + κmĉ ; a larger κ means inflation responds more strongly to
marginal-cost movements, i.e., a steeper short-run trade-off.
Question 5: Which shock is most commonly used to identify monetary-policy effects in VARs?
A) Technology shock
B) Fiscal shock
C) Monetary-policy (Fed-funds-rate) shock
D) Oil-price shock
Correct Answer: C) Monetary-policy (Fed-funds-rate) shock
Explanation: Christiano-Eichenbaum-Evans and similar studies recursively order the policy rate last
and orthogonalise the residual, treating it as the exogenous monetary-policy innovation.
Question 6: In the Calvo (1983) pricing model, a higher probability of price adjustment (1 − θ)
causes the Phillips curve to
A) become vertical
B) become flatter
C) shift upward
D) remain unchanged
, Correct Answer: B) become flatter
Explanation: A higher 1−θ means more firms reset each period, so aggregate inflation responds
less to marginal-cost changes—i.e., the curve becomes flatter.
Question 7: The Taylor (1993) rule prescribes that the nominal policy rate should
A) move one-for-one with core inflation
B) rise more than one-for-one with inflation and respond to the output gap
C) remain constant regardless of inflation
D) fall when the output gap is positive
Correct Answer: B) rise more than one-for-one with inflation and respond to the output gap
Explanation: Taylor’s original rule: i = r* + π + 0.5(π − π*) + 0.5ŷ ; the coefficient on inflation
is 1.5 > 1, ensuring the real rate rises with inflation, and it includes a positive weight on the output
gap.
Question 8: In a Real Business Cycle (RBC) model, a positive technology shock (A↑) immediately
A) lowers consumption
B) raises labor input
C) reduces the real wage
D) increases the real interest rate
Correct Answer: B) raises labor input
with Accurate Solution | Advanced Economics
Guide
Question 1: In a two-period consumption model with no uncertainty, a rise in the real interest rate
(r) causes the representative household to
A) always increase C₁
B) always decrease C₁
C) increase C₁ if the substitution effect dominates the income effect
D) leave C₁ unchanged because PV income is unchanged
Correct Answer: C) increase C₁ if the substitution effect dominates the income effect
Explanation: A higher r makes future consumption cheaper in present-value terms (substitution
effect tends to reduce C₁), but it also raises the return on saving, increasing lifetime resources
(income effect tends to raise C₁). The net change in C₁ depends on which effect is stronger;
nothing in the baseline model fixes the sign a priori.
Question 2: Under Ricardian equivalence, a one-time lump-sum tax cut today financed by higher
taxes next period
A) raises current aggregate demand
B) lowers the real interest rate
C) leaves current consumption unchanged
,D) increases the current-account deficit
Correct Answer: C) leaves current consumption unchanged
Explanation: Ricardian equivalence says households view the tax cut as merely a re-timing of
liabilities; they save the entire windfall to pay next period’s higher taxes, so current consumption
does not change.
Question 3: The Ramsey planner’s optimal capital-income tax rate in the long run (Chamley-Judd
result) is
A) equal to the labour-income tax rate
B) zero
C) slightly positive to correct for depreciation
D) negative to subsidise capital
Correct Answer: B) zero
Explanation: Chamley-Judd shows that in a Ramsey growth model with infinitely lived agents, the
optimal steady-state tax on capital income is zero to avoid intertemporal distortions; labour income
can still be taxed.
Question 4: In the New Keynesian Phillips Curve (NKPC), a higher coefficient on real marginal cost
(κ) implies
A) a flatter Phillips curve
B) a steeper Phillips curve
C) no change in slope
,D) a vertical Phillips curve
Correct Answer: B) a steeper Phillips curve
Explanation: NKPC: π = βE π + κmĉ ; a larger κ means inflation responds more strongly to
marginal-cost movements, i.e., a steeper short-run trade-off.
Question 5: Which shock is most commonly used to identify monetary-policy effects in VARs?
A) Technology shock
B) Fiscal shock
C) Monetary-policy (Fed-funds-rate) shock
D) Oil-price shock
Correct Answer: C) Monetary-policy (Fed-funds-rate) shock
Explanation: Christiano-Eichenbaum-Evans and similar studies recursively order the policy rate last
and orthogonalise the residual, treating it as the exogenous monetary-policy innovation.
Question 6: In the Calvo (1983) pricing model, a higher probability of price adjustment (1 − θ)
causes the Phillips curve to
A) become vertical
B) become flatter
C) shift upward
D) remain unchanged
, Correct Answer: B) become flatter
Explanation: A higher 1−θ means more firms reset each period, so aggregate inflation responds
less to marginal-cost changes—i.e., the curve becomes flatter.
Question 7: The Taylor (1993) rule prescribes that the nominal policy rate should
A) move one-for-one with core inflation
B) rise more than one-for-one with inflation and respond to the output gap
C) remain constant regardless of inflation
D) fall when the output gap is positive
Correct Answer: B) rise more than one-for-one with inflation and respond to the output gap
Explanation: Taylor’s original rule: i = r* + π + 0.5(π − π*) + 0.5ŷ ; the coefficient on inflation
is 1.5 > 1, ensuring the real rate rises with inflation, and it includes a positive weight on the output
gap.
Question 8: In a Real Business Cycle (RBC) model, a positive technology shock (A↑) immediately
A) lowers consumption
B) raises labor input
C) reduces the real wage
D) increases the real interest rate
Correct Answer: B) raises labor input
