1. LARC: Econ 100C w/ EJ Name (Print):
Spring 2015
Practice Final - LARC
6/8/15
Time Limit: 120 minutes
This practice exam contains 10 pages (including this cover page) and 4 problems. Note that this
practice exam was constructed by collecting a variety of questions from the Econ 100C lectures
taught by both professors and the Mankiw textbook.
Disclaimer: This practice final is meant to be a supplement to your notes, homework assignments,
and past midterm exams. Before looking at this practice exam, you should thoroughly go over the
materials for your lecture as there are material that may be omitted or presented di↵erently in
LARC than how it was presented in your class.
You may use your books and notes as this is a practice exam — but try not to! More importantly,
work with your group! Some concepts are unfamiliar as a lot of the material covered in this practice
exam is a cross of both lectures.
You are required to show your work on each problem on this exam. Always remember the following:
• Organize your work, in a reasonably neat and
coherent way, in the space provided. Work scat-
tered all over the page without a clear ordering
will receive very little credit.
• Any and all diagrams should include well-labeled
axes and curves.
• Carefully read the directions — remember that you
don’t have a lot of time on the real exam, so make
sure you’re only writing down answers that are ac-
tually asked by the question.
• Double check your answers if you have the time.
• Don’t stress, and good luck!
Problem Points Score
1 5
2 15
3 11
4 9
Total: 40

2. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 2 of 10 6/8/15
1. Small Open Economy Oceania is a small open economy. Suppose that a large number of
foreign countries begin to subsidize investment by instituting an investment tax credit (while
adjusting other taxes to hold their tax revenue constant), but Oceania does not institute such
an investment subsidy.
(a) (1 point) What happens to world investment demand as a function of the world interest
rate?
(b) (1 point) What happens to the world interest rate?
(c) (1 point) What happens to investment in Oceania?
(d) (1 point) Given that initially, Oceania had balanced trade, construct a diagram for Ocea-
nia’s market for investment and savings, to show what happens to Oceania’s trade balance
after the tax credit.

3. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 3 of 10 6/8/15
(e) (1 point) Construct a diagram for the market for foreign exchange to illustrate what hap-
pens to Oceania’s real exchange rate as a result of the tax credit.

4. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 4 of 10 6/8/15
2. IS-MP A closed economy is described by the following equations:
Y = C + I + G (1)
C = ¯C + ↵(Y T) (2)
I = ¯I (r + ¯f) (3)
T = ¯T (4)
G = ¯G (5)
r = ¯r + ⇡ (6)
The real interest and inflation rates, r and ⇡ are expressed in percentage units. The following
values are also given:
↵ = .75 (7)
= .30 (8)
= .5 (9)
¯C = $5 trillion (10)
¯I = $2 trillion (11)
¯f = 0 (12)
¯G = $3 trillion (13)
¯T = $3 trillion (14)
¯r = 2 (15)
(16)
(a) (5 points) Use the following values above to calculate expressions for the IS, MP, and AD
curves.

5. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 5 of 10 6/8/15
(b) (1 point) Briefly explain the intuition behind what the IS, MP, and AD curves represent.
(c) (2 points) Suppose ⇡1 = 2. Calculate the real interest rate (r1) and quantity of goods
demanded (Y1).
(d) (2 points) Construct a diagram with the IS and MP curves, and another diagram with
the AD and IA curves that reflect the previous answer.

6. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 6 of 10 6/8/15
(e) Suppose that (Y1) is also the equilibrium in the long run. Imagine that Congress and the
president pass a law that will increase government purchases by $500 million.
i. (1 point) True or False: This is considered both a demand and supply shock.
ii. (2 points) How will this a↵ect the demand for goods and services assuming real in-
terest rates do not change? By how much?
iii. Reconstruct the diagrams from part (d) illustrating:
↵) (1 point) The immediate e↵ect of this policy change (regarding r and Y ).
) (1 point) The transition into the long run (regarding ⇡ and Y ).

7. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 7 of 10 6/8/15
3. IS-MP with Zero-Lower Bound Consider the 2008 financial crisis when consumer confidence
fell dramatically. Assume the economy was initially in long-run equilibrium.
(a) (1 point) What is the Fisher equation, and how is it used to imply the zero lower bound
condition?
(b) (2 points) Suppose that initially ⇡0 > 0, r0 > 0, and equilibrium output (Y0) is at a point
such that the country is not in a liquidity trap. Construct IS-MP and AD-IA diagrams
that reflect the information above.

8. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 8 of 10 6/8/15
(c) The following parts involve adjustments to the diagrams you drew in part (b):
i. (1 point) Draw the IA curve in the initial state (IA0).
ii. (2 points) Suppose that the shock was so large that the new short-run equilibrium
now exists on the flat part of the MP curve — NOT THE KINK. Adjust the diagram
in part (b) (i.e. make the appropriate shifts) that reflect this shock.
iii. (1 point) Since we were initially in long-run equilibrium, mark on the diagram where
the natural level of output, ¯Y , is.
iv. (2 points) What happens to ⇡, r, and Y over time? How is this di↵erent from what
we encountered before we considered the zero-lower bound condition.
(d) (1 point) In the literature (Romer, 2013), the term “liquidity trap” is used to describe the
situation the central bank is in due to the zero-lower bound condition. Now that we’ve
seen how the zero-lower bound condition imposes certain restrictions in our model, briefly
explain what the liquidity trap is.
(e) (1 point) Now consider that the zero-lower bound is not restricted by actual inflation but
expected inflation levels (⇡e). Suggest one way the government could attempt to get the
economy out of the liquidity trap.

9. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 9 of 10 6/8/15
4. Solow Growth Model Suppose the following:
• The United States has a capital share of GDP of about 30% (i.e. ↵ = 0.3).
• The growth rate of output is 3%.
• The depreciation rate is 4%.
• The capital-output ratio is about 2.5.
• The United States is in the steady state.
• The aggregate production function is given below:
Y = F(K, EL) = AK↵(EL)1 ↵, where A = 1.
(a) (1 point) What is the savings rate initially? (Hint: ˜i = gdep in the steady state).
(b) (1 point) What is MPK in the initial steady state? (Hint: You will need to use partial
di↵erentiation, and to make the math a little easier, use the fact that MPK is the same
even when you’re using Y = F(K, L) = AK↵L1 ↵). MPK should be a number.
(c) Suppose that there is a policy that calls for the increase in savings rate, s, towards the
Golden rule level of capital.
i. (1 point) What is MPK in the Golden Rule?

10. LARC: Econ 100C w/ EJ Practice Final - LARC - Page 10 of 10 6/8/15
ii. (2 points) Compare MPK in the Golden Rule to the MPK in the initial steady state.
Explain what you observe by sketching a production function and depreciation line
indicating where the steady state level of capital initially is (˜k⇤) and golden level of
capital (˜kg) are.
iii. (2 points) Draw a Solow Model illustrating this policy change.
iv. (2 points) Draw transition paths for ˜y,˜i, ˜c, and ˜k.