Johns Hopkins University Macroeconomic Theory
Department of Economics Spring 2024
Mid-term Exam #2
You have 75 minutes for this exam. There are four questions with equal weights. Write your
answers under the questions, continuing on the back and the following blank page as necessary.
(If that is not enough space, the TAs have extra paper.)
YOUR NAME__________________________________________
SECTION NUMBER____________________________________
Question 1
Consider the Solow growth model without technical change, with all the standard assumptions
from lectures and the textbook. Suppose the economy starts in a steady state. For each of the
following events, say what happens over time to output per worker, Y/L, from before the
event until the economy reaches a steady state after the event. Present the answers with graphs
that have time on the horizontal axis, and explain your reasoning. The events are (consider
each event separately) :
A. A one-time surge in immigration that instantly doubles the size of the labor force. (After
this event, the growth rate of the labor force returns to its level before the event.)
B. A permanent increase in the growth rate of the labor force.
C. The introduction of a new technology that instantly doubles the amount of output
produced by any given combination of labor and capital.
D. A sudden and permanent increase in the labor force participation rate, L/N.
** For Part D, show the path over time of output per person, Y/N, as well as the path of Y/L
Question 2
Consider the ISLM model.
Part A
Make all the standard assumptions of the model. Draw the IS and LM curves and show how the
curves shift if the government raises taxes. Say what happens to the equilibrium levels of output
and the interest rate: for each variable, say whether it rises, falls, remains constant, or may either
rise or fall. Explain your answers.
Part B
Now consider the following changes in the model. Answer the same questions as in Part A for
each case.
1. Money demand depends on output but does not depend on the interest rate.
2. Money demand depends on the interest rate and on disposable income (rather than
output).
3. Money demand depends on disposable income (rather than output) and does not
depend on the interest rate.
4. Consumption depends on the money supply as well as on disposable income. For a
given level of disposable income, a higher money supply raises consumption. (In this
case, make the standard assumptions about money demand, not the assumptions in the
cases above.)
Question 3
Answer each of these questions concisely (a few sentences or a paragraph):
A. If the Federal Reserve raises its long run inflation target from 2% to 4%, would it become
easier or harder for the Fed to end recessions? Explain.
B. What is Okun’s Law? State this relationship as precisely as possible.
C. What is the problem of the double coincidence of wants and how does money overcome
the problem?
D. What is quantitative easing, how does it affect the economy, and what prompted the Fed
to start using this policy in 2009?
E. How might habit formation in consumption help explain the East Asian growth miracle?
Question 4
Consider the Solow growth model with no technical change. Assume the production function is
Cobb-Douglas: Y = KαL1-α.
Part A
Make all the standard assumptions of the model and assume that capital per worker (k) starts at
some positive level. Derive an equation for the change in k over time, and derive a formula for
steady state output per worker (y) in terms of the model’s parameters. Show your reasoning.
Part B
Now consider the following changes in the model. For each case, derive an equation for the
change in k over time. Also determine whether y converges to a steady state and, if it does,
derive a formula for the steady state y. If more than one answer could be correct, describe all
possibilities. Show your reasoning.
1. The population growth rate n is negative (that is, the labor force shrinks over time).
2. The population growth rate is not a constant, but rather depends inversely on output per
worker: n = 1/y. In addition, capital does not depreciate (δ = 0) and α < 0.5. For this case,
also say why the assumption about n might be realistic.
3. The parameter α equals one. That is, the production function is Y = K. (In this case, make
the usual assumptions that n and δ are positive constants.)