Econ 1102 Practice Final

Name: (2 RP)

(+2 RP for writing name as it appears on the class roster)

Section #: (2 RP) TA Name: (2RP)

(+2 RP for section enrolled in)(+2 RP for correct TA name)

Non-programmable calculators only

No cell phones, no notes

Time limit: 120 minutes

Each page may have has its own directions. Follow the directions carefully.

Clearly indicate which question you are answering.

Correctly answering extra questions on a page will generate Replacement Points for that page only.

For full credit, graphs must be completely LABELED and math work shown.

Be sure to justify your answers clearly and precisely for full credit,.

Rambling, incoherent or illegible responses shall be penalized even if correct. Points are rewarded for answers consistent with those your instructor would give to the same question.

This exam is 9 pages (including this front page), numbered 1-9.

GOOD LUCK!

RP:_____1:______2:______3:______4:______

5:______6:______7:______8:______Total:______


QUESTIONS 1 (25 pts, 8RP)

1.(8 pts) Draw and label a flow diagram with three agents: consumers, profit earning firms, rest of world and three places of exchange: factor market, output market, financial market. On your diagram, clearly mark each component we use to calculate GDP.

2.(12pts) Give one example of an economic policy that Econland could implement to encourage growth. Using supply-demand graph analysis, what are the potential negative effects of the economic policy you recommended? Clearly discuss surplus, quantity and price effects. Be sure to mention If there is an additional effect on the general economy (i.e. government budget problems, unemployment).

3.(5 pts) Draw the Econland PPF in 1982, placing bread on the x-axis. Indicate a point where this economy might be if it is producing efficiently. Inefficiently. Show how the PPF moves if the economy experiences war.

4.(2 RP) Define an Economic System

5.(4 RP) List 4 characteristics of the market system.

6. (2 RP) Define Economic Growth

1.

GROUP B

  1. A rebate on food to increase health and nutrition of workers, would increase demand for food.

Quantity of food purchased in equilibrium would increase, price of food would increase as well. Total, Consumer and Producer Surplus would increase.Unless the government increases taxes somewhere else, it will have a budget deficit (spend more than it earns in taxes). If the government increases taxes on a different good, it would generate a dead-weight loss for that good.

  1. A set of institutional arrangements to determine how to distribute scarce resources to satisfy peoples wants.
  1. Any four of the following:
  2. Extensive Private Property Rights
  3. Freedom of Enterprise and Choice
  4. Self Interest as the primary motivating force
  5. Competition
  6. Existence of market and prices
  7. Active, but limited government
  1. An increase in RGDP per capita.

QUESTIONS 2 (25 pts, 25 RP)

  1. (2 pts) What is the official size of Econland’s population?
  2. (2 pts) What is the size of the Econland’s labor force?
  3. (2 pts) How many people are unemployed in Econland?
  4. (2 pts) What is the participation rate in Econland?
  5. (5 pts) What is the Econland’s Nominal GDP in 2000?
  6. (3 pts) What is the Econland’s Real GDP in 2000?
  7. (2 pts) Suppose RGDP is $20,000 in 2005, and population is the same as it was 2000. Has Econland experienced growth or a recession?
  8. (2 pts) What is the GDP Deflator in 2000?
  9. (5 pts) What is CPI inflation from 1982 to 2000?
  10. (2 RP) Define Gross Domestic Product (GDP):
  11. (5 RP) State 1 reason why economists use real GDP per capita to study growth instead of Nominal GDP per capita. Why don’t economists use Real GDP to study growth?
  12. (5 RP) Suppose that USA unemployment rate falls from 9.7% to 9.3%. State and explain one reason why this number alone NOT a clear sign that more people are finding jobs. Name at least one other economic indicator we should know before we can reach the conclusion that more people are finding jobs, and briefly explain why this additional information helps.
  13. (3RP) What is the Natural Rate Hypothesis?
  14. In April 2010, the European Union declared that travelling for tourism is a basic human right and plan to have taxpayers pay up to 30% of travelling costs for youth and the elderly tourists in the EU.
  15. (5RP) Why may you expect GDP for individual countries in the EU to decrease under this plan?
  16. (5 RP) Why may GDP for at least one country in the EU increase (you don’t need to name a country, just explain why GDP may increase).
  1. 15+50+10+5+20=100
  2. 50+10=60
  3. 10
  4. (60/100)=0.6=60% (Answer Q12/ Answer Q11)
  5. Bread in 2000: 6000 thousand. Flour purchased by consumers: 200-6000/100=200-60=140

[6000*3.50+140*15]=21000+2100=$23,100 thousand (or $23,100,000)

  1. RGDP_00=[6000*2.00+140*10] = 12000+1400=$13,400 thousand
  2. Growth
  3. Nominal/Real=(23,100/13,400)x100=172
  4. CPI_2000: (2*3.5/2*2)=1.75

CPI Inflation: ((1.75-1)/1)*100 = 75

  1. The market value of final goods and services produced within the borders of a given country within a given period of time (+0.5 for each highlighted)
  2. Nominal GDP can be misleading because it doesn’t adjust for different prices over time. Use Real per capita so that we can see how much output each person receives – for welfare to improve, need each person to be receiving more.
  3. Example: Maybe some of the unemployed become discouraged workers, instead of finding jobs. Therefore, the decrease unemployment is because people have given up looking, not because they have found a job. Examples of additional info (only need 1):
  4. Participation Rate – can see if people are leaving the labor force as discouraged workers
  5. Employment number – can see if there are literally more people working.
  6. Labor Force.—can see how many are employed and unemployed with the unemployed rate.
  7. Unemployed number-can see if the labor force is increasing or not.
  8. Number of discouraged workers
  9. The claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation.
  10. (a) To fund the plan the government needs to increase expenditures, G – BUT this G will probably not stay within the country as people are using it to travel to different countries. So, either the government increases taxes and decreases C or it runs a deficit and decreases I through crowding out, without a matching increase in G.

(b)The countries to which people are travelling to will experience an increase in C (from tourism), which will be reflected as an increase in GDP.

QUESTIONS 3 (25 pts, 25RP)

  1. (8 pts) Gina has $100 to spend or save. Suppose that inflation=0%. She could:
  2. Buy $100 of stocks in a company, BigBubble for a year. There is a 90% chance that BigBubble collapses and she loses all her money, a 9% chance that it gives her a 100% interest, and a 1% chance that it gives her a 2000% interest.
  3. Put it in a jar on her bookshelf.
  4. Spend $100 on a 1 year Tbill that pays 7% real interest.

Which option would give her the highest expected yield a year from now?

  1. (4 pts) How much would you need to invest this year if you would want $5000 a year from now, and real interest rates are 5%?
  2. (2 pt) Suppose someone in Econland saves $500 in 1970 by putting burying money in their back yard. How much is that money worth in nominal terms in 2000?
  3. (3 pts) Suppose instead that they invested their money in the bank at a nominal interest rate of 18% from 1970 to 2000 when inflation is 5%. What is the real interest rate they earn?
  4. (3 pts) What is the equivalent value of $2500 in 2000 in 1970 if Cost of living in 1970 is 35 and Cost of living in 2000 is 42? (I.e how much money would you need in 1982 to buy the same amount of stuff as you can with $2500 in 2000)
  5. (2 pt)What is the value of money in the economy if average price level is $10?
  6. (3 pts) What is the velocity of money in the economy if price level is $10, RGDP is 5000, money supply is $8000?
  7. (2 RP) What is the Central Bank of the USA called?
  8. (3 RP) Define Fractional Reserve Banking.
  9. (6 RP) A friend of yours needs to take out a 5 year loan to pay tuition. They can choose between two loans: One has a 3% interest for the duration of the loan. The other loan has an adjustable interest rate – it will change with the interest rate in the loanable funds market (currently 2.75%). Based on what you’ve learnt in this class, which loan would you advise your friend to take, and why?
  10. (4 RP) What is crowding out, and how is it caused by expansionary fiscal policy?
  11. (2 RP) If there is a recession, will the Central Bank use expansionary or contractionary monetary policy?
  12. (2 RP) If there is a recession, will the government use expansionary or contractionary fiscal policy?
  13. (6 RP) Define the 3 tools of monetary policy

21.Of the three options, buying the Tbill is the best.

(a)After 1 year: 0.90(0)*100+0.09*(1+1)*100+0.01*(1+20)*100 =0 + 18+21= $39

(b)$100

(c)After 1 year: 100*(1.07) = $107

22.$5000 = P*(1.05) ; P=$4761.90

23.$500

24.13%

25.2500*(35/42)=$2083.3333

26.V=1/P = 1/$10=0.10

27.V=P*Y/M = ($10*5000)/$8000 = 6.25

28.Federal Reserve Bank

29.Banking system in which banks are required to keep a percentage (fraction) of checkable deposits in cash or with the central bank.

30.Choose fixed interest rate. Due to the recession interest rates are currently low. When the recession ends, the Fed will tighten money supply, increasing interest rates, thereby increasing the interest rate of the adjustable rate loan.

31.Crowding out is the decrease in investment that results from decrease in public savings/expansionary fiscal policy. With expansionary fiscal policy, the public savings decreases, therefore the supply of loanable funds decreases. This results in a higher interest rate and a lower demand for loans in the new equilibrium in the loanable funds market (full credit if explained with diagrams instead).

32.Expansionary Monetary Policy

33.Expansionary Fiscal Policy

34.Reserve Ratio (RR): Regulations on the minimum amount of reserves that banks must hold against deposits; Open-Market Operations: The purchase and sale of US government bonds by the Fed

Discount Rate: The interest rate on the loans that the Fed makes to the banks.

QUESTIONS 4 (25 pts, 18RP)

For the following questions, use the data for Econland in 2005.

  1. (4 pts) What is the Money Supply in this economy?
  2. (3 pts) What is demand for Loanable funds?
  3. (3 pts) How much does Initial Spending in the Output Market need to change to return the Econland to the AD-AS Equilibrium?
  4. (5 pts) Ifthe Government decides to change taxes to achieve this objective, what will the new level of taxes be?
  5. (5 pts) If the Central Bank implements OMOs to return the economy to the AD-AS Equilibrium, what value of bonds will the Fed buy/sell to close the GDP gap?
  6. (4 RP) The four components of aggregate demand are:
  7. (8 RP) In 2010, Haiti experienced a large earthquake. Explain how each of the following events changes the price level: the loss of life, damage to infrastructure, inflow of monetary aid, and inflow of goods aid. (You are NOT asked to find the overall change in price)
  8. (4 RP) Correctly name 2 groups of economic thought and what they believe to be the main cause of economic fluctuations.
  9. (2 RP)List 2 reasons in favour OR List 2 reasons against a balanced government budget.

35.Money Multiplier = 1/RR = 1/(0.05) = 20

Money Supply = (20)x(400)=$8000

36. Money Demand = Money Supply

8000 = 12000-2000i => i=2%

Loanable Funds Demand = 1000-100(2)=$800

37.Need to increase GDP by $6000-$5000=$1000.=>Change GDP=$1000

Change GDP=(1/(1-MPC)*(ChangeInitialSpending)

1000=(1/1-0.95)*ChangeInit=>1000/20=ChangeInit => ChangeInitialSpending = $50

38. ChangeInitial=ChangeConsumption= $50

ChangeConsumption=MPC*ChangeTax

$50=MPC*ChangeTax

ChangeTax=$52.63

$52.63=TaxOld-TaxNew

Taxnew=$200-$52.63 = $147.37 (+1 correct new level of taxes)

39. ChangeInvestment=ChangeInitialSpending=$50

New Loanable Funds Demand = $800+$50=$850

$850=1000-100i (+1: Correct use of loanable funds equation)

i=1.5% (Interest rate has to be 3.5%) (+0.5 Correct interest rate)

Money Demand = 12000 – 2000(1.5) = $9000 = Money Supply

$9000 = 20 * InitialDeposits (+1: correct MS)

Initial Deposits = $450 (+0.5 correct answer)

Fed buys $450-$400 = $50 of Bonds.

40.Consumption, Investment, Government purchases, Net Export

41. Earthquake kills a bunch of people => AD decreases => decrease local prices

Earthquake damages infrastructure => AS decreases =>Increase local prices

Inflow of monetary aid => AD increases =>Increase local prices,

Inflow of “goods” aid => AS increases =>decrease local prices

42.

  1. New Keynesians: Unexpected shocks to either aggregate demand or aggreagate supply interacting with sticky prices
  2. Monetarists: Inappropriate Government Policy (esp. monetary policy)
  3. Real Business Cycle: Shocks to Real Factors
  4. Coordination Failure: People lack a way to coordinate their actions, and therefore we have events that result from people’s expectations, rather than anything fundamental to the economy.

43.Pro: Places a burden on a future taxpayer, Lower National Savings

Con: Tax Burden is not large compared to a person’s lifetime income, Budget deficit has to be seen in the picture

QUESTIONS 5 (25 pts)

  1. (3 pts) Draw the joint equilibrium in the loanable funds, NCO and Foreign Exchange Markets.
  2. (2 pts) Suppose the government is trying to maintain fixed exchange rate but runs a budget deficit. What policy can the government or central bank implement to return the RER to the pre-budget deficit level?
  3. (3 pts) What happens to the Real Exchange Rate, Interest Rates, Net Capital Outflows, and the Trade Balance after the government implements the policy above to return RER to the pre-deficit level?
  4. (2 pts) Define Fixed Exchange Rate
  5. (2 pts) Define Flexible Exchange Rate
  6. (3 pts) What are 3 disadvantages of a Flexible Exchange Rate?
  7. (1 pt) What is currently the most common exchange rate system?
  8. ( 4 pts) List 4 ways in which the government can control the exchange rate.
  9. (5 pts) Between September 2002 and September 2003, the exchange rate between the euro and the dollar changed from 1.02 euros per dollar to 0.87 euro per dollar. What effect would you expect this change to have on GDP and Net Exports in Europe and America?

44.

.

  1. Expansionary Monetary Policy
  2. Decrease Interest Rate, Increase NCO, and Decrease RER and Increases NX
  3. Governments determine exchange rates and make necessary adjustments in their economies to maintain those rates.
  4. Demand and supply determine exchange rates and no government intervention occurs
  5. Uncertainty and Diminished Trade; Terms of Trade Changes; Instability
  6. Managed Exchange Rate Float
  7. Trade Policies, Exchange Rate controls and Rationing, Domestic Macroeconomic Adjustment, Currency Intervention
  8. USA: Net Exports to Europe Increases, GDP Increases

Europe: Net Exports to USA Decreases, GDP decrease

QUESTIONS 6 (25 pts)

  1. (8 pts) Using the given economic data, construct the large country trade equilibrium between USA and Canada in Nickel. What is the world price of Nickel? How much imported/exported What is demand and production of nickel in Canada?
  2. (2 pts) Consider Austria and Switzerland. Which country has absolute advantage in Skis? Which country has absolute advantage in Snowboards? Which country has comparative advantage in skis? Which country has comparative advantage in snowboards?
  3. (5 pts) Suppose that before trade both Austria and Switzerland produced at C, and after trade the country with the comparative advantage in skis produces at B, and the country with the country advantage in snowboards produces at E. What is global production gain from trade?
  4. (5 pts) What are the limits of the terms of trade between Austria and Switzerland?
  5. (5 pts) Suppose terms of Trade set 1 ski = 1 snowboard, Switzerland consumes 500 skis, and production plans are as described in 62. What are the import, export, and consumption plans after trade?
  1. Canada: At Price 2.50, Net exports of 20; at price 2.00, Net imports of 0

USA: At Price 2.00, Net imports of 40; at price 3.00, Net imports of 0

Price is 2.50, Imports/Exports =20

Canada: Produces 30, Consumes 10

  1. Switzerland has absolute advantage in Skis and Snowboards.

Switzerland: 800 skis=400 snowboards => 2 skis = 1 snowboards

=> OC of 1 ski = 0.5 snowboards

Austria: 100 skis=200 snowboards => 1 skis = 2 snowboards.

=> OC of 1 ski is 2 snowboards.

Switzerland has Comp. Adv. in skis, Austria has Comp. Adv. in snowboards

  1. Before trade: Switzerland (400 skis, 200), Austria (50 skis, 100)

After trade: Switzerland (600 skis, 100), Austria (0 skis, 200 snow)

Before Trade Total: (450 skis, 300 snowboards)

After Trade: (600 skis, 300 Snowboards)

Gain 150 skis, 0 snowboards

  1. Minimum Terms of Trade: 1 ski = 0.5 snowboard; Max Terms of Trade: 1 ski = 2 snowboard
  2. Switzerland consumes 500 skis, produces 600, therefore must export 100 skis andimport 100 snowboards.Austria Produces 200 snowboards, exports 100 => consumes 100 snowboards

Switzerland produces (600 skis,100 snow), consumes (500 skis, 200 snow)

Austria produces (0 skis, 200), consumes (100 skis, 100 snowboards)


QUESTIONS 7 (25 pts)

  1. (1 pt) Suppose Coca-Cola sells for $2 in the USA, and the nominal exchange rate is $2=€1. What is the approximate price of Coca-Cola in Euros?
  2. (4 pts) Now suppose the exchange rate is $1=€1. What is the approximate price of Coca-Cola in Euros? Has the Euro appreciated or depreciated relative to the dollar?
  3. (2 pts) Suppose that the exchange rate is $1=€2 and Coca-Cola sells for $1 in the USA, and €2 in Europe. What is the Real Exchange Rate?
  4. (2 pts) What should the nominal exchange rate be for PPP to hold in the example above?
  5. (1 pts) What should the real exchange rate be for PPP to hold in the example above?
  6. (5 pts) Suppose that a country goes from a trade deficit to a trade surplus. Which is larger with a trade surplus, imports or exports? What happens to NX, NCO and GDP?
  7. (4 pts) A common argument for a “Buy-American” clause is as follows: The wage of foreign workers is so far below that of American workers that there is no way that Americans companies can remain competitive. To save American jobs, the government should pass a law mandating that all Federal projects use American-made products, thereby boosting demand for the goods made by American firms, and saving the American manufacturing sector. Evaluate this argument based on information from this class (Hint: This statement is not necessarily right or wrong - you are free to agree or disagree, as long as you can make a coherent, economics-based argument for your position.
  1. P*=eP = (€1/$2) $2=€1

Coca-cola is €1

  1. P*=eP = (€1/$1) $2=€2

Now, Coca-Cola is €2. Euro has depreciated.

  1. RER=(eP)/P* =(€2/$1)*($1 per American Coke/ €2 per Euro coke)

= 1 European Cola/ 1 American Cola

  1. PPP implies: (1/P) = (e/P*)

e=P*/P =€2/$1

€2 for $1

  1. PPP ALWAYS implies that RER=1
  2. Exports are larger than imports. NX becomes positive, NCO becomes positive, GDP increases.
  3. Full Points for a coherent, economics based arguments either for or against a Buy-American clause.

QUESTIONS 8 (23 pts)