Name: First Prelim ECON 102 – 16 March 2006
Section Number:
This exam has 5 pages: 20 multiple choice questions, 5 short answer questions and 3 essay questions
Multiple Choice Questions
One point per question.
Write the answers on the separate sheet provided.
1. In the long-run demand for oil products is more ___ compared to the short-run where the demand for oil-products exhibits a rather ___ demand curve.
a) elastic, flat
b) elastic, steep
c) inelastic, flat
d) inelastic, steep
Answer: b
2. What would NOT be included in the GDP of the US?
a) my lunch at Peace restaurant, owned by a Chinese family
b) the locally brewed beer I had yesterday
c) the cloth used to make the Cornell T-shirt I bought in the campus store
d) the 100 dollars my bank has charged me to open a new account
Answer: c
3. The tomatoes picked by Mexican workers in California is part of ___. The salary of those workers, repatriated to Mexico is part of Mexican ___ but not Mexican ___.
a) US GDP; GNP; GDP
b) US GDP; GDP; GNP
c) Mexican GDP; GNP; GDP
d) Mexican GNP; GNP; GDP
Answer: a
4. The drug traffic between Colombia and the US is included in:
a) Colombian GDP
b) US GDP
c) US GNP
d) none of the above
Answer: d
5. Who are included in the number of unemployed people in the US?
a) the inmates in the jail of San Francisco
b) my neighbor, who was fired a few days ago and is trying to find a new job soon
c) the 19 year old son of a farmer who helps his father on a farm but does not receive a wage
d) my doctor since he has almost no patients left
Answer: b
6. The MPS refers to:
a) the average amount of saving in a society.
b) the fraction of an increase in income that is saved.
c) the slope of the consumer function
d) the fraction of a change in income that is consumed.
Answer: b
7. Decreasing interest rates are likely to ____ spending and increasing income is likely to ____ spending.
a) increase, decrease
b) decrease, increase
c) increase, increase
d) decrease, decrease
Answer: c
8. In a closed economy with no government, only when ___ equals ____ there will be equilibrium.
a) unplanned investment, savings
b) planned consumption, savings
c) planned investment, savings
d) planned investment, aggregate output
Answer: c
9. If firms react to unplanned inventory reduction by ___ output, an economy with planned spending _____ than output will adjust to equilibrium, with Y ____ than before.
a) decreasing, less, higher
b) decreasing, greater, lower
c) increasing, greater, higher
d) increasing, less, lower
Answer: c
10. When planned investment increases by a certain amount, the equilibrium level of output ____ by a _____ amount.
a) increases, greater
b) increases, lesser
c) increases, constant
d) decreases, greater
Answer: a
11. In the leakage, injection approach to equilibrium in an open economy where the government exists,
a) S+T+Ex = I +G + Im
b) S = I
c) S+T+Im = I + G + Ex
d) Y = AE = C + I + Ex - Im
Answer: c
12. The money multiplier represents the concept that deposits can ____ for every dollar in _______
a) increase, decreased reserves
b) increase, increased deposits
c) increase, increased reserves
d) decrease, decreased deposit
Answer: c
13. When the Federal Reserve wants to decrease the money supply in the economy it can engage in:
a) open-market sales of securities or decrease of discount rate
b) open-market purchase of securities or decrease of discount rate
c) open-market sale of securities or increase the discount rate
d) open-market purchase of securities or increase the discount rate
Answer: c
14. An expansionary monetary policy has the following effects:
a) increases the money supply, and increases the interest rate
b) increases the money supply and decreases the interest rate
c) decreases the money supply and increases the interest rate
d) decreases the money supply and decreases the interest rate
Answer: b
15. When we speak of the demand for ____, we are concerned with how much of your financial assets you want to hold in the form of _____ which does not earn interest versus how much you want to hold in interest-bearing securities such as _____
a) bonds, money, bonds
b) money, stocks, bonds
c) money, money, bonds
d) bonds, bonds, money
Answer: c
16. A government that wanted to decrease Y without changing r could do so by _____ G and _______ by the appropriate amounts.
a) increasing, decreasing money supply
b) increasing, decreasing money supply
c) decreasing, decreasing money supply
d) decreasing, increasing money supply
Answer: c
17. Contractionary monetary policy combined with expansionary fiscal policy would
a) have an uncertain effect on the interest rate and planned investment
b) drive income and consumption up
c) drive the interest rate up and planned investment up
d) drive the interest rate up and planned investment down
Answer: d
18. Suppose investment is independent of the interest rate (i.e. the planned investment curve is vertical), and increase in government spending will cause
a) no change in interest rate
b) no crowding out effect
c) no shift of the AE curve
d) an increase in output and a reduction in investment
Answer: b
19. Fill in the blanks:
GDP = national income + (indirect taxes – subsidies) + net factor payments to the rest of the world + other + ____
Answer: depreciation
20. Fill in the blanks:
An increase in the price of one good will have a(n) _______ effect on the total revenue of the producers selling that product.
Answer: uncertain, ambiguous…
Part 2: Short Answer Questions (Total of 10 points)
Instructions: answer briefly (up to 5 lines) and make a drawing if requested. Write the answers in your first exam booklet.
1. Define national debt. What is its relationship to fiscal policy? (2 points)
National debt is the total outstanding amount owed by the Treasury. National debt is the sum of all historical deficits and surpluses resulting from annual fiscal policy.
2. Explain the three roles of money briefly (3 points)
Answer: Money is a means of payment, without money there would be barter (you would have to be lucky to find people who are willing to trade with you). Secondly, money is a store of value, or an asset that can be used to transport purchasing power from one period to another. Thirdly, money is a unit of account, or a consistent way of quoting prices.
3. Explain the differences between frictional unemployment, structural unemployment and people counted as discouraged workers. (3 points)
Answer: Discouraged workers are not counted as unemployed as they have stopped looking for a job. Structural unemployment is unemployment that arises from structural shifts in the economy (like steel and textile industries). Often these people will need to learn new skills in order to find a new job. Frictional unemployment is part of the normal worker of the labor market, it includes graduates, and people who switch jobs.
4. Define inflation, and give an example of who might be happy with inflation. (2 points)
Answer: Inflation is an increase in the overall price level. In general inflation and especially hyperinflation has negative impacts on the economy, such as driving away potential investors. However when you are a debtor you might be happy with inflation as the amount of money you need to pay back is less than before.
Part 3: Essay Style Questions (Total of 10 points)
Instructions: answer all these questions in your second booklet.
1. Read the following article which appeared in BBC news on February 16, 2006
Growth stance lauded, but companies moan over tax
Cape Town - Finance minister Trevor Manuel's 2006/07 budget yesterday generally won praise all round for its sound fiscal policy and pro-growth stance. Tax breaks for individuals, small businesses and first-time home buyers were particularly welcomed but many said the budget could have been stronger on tax incentives for companies. There were indications of a move towards a self-assessment system for companies and the introduction of an advance tax ruling procedure this year. Firms were also offered training incentives to deal with the skills shortage as well as higher deductions for research and development.
Small businesses were offered a tax amnesty, starting with the taxi industry, and incentives to cut the cost of starting a business.
Twine said spending on social security and infrastructure development had been generously budgeted for, as expected. The rise in pensions to R840 a month "is a particularly bold increase".
1.1. Explain the multiplier effect of a tax cut with a graph showing the goods market only. (2 points)
Answer: See the drawing of the goods market below. Due to a tax cut consumption will rise, and Y will increase. The amount with which Y will increase equals
1.2. Explain the effect of a tax cut on the economy using a three panel graph illustrating the money market, planned investment and the goods market. (4 points)
Answer: Start with the goods market – they have to draw that a AE curve which shifts up because of an increasing C. As a consequence the Y* shifts up. Then go to the money market where the demand for money shifts up. The supply remains the same, and the interest rate shifts up. The investment shifts down, and as a consequence the AE curve shifts down again a little due to which the Y shifts down a little. We could continue a few more rounds like this.
2. Read the following extract of article on Yahoo news on 28 February 2006
Fed may go too far in hiking rates
The U.S. Federal Reserve Board may well overdo its current round of monetary policy tightening, warn TD Bank economists in a new report. TD Economics says that the Fed is nearing the end of the current tightening cycle. “While the inflation risks are certainly present, inflation itself remains very well-contained. Overall economic growth has been proceeding at a modest clip – close to the economy’s long-run potential rate, despite the swings and bumps from one quarter to the next. And, the level of the Fed funds rate is no longer in stimulative territory – the Fed’s initial task of bringing its Fed funds rate back to neutral is complete,” it says.
TD’s call is still for a 4.75% Fed funds rate, “and given the amount of tightening that the Fed has already put into place, we also believe that a pause at this stage would be the better policy outcome. Nonetheless, given the recent strength in U.S. economic indicators, the odds are high that the Fed will overshoot that level,” it cautions. “The problem is that monetary policy is not a high-precision surgical instrument. It’s more like a sledgehammer – it gets the job done, but often in a less-than-elegant way,” it says, noting that monetary policy operates with a lag, and that lag tends to be long and variable.
Illustrate the effect of a tightening monetary policy on the economy using a three panel graph. (4 points)
Answer: The supply for money decreases, the increases the interest rate. This decreases the investment (panel 2) and this decreases the AE curve in the goods market which decreases Y (up to Y’). This decreases the demand for money (back to the first panel) and decreases the interest rate a little. We could continue a few more rounds like this.
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