Name: First Prelim Makeup
ECON 102 – Professor Steven Kyle
Section Number: March 13, 2008
PART I: Multiple Choice/Fill-In. 10 points (each question is worth ½ point).
1. Which of the following transactions would NOT increase U.S. GDP in 2008?
a) New automobiles placed into inventory by Ford in Connecticut on Mar. 18, 2008
b) The purchase of a share of stock through a fee-based stock broker in New York on May 8, 2008
c) The purchase of an American-made video game in Beijing, China on Dec. 31, 2008
d) The purchase of a new clock from Timex’s 2007 inventory in New Mexico on Apr. 1, 2008
Answer: D
2. Suppose Boeing purchases $500,000 of airplane parts to construct new airplanes. If the MPS is 0.2,
what effect would this have on the equilibrium level of aggregate consumption if the goods market is
assumed to be independent of the money market?
a) Increase aggregate consumption by $3 million
b) Increase aggregate consumption by $2 million
c) Increase aggregate consumption by $3.5 million
d) Increase aggregate consumption by $500,000
Answer: B
3. When commercial banks borrow from the Federal Reserve, the interest rate they pay is known as the:
a) Federal Funds rate
b) Reserve lending rate
c) Discount rate
d) None of the above
Answer: C
4. Suppose the CPI is 150 in 2000 and 195 in 2008. Then the overall price level has increased by what
percentage from 2000 to 2008?
a) 33%
b) 30%
c) 45%
d) It cannot be determined from the information given
Answer: B
5. A problem with the barter system is:
a) Fiat money is the only valid medium of exchange
b) A double coincidence of wants makes trade inefficient
c) Coins and cash in consistent denominations are the only valid units of account
d) All of the above
e) None of the above
Answer: B
6. Suppose the Federal Reserve buys $10 million of government bonds from the public, and the supply of
money is $100 million before the bond purchase. If the interest rate is 6% and banks must keep 10%
of deposits in reserves, what will the money supply be after the bond purchase?
a) $190 million
b) $90 million
c) $106 million
d) $200 million
Answer: D
7. The natural rate of unemployment is sometimes taken as the sum of:
a) Frictional and structural unemployment
b) Frictional and cyclical unemployment
c) Structural and cyclical unemployment
d) None of the above
Answer: A
8. GDP = final sales + ______
a) Change in net investment
b) Change in net factor payments
c) Change in business inventories
d) Change in depreciation
Answer: C
9. Suppose the U.S. government increases government spending by $150 billion, and increases taxes by
$50 billion. What effect would this have on the equilibrium level of output if (1 – MPS) is 0.50 and
the goods market is assumed to be independent from the money market?
a) Increase output by $250 billion
b) Increase output by $150 billion
c) Decrease output by $50 billion
d) Increase output by $200 billion
Answer: A
10. If the Federal Reserve institutes a contractionary monetary policy and the U.S. Congress and
president institute a contractionary fiscal policy, then which of the following would NOT decrease for
certain, other things equal:
a) Aggregate output
b) Equilibrium interest rate
c) Aggregate consumption
d) It cannot be determined from the information given
Answer: B
11. The GDP Deflator is:
a) A price index that uses a fixed-weight procedure
b) A quantity index that uses a chained procedure
c) A price index that uses a basket of “deflated” consumer goods
d) None of the above
e) Both A and C
Answer: D
12. Suppose the interest rate is such that there is an excess supply of money in the money market. Then
we would expect which of the following adjustments to equilibrium to occur:
a) The money supply curve will shift inward and interest rates will increase
b) The money demand curve will shift outward and interest rates will increase
c) Interest rates will decrease and the total supply of money will decrease
d) None of the above
Answer: D
13. If the federal government enacts an expansionary fiscal policy by increasing government spending,
then we would expect:
a) The equilibrium interest rate to increase and planned investment to decrease
b) The equilibrium interest rate to decrease and planned investment to increase
c) Aggregate output to increase initially and the interest rate to decrease
d) Aggregate output to decrease initially and the interest rate to increase
Answer: A
14. Which of the following would result in an increase in planned investment:
a) An increase in the equilibrium interest rate
b) An increase in the rental rate of capital
c) An expectation that sales will increase in the future
d) All of the above
Answer: C
15. If a U.S. firm located in Singapore exports shoes to Mexico, which of the following is correct?
a) The profit on the shoes should be included in U.S. GNP
b) The shoes should be included in Singapore’s GDP
c) The shoes purchases induce a leakage from the Mexican spending stream
d) All of the above
e) None of the above
Answer: D
16. If the Federal Reserve “accommodates” an expansionary fiscal policy:
a) It can increase the discount rate
b) It can target a higher Federal Funds rate
c) It can buy bonds from the public
d) All of the above
e) None of the above
Answer: C
17. When the Federal Reserve engages in open market operations, it __buys and sells__ government
securities.
18. In an open economy without a government, equilibrium in the goods market implies that planned
investment plus exports equals ____saving plus imports_____.
19. The government spending multiplier minus the planned investment multiplier equals __0__.
20. Suppose the U.S. government is running a budget deficit. Which government entity issues
government securities to the public to finance the deficit?
a) Federal Reserve
b) Office of Management and Budget
c) Securities and Exchange Commission
d) Treasury Department
Answer: D
PART II. Short Answer. 10 points (each question is worth 2 points).
Answer each question and make a drawing if requested. You must show your work to receive full credit.
1. List the three different types of unemployment and briefly discuss their respective causes.
Structural unemployment, caused by changes in the underlying structure of the economy. Frictional unemployment, caused by short-run job/skill matching problems between workers and firms. Cyclical unemployment, caused by the business cycle such that there is higher unemployment during recessions and depressions.
2. Suppose an economy produced only automobiles and bicycles. Illustrate graphically how an
improved automobile technology would affect the production possibility frontier (PPF). Is it
true that all points on the frontier are efficient? Why or why not?
Automobiles
All points on the frontier, such as point A above, are efficient by definition of the PPF. The only inefficient points are those that are strictly below the frontier, such as point B.
3. Suppose the goods market is in disequilibrium, such that planned aggregate expenditures are
greater than aggregate output. Briefly describe how this market would reach equilibrium, and
whether aggregate output would increase or decrease in equilibrium. Draw a graph illustrating
this situation.
When planned aggregate expenditures exceed aggregate output, planned investment does not equal actual investment, resulting in a decrease in unplanned inventories. Firms respond to this decrease by increasing production in subsequent production periods until planned aggregate expenditures equal aggregate output. Thus, aggregate output increases in equilibrium. Graphically:
4. Suppose in a two-good economy you’re given the following information on GDP over a two-year
period:
Year 1 GDP in Year 1 Prices / Year 1 GDP in Year 2 Prices / Year 2 GDP in Year 1 Prices / Year 2 GDP in Year 2 PricesGood A / $300 / $200 / $500 / $400
Good B / $200 / $700 / $100 / $400
Find real GDP for this economy in each year if the base year is year 2 and a fixed-weight
procedure is used.
If year 2 is the base year, real GDP for good A in year 1 is $200 and real GDP for good B in year 1 is $700. Therefore, real GDP for the economy in year 1 is $200 + $700 = $900. In year 2, real GDP is $400 for both goods A and B. Therefore, real GDP for the economy in year 2 is $800.
5. Suppose the money market is in equilibrium. Discuss and illustrate graphically how a
contractionary monetary policy would affect the quantity of money supplied and demanded, as
well as the equilibrium interest rate.
We have MS ↓ → r ↑ → I ↓ → Y ↓ → Md ↓ → r ↓. Therefore, the money supply curve would shift to the left, decreasing the quantity of money supplied and demanded, and increasing the interest rate. Secondarily, the money demand curve would shift to the left, decreasing the interest rate by an amount smaller in absolute value than the initial increase. Thus, the quantity of money supplied and demanded would decrease (from M0 to M1), and the equilibrium interest rate would increase (from r0 to r2).
PART III. Newspaper Analysis. 10 points (each question is worth 5 points).
Answer each question and make a drawing if requested. You must show your work to receive full credit.
1. Read the following excerpt from an article that appeared on Bloomberg.com on March 3, 2008:
Australia to Raise Interest Rate to 12-Year High, Survey Shows
“Australia's central bank will probably increase interest rates to a 12-year high to cool an economic expansion stoking the fastest inflation in almost two decades. Governor Glenn Stevens will raise the overnight cash rate target by a quarter point to 7.25 percent, adding to last month's increase, according to all 27 economists surveyed by Bloomberg News. Accelerating inflation, stoked by a shortage of skilled workers and rising fuel prices, is forcing Stevens to raise rates as counterparts in the U.S. and the U.K. signal cuts to cushion their economies from slower growth.”
1.1 Describe the three main functions of the U.S. central bank. (1 point)
The three main functions of the U.S. central bank (the Federal Reserve) are to: 1) control the money supply through open market operations, the required reserve requirement, and the discount rate; 2) serve as a lender of last resort for commercial banks; and 3) to clear interbank payments.
1.2 According to the article, what are some of the reasons why Australia’s central bank may increase interest rates? (1 point)
Australia’s central bank may increase interest rates to slow an economic expansion in that country. The economic expansion is producing inflation due to skilled worker shortages and rising fuel prices.
1.3 Illustrate graphically how the action by the Australian central bank described in the article above will affect the money market, the goods market, and the level of planned investment in Australia. (3 points)
We have MS ↓ → r ↑ → I ↓ → Y ↓ → Md ↓ → r ↓. Graphically:
Money Market Goods Market
Planned Investment Schedule
2. Read the following excerpt from an article which appeared in the Economist on February 28, 2008:
Russia’s Economy: Smoke and Mirrors
“Productivity remains far below that of most developed countries. In the first years after the 1998 crisis, labour and capital efficiency went up by 5.8% a year. But that growth was driven by using spare capacity left from Soviet times. Sustaining it will require more investment. Meanwhile the economy, unable to digest the money generated by the oil-and-gas boom, is clearly overheating. Inflation moved into double digits in late 2007, pushed up by, among other things, a huge inflow of capital attracted by swelling reserves and the strong rouble. Unlike oil revenues, which can be partially channelled into the stabilisation fund, this money cannot easily be absorbed.”
2.1 Define inflation and deflation. (1 point)
Inflation (deflation) is an increase (decrease) in the overall price level.
2.2 If the Russian economy continues to experience the inflationary changes suggested by the article,
what would happen to the demand for money balances in Russia? Why would this occur? (1 point)
We would expect the demand for money balances to increase. This occurs because the value of economic transactions increases with increases in the price level, and therefore more money is needed to conduct these transactions. If the central bank does nothing to change the money supply, there will be an increase in interest rates.
2.3 What policy options does the central bank have in this situation, and what would be the result of
each? (1 point)
1) They can increase the money supply, which will reduce the tendency of interest rates to rise and will induce further expansion of the economy; 2) they can do nothing and accept the higher interest rates; 3) they can decrease the money supply, increasing interest rates still further and slowing the economy down.
2.4 Suppose the Russian economy experiences an increase in planned investment of $20 billion in an
effort to sustain the current growth rate. By how much will the equilibrium level of output change
if we assume that the goods market is independent of the money market and the MPC is 0.80?
(2 points)
The equilibrium level of output would increase by ($20 billion)*(1/(1 – 0.80) = $100 billion. Since we are assuming the goods market is independent of the money market, we can ignore secondary effects.