Download March 12, 2004

ECMA06H
Second Term Test – March 12, 2004
Profs. Michael Krashinsky and Gordon Cleveland
Time:100 minutes
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If two multiple choice answers both seem to be approximately correct, choose the best of
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ECMA06H SECOND TERM TEST
March 12, 2004
MULTIPLE CHOICE (4 marks each)
1.
Suppose that the chartered banks have deposits in the Bank of Canada equal to $30B; there are $10 B in
cash reserves held by the chartered banks; currency in circulation equals $18B, the amount of gold held by
the Bank of Canada is $10B, the target (or desired) reserve ratio of all banks equals 12.5%, and there are no
excess reserves. Then, in equilibrium, the money supply (M1) will equal:
A) $18 billion
E) $68 billion
I) $258 billion
M) $544 billion
B) $28 billion
F) $98 billion
J) $320 billion
N) none of the above
C) $40 billion
G) $144 billion
K) $338 billion
D) $50 billion
H) $194 billion
L) $400 billion
2.
Suppose that the target reserve ratio across the entire banking system is 4%. If there are no excess reserves,
then a Bank of Canada purchase of $100 million in bonds will (eventually):
A) decrease reserves by $100 million and decrease money supply by $400 million
B) decrease reserves by $100 million and decrease money supply by $800 million
C) decrease reserves by $100 million and decrease money supply by $2500 million
D) increase reserves by $100 million and increase money supply by $400 million
E) increase reserves by $100 million and increase money supply by $800 million
F) increase reserves by $100 million and increase money supply by $2500 million
G) none of the above
3.
Suppose that an investment will yield a return of $100,000 at the end of the fourth year (and no other
return). What is the present value of this investment if the expected annual interest rate is 5%?
A) $67,854
E) $92,000
B) $76,752
F) $96,867
C) $82,270
G) $99,896
D) $89,692
H) none of the above
4.
An investment yields a return of $200,000 after four years and then another $300,000 after one more year
(five years in total). At that point, the investment has no further value. The cost of the investment is
$380,000, initially. Which of the following statements are true?
I)
the investment is attractive if the interest rate is 4%
II)
the investment is attractive if the interest rate is 6%
III)
the investment is attractive if the interest rate is 8%
IV)
the investment is attractive if the interest rate is 10%
(A) I
(B) II
(C) III
(D) IV
(E) I and II
(F) I and III
(G) I and IV
(H) II and III
(I) II and IV
(J) III and IV
(K) I, II and III
(L) I, II and IV
(M) I, III and IV
(N) II, III and IV
(O) all four
(P) none of the four
5.
The Bank of Canada:
(I) buys and sells bonds on the open market;
(II) may provide loans to affluent individuals as the lender of last resort;
(III) holds some of the federal government’s bank accounts;
(IV) is operated by the federal Minister of Finance to achieve the economic objectives of the government
of the day.
Which of the above statements are true? Choose the best answer:
(A) I
(B) II
(C) III
(D) IV
(E) I and II
(F) I and III
(G) I and IV
(H) II and III
(I) II and IV
(J) III and IV
(K) I, II and III
(L) I, II and IV
(M) I, III and IV
(N) II, III and IV
(O) all four
(P) none of the four
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6.
Why does the interest rate affect the demand for money? Here are several possible answers:
(I) bonds pay interest but holding money pays none (or less); citizens who hold money give up this interest
return on their money assets;
(II) when the interest rate is low, it is easier to cash in bonds; citizens will need to hold less money for
transactions;
(III) bonds with higher interest rates are worth more, increasing wealth and spending; by the transactions
demand, the public will want to hold more money to conduct this higher level of transactions;
(IV) when interest rates are low, the public is likely to believe they cannot go lower; the fear of rising
interest rates will encourage the public to hold money rather than bonds (whose value may fall).
Which of the above statements are true? Choose the best answer:
(A) I
(B) II
(C) III
(D) IV
(E) I and II
(F) I and III
(G) I and IV
(H) II and III
(I) II and IV
(J) III and IV
(K) I, II and III
(L) I, II and IV
(M) I, III and IV
(N) II, III and IV
(O) all four
(P) none of the four
7.
A decrease in the money supply (caused by contractionary monetary policy) will cause:
(I)
a temporary excess supply of money to exist at the current interest rate;
(II)
the public to try to sell bonds in exchange for money;
(III)
a rise in the price of bonds;
(IV)
a rise in the interest rate.
Which of the above statements are true? Choose the best answer:
(A) I
(B) II
(C) III
(D) IV
(E) I and II
(F) I and III
(G) I and IV
(H) II and III
(I) II and IV
(J) III and IV
(K) I, II and III
(L) I, II and IV
(M) I, III and IV
(N) II, III and IV
(O) all four
(P) none of the four
8.
The Canadian economy is in a short and long run equilibrium position with Aggregate Demand equal to
Aggregate Supply at Potential GDP. Now, a new Belinda Stronach government convinces investors that future
profits will be high, so Investment spending rises, and as a result, Canada’s Aggregate Demand curve shifts to the
right. Consider the following statements about what happens:
I) the price level rises and real GDP falls as the economy moves towards its new short-run equilibrium
II) the nominal wage level stays constant in the short-run
III) in the transition to the long run, the nominal wage level rises
IV) In the long run, equilibrium GDP is back at Potential GDP, and lower than
the level of GDP in the short-run equilibrium
Which of the above statements is true about what happens in the AD-AS model when Investment spending
rises?
(A) I
(B) II
(C) III
(D) IV
(E) I and II
(F) I and III
(G) I and IV
(H) II and III
(I) II and IV
(J) III and IV
(K) I, II and III
(L) I, II and IV (M) I, III and IV
(N) II, III and IV
(O) all four
(P) none of the four
9.
A fall in the overall price level will:
(A) cause the Aggregate Demand function to shift downwards.
(B) cause the Aggregate Demand function to shift upwards.
(C) shift the Consumption Function downwards, and therefore shift the Aggregate Expenditure Function
downwards.
(D) shift the Consumption Function upwards, and therefore shift the Aggregate Expenditure Function upwards.
(E) change the Government Expenditure Multiplier, causing a decrease in the overall level of National Income.
(F) cause an increase in the level of saving out of Disposable Income, therefore allowing Investment to rise.
(G) cause the Aggregate Supply Function to shift upwards.
(H) cause the Aggregate Supply Function to shift downwards
(I) none of the above.
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10-12.
An economy with no government and no foreign trade sector has the following spending functions:
C = 250 + 0.8Y + (200 – 2P)
I = 300
The short-run Aggregate Supply curve is given by P = 50 + 0.4Y.
Potential GDP in this economy is 400.
These equations will be useful in answering questions 10-12.
10.
If this economy were left to adjust gradually to its long-run equilibrium, the price level in this economy would
be:
(A) 100
(B) 200
(C) 210
(D) 220
(E) 230
(F) 235
(G) 250
(H) 260
(I) 275
(J) 280
(K) 290
(L) 300
(M) 310
(N) 315
(O) 325
(P) 335
(Q) 340
(R) 350
(S) 355
(T) 365
(U) 375
(V) 380
(W) 390
(X) 395
(Y) 400
(Z) none of the above
11.
Currently, the output gap in this economy could be described in this way:
A. A recessionary gap of 50
B. A recessionary gap of 100
C. A recessionary gap of 150
D. A recessionary gap of 200
E. A recessionary gap of 250
F. A recessionary gap of 300
G. A recessionary gap of 350
H. An inflationary gap of 50
I. An inflationary gap of 100
J. An inflationary gap of 150
I. An inflationary gap of 200
J. An inflationary gap of 250
K. An inflationary gap of 300
L. An inflationary gap of 350
M. None of the above
12.
Given the equations provided above, the change in I which would eliminate the output gap would be:
A. Reduce I by 50
B. Reduce I by 100
C. Reduce I by 150
D. Reduce I by 200
E. Reduce I by 250
F. Increase I by 50
G. Increase I by 100
H. Increase I by 150
I. Increase I by 200
N. Increase I by 250
O. Use monetary policy instead
P. None of the above
13.
A two-year bond which pays out $100 in interest next year, and $100 in interest plus the principal of $500 two
years from now, is selling for $605. What interest rate just makes this worth buying?
(A) 0%
(B) 2%
(C) 4%
(D) 5%
(E) 6%
(F) 7%
(G) 8%
(H) 9%
(I) 10%
(J) 12%
(K) 14%
(L) 16%
(M) 18%
(N) 20%
(O) 22%
(P) 24%
14-17. Assume there is only one private sector chartered bank in Canada. Because Canadians are already holding the
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amount of cash they wish to hold, every time a loan is taken out of the bank and the money spent, it winds up as a new
deposit in this chartered bank. The target reserve ratio (or desired reserve ratio) of the chartered bank is 4% (.04). There are
no excess reserves at present. Initially, the balance sheet of the Bank appears as below:
CHARTERED BANK BALANCE SHEET
ASSETS
Reserves held in Cash
Reserves held in the Central Bank
Loans
LIABILITIES AND NET WORTH
$20,000
$60,000
$1,920,000
Chequing Deposits
$2,000,000
14.
The Central Bank (Bank of Canada) engages in open market operations, buying $2,000 of Government of Canada
bonds. After all of the effects of this open market operation have worked themselves through Canada’s financial
system, what will be the total change in reserves held by the chartered bank?
(A) zero
(B) +$80
(C) +$1,920
(D) +$2,000
(E) +$5,000
(F) +$7,500
(G) +$10,000
(H) +$20,000
(I) +$40,000
(J) +$48,000
(K) +$50,000
(L) +$200,000
(M) +$250,000
(N) +$300,000
(O) -$80
(P) -$1,920
(Q) -$2,000
(R) -$5,000
(S) -$10,000
(T) -$20,000
(U) -$40,000
(V) -$48,000
(W) -$50,000
(X) -$200,000
(Y) -$250,000
(Z) none of the above
15.
After all of the effects of the open market operation have worked their way through Canada’s financial system, what
will be the change in the amount of loans?
(A) zero
(B) +$80
(C) +$1,920
(D) +$2,000
(E) +$5,000
(F) +$7,500
(G) +$10,000
(H) +$20,000
(I) +$40,000
(J) +$48,000
(K) +$50,000
(L) +$200,000
(M) +$250,000
(N) +$300,000
(O) -$80
(P) -$1,920
(Q) -$2,000
(R) -$5,000
(S) -$10,000
(T) -$20,000
(U) -$40,000
(V) -$48,000
(W) -$50,000
(X) -$200,000
(Y) -$250,000
(Z) none of the above
16.
Go back to the balance sheet above and assume that the transactions listed in questions 14 and 15 did not occur.
Now, the managers of the chartered bank have a discussion. Because of an impending recession, they decide to
change their desired reserve ratio to 0.05 (5%). What is the change in Canada’s money supply after all adjustments
have taken place?
(A) zero
(B) +10,000
(C) +$20,000
(D) +$30,000
(E) +$48,000
(F) +$50,000
(G) +$100,000
(H) +$120,000
(I) +$160,000
(J) +$180,000
(K) +$200,000
(L) +$300,000
(M) +$400,000
(N) +$500,000
(O) -$10,000
(P) -$20,000
(Q) -$30,000
(R) -$48,000
(S) -$50,000
(T) -$100,000
(U) -$150,000
(V) -$180,000
(W) -$200,000
(X) -$400,000
(Y) -$500,000
(Z) none of the above
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17.
Go back to the balance sheet above and assume that the transactions listed in questions 14,15 and 16 did not occur.
Now, nervous depositors decide to withdraw $2,000 from their chequing accounts and hide the money in
mayonnaise jars in their refrigerators. What is the change in the money supply once all adjustments have taken
place?
(A) zero
(B) +10,000
(C) +$20,000
(D) +$30,000
(E) +$48,000
(F) +$50,000
(G) +$100,000
(H) +$120,000
(I) +$160,000
(J) +$180,000
(K) +$200,000
(L) +$300,000
(M) +$400,000
(N) +$500,000
(O) -$10,000
(P) -$20,000
(Q) -$30,000
(R) -$48,000
(S) -$50,000
(T) -$100,000
(U) -$150,000
(V) -$180,000
(W) -$200,000
(X) -$400,000
(Y) -$500,000
(Z) none of the above
18–21. The island nation of Markham is self-sufficient (a closed economy), and in particular, its financial markets are
independent of financial markets elsewhere in the world. Investment demand in Markham is given by the
equation:
I = 200 - 1000r
where I represents planned Investment spending and r represents the interest rate. Investment is the only type
of spending affected by changes in the interest rate. The current money supply (MS) is 1,500. Money demand
(MD) is given by the equation:
MD = 3,000 - 20,000r
This is a simple economy in which the price level is fixed (the aggregate supply curve is horizontal) and
dAE/dY (or CY) = 0.8
18.
What is the equilibrium rate of interest?
(A) 0
(B) 0.010
(C) 0.030
(D) 0.045
(E) 0.055
(F) 0.060
(G) 0.075
(H) 0.080
(I) 0.095 (J) 0.100
(K) 0.125
(L) 0.140
(M) 0.150
(N) 0.165
(O) 0.170
(P) 0.185
(Q) 0.190
(R) 0.200
(S) none of the above
19.
Assume now that the central bank of Markham decides that it is necessary to increase equilibrium GDP by 100.
What rate of interest would give Markham the necessary change in Aggregate Demand?
(A) 0
(B) 0.010
(C) 0.030
(D) 0.045
(E) 0.055
(F) 0.060
(G) 0.075
(H) 0.080
(I) 0.095 (J) 0.100
(K) 0.125
(L) 0.140
(M) 0.150
(N) 0.165
(O) 0.170
(P) 0.185
(Q) 0.190
(R) 0.200
(S) none of the above
20.
What change in the money supply would be necessary to achieve this change in the rate of interest?
(A) zero
(B) +10
(C) +20
(D) +30
(E) +40
(F) +50
(G) +60
(H) +75
(I) +80
(J) +90
(K) +100
(L) +200
(M) +300
(N) +400
(O) -10
(P) -20
(Q) -30
(R) -40
(S) -50
(T) -75
(U) -80
(V) -90
(W) -100
(X) -200
(Y) -400
(Z) none of the above
21.
Assuming that the desired reserve ratio in all banks in the banking system of Markham is 0.25 and that banks do
not hold excess reserves, and that the public keeps its cash holdings constant, what value of assets would the
Central Bank of Markham have to buy (+) or sell (-) in open market operations in order to achieve the required
change in the money supply?
(A) zero
(B) +10
(C) +20
(D) +30
(E) +40
(F) +50
(G) +60
(H) +75
(I) +80
(J) +90
(K) +100
(L) +200
(M) +300
(N) +400
(O) -10
(P) -20
(Q) -30
(R) -40
(S) -50
(T) -75
(U) -80
(V) -90
(W) -100
(X) -200
(Y) -400
(Z) none of the above
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22-24. In the diagram below, line #1 represents the AE curve with price at its original level of 100. Line #2
represents the effect on AE of an increase of 200 in investment spending (at the same price level). Line #3
represents this same higher level of investment spending, but after a rise in the price level by 25. The size of
the multiplier (1/(1-dAE/dY) or 1/(1 – CY)) is 5. The corresponding points are also shown on the diagram
below. Answer the next two questions using the information above plus the diagrams shown below.
Line #2
AE
Line #3
Line #1
Line A
Y
SRAS
P
Line B
P1
P0
AD1
AD0
Y
22.
What is the distance represented by the line marked as Line A?
(A) zero
B) 10
(C) 20
(E) 40
(F) 50
(G) 60
(I) 80
(J) 90
(K) 100
(M) 300
(N) 400
(O) 500
(Q) 700
(R) 800
(S) 900
(U) 1200
(V) 1500
(W) 1600
(Y) 2000
(Z) none of the above
(D) 30
(H) 75
(L) 200
(P) 600
(T) 1000
(X) 1800
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23.
24.
25.
What is the distance represented by the line marked as Line B?
(A) zero
B) 10
(C) 20
(E) 40
(F) 50
(G) 60
(I) 80
(J) 90
(K) 100
(M) 300
(N) 400
(O) 500
(Q) 700
(R) 800
(S) 900
(U) 1200
(V) 1500
(W) 1600
(Y) 2000
(Z) none of the above
(D) 30
(H) 75
(L) 200
(P) 600
(T) 1000
(X) 1800
What is the difference between P1 and P0?
(A) zero
B) 5
(E) 20
(F) 25
(I) 40
(J) 45
(M) 60
(N) 65
(Q) 80
(R) 85
(U) 100
(V) 105
(Y) 120
(Z) none of the above
(D) 15
(H) 35
(L) 55
(P) 75
(T) 95
(X) 115
(C) 10
(G) 30
(K) 50
(O) 70
(S) 90
(W) 110
The following statements refer to automatic stabilizers in the economy:
(I) taxes and transfers act as automatic stabilizers;
(II) if taxes take a larger fraction of each dollar of consumers’ incomes, taxes act as a stronger automatic
stabilizer;
(III) automatic stabilizers work by making the expenditure multiplier smaller in the economy;
(IV) automatic stabilizers make other forms of fiscal policy unnecessary.
Which of the above statements are true? Choose the best answer:
(A) I
(B) II
(C) III
(D) IV
(F) I and III
(G) I and IV
(H) II and III
(J) III and IV
(K) I, II and III
(L) I, II and IV
(N) II, III and IV
(O) all four
(P) none of the four
(E) I and II
(I) II and IV
(M) I, III and IV