Download Review Sheet - Syracuse University

Syracuse University
Department of Economics
Wayne A. Grove
Spring 2002
Review Questions for EXAM II
(most of Fall 2001 Exam II and some more)
Economics 102: Introductory Macroeconomics
I. Multiple Choice Questions
1. A medium of exchange is:
(a) what sellers generally accept and buyers generally use to pay for goods and services.
(b) an asset that can be used to transport purchasing power from one period of time to another.
(c) a standard unit that provides a consistent way of quoting prices.
(d) the ability to buy something today but to deter payment to the future.
2. If the government wants to decrease output, government spending should be ________ and/or
taxes should be __________. a. increased; increased.
b. increased; decreased.
c. decreased; increased.
d. decreased; decreased.
3. The fee that borrower pays a lender for the use of the lender’s funds is
(a) points.
(b) interest. (c) the loan premium. (d) the application fee.
4. For the Fed to keep the interest rate unchanged as the government increases spending, the Fed
must continue to:
a. decrease the money supply.
b. increase the money supply.
c. decrease the demand for money.
d. increase the demand for money.
5. Lower interest rates are likely to:
a. have no effect on consumer spending or saving.
b. increase both consumer spending and consumer saving.
c. decrease both consumer spending and consumer saving.
d. increase consumer spending and decrease consumer saving.
6. When the economy grows quickly out of a recession then automatically, ceteris paribus:
a. Tax revenues are reduced.
b. Government outlays are increased.
c. Budget deficits become smaller.
d. Government investment surges.
7. Monetary policy can best cure a recession by:
a. Lowering interest rates to increase planned investment.
b. Lowering interest rates to increase savings.
c. Increasing interest rates to increase planned investment.
d. Increasing interest rates to increase savings.
8. Fiscal policy can best cure a recession by:
a. Lowering taxes to increase spending.
b. Lowering taxes to increase savings.
c. Increasing taxes to increase spending.
d. Increasing taxes to increase savings.
9. Which of the following is a bank liability? a. Reserve deposits at the Fed.
b. Treasury bonds the bank has purchased.
c. Checking account deposits. d. Loans.
10. Banks try to keep their holdings of excess reserves low: a. To please bank examiners.
b. To keep the money multiplier low. c. To escape Fed penalties. d. To maximize profits.
11. If the banking system has a minimum reserve ratio of 20%, the deposit (or money) multiplier
is: a. 0.2.
b. 0.8.
c. 1.25.
d. 5.
12. The direct exchange of one good for another is: a. Barter. b. Most efficient for an economy.
c. Facilitates specialization in production. d. Facilitates market exchanges.
13. The interest rate banks pay to borrow money from the Fed is the: (a) federal funds rate.
(b) prime lending rate.
(c) reserve rate.
(d) discount rate.
14. The best instrument for controlling day-to-day changes in the money supply is:
(a) the open market operations (OMO).
(b) the required reserve ratio. (c) the discount rate.
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(d) the federal funds rate.
15. Bradley digs out $100 from his cookie jar. In the moment he deposits it into a checking
account in his bank, M1 has: a. Not changed. b. Increased by more than $100.
c. Increased by less than $100. d. Increased by $100.
16. A unit of account is:
(a) what sellers generally accept and buyers generally use to pay for goods and services.
(b) an asset that can be used to transport purchasing power from one period of time to another.
(c) a standard unit that provides a consistent way of quoting prices.
(d) the ability to buy something today but to deter payment to the future.
17. Banks create money:
(a) by illegally printing additional dollar bills.
(b) by paying interest to their depositors.
(c) by making loans that result in additional deposits.
(d) by offering financial services, such as money market accounts.
18. An open market purchase of government bonds by the Fed results in ________ in reserves and ________
in the supply of money. (a) an increase; a decrease. (b) an increase; an increase.
(c) a decrease; a decrease.
(b) a decrease; an increase.
19. Suppose a bank has $400,000 in deposits and a required reserve ratio of 15%. Then required
reserves are: a. $6,000.
b. $2,666,666. c. $6,000,000.
d. $60,000.
20. Money is anything: a. Used to barter. b. Generally accepted as a medium of exchange.
c. That has value. d. That a government declares to have value.
21. A bank may lend an amount equal to its:
a. Required reserves. b. Total reserves. c. Total assets.
d. Excess reserves.
22. Currency in circulation is included in:
a. M1 only. b. M2 only. c. both M1 and M2.
d. neither M1 nor M2. e. none of these.
23. Savings accounts are included in:
a. M1 only. b. M2 only. c. both M1 and M2.
d. neither M1 nor M2. e. none of these.
24. Checking accounts are included in:
a. M1 only. b. M2 only. c. both M1 and M2.
d. neither M1 nor M2. e. none of these.
25. Suppose a bank has $2 million in deposits, a required reserve ratio of 20%, and reserves of
$500,000. It has excess reserves of: a. $100,000. b. $200,000. c. $300,000. d. $500,000.
26. An increase in the discount rate: a. Signals the Fed's desire to restrain money growth.
b. Reduces the cost of reserves borrowed from the Federal Reserve.
c. Signals the Federal Reserve's desire to support credit creation.
d. Signals the Federal Reserve's eagerness to lend additional reserves.
27. The main reason that people hold money—to buy things—is referred to as the:
(a) speculative motive. (b) precautionary motive. (c) transactions motive. (d) profits motive.
28. A store of value is:
(a) what sellers generally accept and buyers generally use to pay for goods and services.
(b) an asset that can be used to transport purchasing power from one period of time to another.
(c) a standard unit that provides a consistent way of quoting prices.
(d) the ability to buy something today but to deter payment to the future.
II. Problem Solving Questions
1. Macroeconomic Policymaking
Federal Reserve Chairman Greenspan has been stimulating (increasing) the U.S. economy for the
last six months or so. Start with the economy at Y0 and r0 and then show how the Fed stimulates
the economy. Show these effects using arrows in the convenient chain-of-effects shorthand
shown below.
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(a) MS

r1

I

Y

Md

r2
(b) Is r1 greater, equal to, or less than r2? (circle the correct answer)
(c) Draw in the money market and planned investment graphs below. Show what would happen
if the Fed attempted to stimulate the economy. Be sure to show all the links that you indicated
above: MS  r1  I  Y  Md  r2.
Money Market
Planned Investment
Aggregate Expenditures Model
Y = C + I + G + (EX – IM)
(d) “Crowding Out” Effect
What causes “crowding out”?
Why?
What is being “crowded out”?
2. What is the federal deficit vs. the debt?
3. How do the federal deficit and the debt change with the state of the economy? Explain
what automatic stabilizers are and their importance in the post-World War II economy.
III. Inflation and Nominal vs. Real Values
1. What macroeconomic problems does inflation pose?
2. The two biggest problems with unanticipated inflation are (i) the arbitrary redistribution of
income, and (ii) too much or too little borrowing and lending. Regarding the arbitrary
redistribution of income, if inflation is greater than expected, are employers or workers better off
or worse off? Why? Regarding too much or too little borrowing and lending, if inflation is
greater than expected, are lenders or borrowers better off or worse off? Why?
3. Student Price Index (SPI)
Suppose a survey of student spending and consuming revealed that for three decades the typical
SU student consumed only three items each month: 15 pizzas, 88 cups of coffee, and 140
photocopies. The following table indicates the price paid for each item in three different years:
1979 1989 1999
Photocopying $0.10 $0.07 $0.05
Pizza
$8.00 $8.50 $9.00
Coffee
$0.75 $.80 $0.85
(a) Calculate a student price index (SPI) for SU for each year, designating 1989 as the base year
(show your work).
(b) Calculate the rate of inflation from 1979 to 1989, 1989 to 1999, and 1979 to 1999:
4. The Congressional Commission to investigate the CPI determined that it overstates actual
average consumer prices. List 3 of the sources of bias that cause the CPI to overstate inflation.
Then, briefly explain how each of the three biases might have caused an overestimate of inflation
in the example above of the SPI at SU.
5. During the Christmas of 1999 a dear friend of my family’s (a retired professor of British
literature) announced that he was no longer sending out Christmas cards because at 33 cents it
had simply become too expensive. He recalled when stamps cost only 10 cents in 1974 and
declared a 300% increase unacceptable. Below you will find a list of the dates when the cost of a
first class stamp increased along with the CPI for the corresponding year.
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Year
1974
1981
1985
1991
1999
Stamp Price
10 cents
18 cents
22 cents
29 cents
33 cents
CPI (1982-84=100)
0.493
0.909
1.076
1.363
1.667
Real Stamp Price
(a) Calculate the real cost of a stamp in each year list above. Below carefully show for at least
one year your calculations. List your answers above.
(b) Was my friend, Bill D., correct in concluding that stamps have become three times more
expensive? How would you characterize how the real price of stamps has changed from 1974 to
1999?
(c) What does the “real” price of a stamp mean as opposed to the nominal price?
(d) The Post Office is planning to increase the price of a first class stamp. If they want the real
price to be roughly the same as the price in 1999, what should the new price be if the CPI is 1.77
(it’s the Dec. 2001 CPI, the most recent)?
IV. Money, Money Supply, the Fed
1. Discuss how each of the following satisfies the three characteristics of money: oranges, gold, a
foreign currency with high and highly variable inflation, AT&T stock and cattle.
2. Why is money better than barter?
3. Review the money creation process and the deposit multiplier. What limits how much money
creation occurs—list something the Fed controls and something it does not (hint for the latter:
think in terms of the Great Depression—how would the money creation process work)?
4-5. Problem Set Questions from Chapter 10: #6 and 8 (see answers in textbook).
V. Money Demand, Interest Rate, and Monetary Policy
1. What is the discount rate? The federal funds rate?
2. Does the Fed increase or decrease the discount rate to slow the economy? Specifically, how
does the change in discount rate cause the money supply to change?
3. What are open market operations (OMO)? Specifically, how does the Fed use open market
operations (OMO) to cause the money supply to change?
4-5. Problem Set Questions from Chapter 11: # 4 and 6 (see answers in textbook).
VI. Policy Making—The Money Market and Goods Market Link
1. Monetary policy: How would the Fed slow the U.S. economy? Write out the linkages between
monetary policy and changes in the economy (as we did in lecture and as it is in Ch. 12). Relate
those changes to the money market and the market for planned investment.
2. Is monetary policy better at slowing down or speeding up the economy? Think about the links
and markets involved and the extreme conditions of a booming economy or the Great
Depression. Refer to the WSJ article about the Japanese “liquidity trap.”
3. Is fiscal policy better at slowing down or speeding up the economy? Think about the links and
markets involved and the extreme conditions of a booming economy or the Great Depression.
4. Fiscal policy: How President Bush’s proposed $1.6 trillion tax cut affect the economy? Write
out the linkages between monetary policy and changes in the economy (as we did in lecture and
as it is in Ch. 12). Relate those changes to the money market and the market for planned
investment.
5. Fiscal policy: What is the “crowding out” effect? Why is it a problem? What is “Fed
accommodation”? How can it solve the “crowding out” effect?
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6. The Fed’s discount rate was 3% from 1992-94, rose gradually to 5.25% in 1995, fell to 4.5%
until June of 1999, raised five times since then, and now since January has lowered it three times.
Explain what Fed policy makers must have been thinking to motivate these changes.
7-10. Problem Set Questions from Chapter 12: #2, 4, 6 and 8 (see answers in textbook).
VII. Aggregate Demand and Aggregate Supply
A. (a) Label both axes of an AD/AS graph, draw in AD and AS, and indicate the equilibrium on
both axes.
(b) Draw a decrease in AS.
(c) Explain what might have caused such a movement
(d) Indicate the new equilibrium in the graph.
(e) Report the implication of changes from each axis in language your parents would understand.
(f) Explain the implication of the horizontal and vertical sections of the aggregate supply curve.
(g) Defense spending decreased dramatically in recent years prior to the current one. Show in an
aggregate demand and aggregate supply diagram the effect of this change on equilibrium output
and the aggregate price level.
(h) Inflation has only been a fact of life since World War II. What has changed to explain why
that is the case? Think about Supply-side vs. Demand-side inflation.