Download PART I: Multiple Choice/Fill-In

Name:
Section Number:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
PART I: Multiple Choice/Fill-In. 10 points (each question is worth ½ point).
1. Suppose the consumption function were defined as: C = 300 + 0.85(Y-T). What is the MPS?
a)
b)
c)
d)
0.85
1.85
0.15
300
Answer: C
2. When your aunt attended Cornell in 1980, she paid $300 for rent. Coincidentally, you now live in the
same apartment in which she lived, and pay $500 for rent. Suppose that the CPI in 1980 was 150, and
in 2008 is 200.
a) In real terms, you're paying more than your aunt
b) In real terms, you're paying less than your aunt
c) In real terms, you're paying the same amount
d) It cannot be determined from the information given
Answer: A
3. Suppose a 17 year-old worker is fired from his full-time job. If he is available for work, made
specific efforts to find work exactly five weeks ago, and has been volunteering without pay for four
hours a week at a local soup kitchen, then he is considered:
a)
b)
c)
d)
Unemployed
Employed, but not at work
Not in the labor force
None of the above
Answer: C
4. If real GDP has increased, then we can conclude that:
a)
b)
c)
d)
Everybody in the economy is better off
Price levels are higher
There is more unemployment
None of the above
Answer: D
5. Which price index includes the prices of intermediate goods?
a)
b)
c)
d)
Producer price index
Consumer price index
Housing price index
All of the above
Answer: A
Name:
Section Number:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
6. When the Federal Reserve sells a government bond, the money supply is:
a)
b)
c)
d)
Decreased
Increased
Not affected
First decreased, then increased
Answer: A
7. Which of the following would NOT increase GDP in 2008?
a)
b)
c)
d)
Michelle’s birth in a private hospital on Feb. 22, 2008
Amy’s purchase of a share of Microsoft stock on Dec. 31, 2008
Brea’s purchase of a new Ford Taurus on Mar. 19, 2008
ILR’s purchase of new computers for its offices on Jan. 1, 2008
Answer: B
8. To stimulate economic growth, the government decides to increase government expenditures and cut
taxes at the same time. This economic policy would be described as:
a)
b)
c)
d)
Income Policy
Fiscal Policy
Monetary Policy
Financial Policy
Answer: B
9. The new U.S. president decides to increase personal income taxes by $200 billion in 2009. What
effect would this have on the equilibrium level of output if (1 – MPS) is 0.60 and the goods market is
assumed to be independent from the money market?
a)
b)
c)
d)
Decrease output by $200 billion
Decrease output by $120 billion
Decrease output by $124 billion
Decrease output by $300 billion
Answer: D
10. If a U.S. firm located in China exports clothes to Germany, which of the following is correct?
a)
b)
c)
d)
The clothes should be included in U.S. GDP
The clothes should be included in China’s GNP
The clothes purchases induce a leakage from the German spending stream
All of the above
Answer: C
Name:
Section Number:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
11. Suppose the Federal Reserve wants to restrict the money supply. Then it could do so by:
a)
b)
c)
d)
e)
f)
Buying 3-month Treasury bills
Decreasing the required reserve ratio
Purchasing 30-year Treasury bonds
Decreasing the discount rate
None of the above
All of the above
Answer: E
12. Suppose the U.S. government decreases government expenditures by $300 billion, and
simultaneously decreases taxes by $300 billion. Then the effect on the equilibrium level of output
when the MPC is 0.7, and the goods market is assumed to be independent from the money market, is:
a)
b)
c)
d)
An increase of $210 billion
A decrease of $1 trillion
A decrease of $300 billion
An increase of $600 billion
Answer: C
13. If aggregate output is greater than planned aggregate expenditure, then which of the following
adjustments to equilibrium will occur:
a)
b)
c)
d)
There will be an unplanned inventory increase and firms will reduce production
There will be an unplanned inventory decrease and firms will reduce production
There will be an unplanned inventory increase and firms will increase production
There will be an unplanned inventory decrease and firms will increase production
Answer: A
14. Saving and Wealth are:
a)
b)
c)
d)
Stock and flow variables, respectively
Flow and stock variables, respectively
Both individually stock and flow variables
Both neither stock nor flow variables
Answer: B
15. If the federal government enacts an expansionary fiscal policy by decreasing taxes, then we would
expect:
a)
b)
c)
d)
The demand for money to decrease and the interest rate to decrease
The supply of money to increase and the interest rate to decrease
The demand for money to increase and the interest rate to increase
None of the above
Answer: C
Name:
Section Number:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
16. If the Federal Reserve initiates a contractionary monetary policy through open market operations,
then we would expect:
a)
b)
c)
d)
The demand for money to decrease and the interest rate to decrease
The supply of money to increase and the interest rate to increase
The quantity of money in the hands of the public to decrease and the interest rate to increase
The supply of money to decrease and the interest rate to decrease
Answer: C
17. Suppose exports and imports are zero. Then planned aggregate expenditure minus government
purchases equals ____aggregate consumption plus planned investment____
18. The money multiplier multiplied by the required reserve ratio equals __1__
19. The price of bonds goes:
a) Up whenever stock prices go up
b) Up when an increase in inflation is expected
c) Up when an increase in risk becomes apparent
d) Up when the Federal Reserve uses open market operations to increase the money supply
Answer: D
20. True/False: Investment tends to respond negatively to decreases in the interest rate
Answer: False
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. Briefly discuss some of the problems that arise with a price index that uses a fixed-weight
procedure.
Structural changes in the economy may make fixed weights inappropriate for different time periods. No
accounting for supply shifts in the economy (i.e., substitution effects).
2. Suppose the goods market in a closed economy with a government is in equilibrium. Using the
leakages/injections approach, state the equilibrium condition, and discuss whether the
government’s budget must necessarily be balanced.
Name:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
Section Number:
It is helpful to note that equilibrium requires that Y = C + I + G. Also, Y ≡ C + S + T. So, stating the
equilibrium condition, we have S + T = I + G. This condition does not require a balanced government
budget (G = T).
3. Suppose the money market is in equilibrium. Discuss and illustrate graphically how an
expansionary monetary policy would affect the quantity of money supplied and demanded, as
well as the equilibrium interest rate.
MS
r
MS’
r0
r2
r1
Md’
Md
M0
M1
M
M
We have MS ↑ → r ↓ → I ↑ → Y ↑ → Md ↑ → r ↑. Therefore, the money supply curve would shift to the
right, increasing the quantity of money supplied and demanded, and lowering the equilibrium interest
rate. Secondarily, the money demand curve would shift to the right, increasing the interest rate by an
amount smaller in absolute value than the initial decrease. Thus, the quantity of money supplied and
demanded would increase, and the equilibrium interest rate would decrease.
4. Briefly describe the transaction and speculation motives in their relation to money demand. If
market interest rates increase, is an individual more or less likely to hold money balances relative
to bonds?
Transaction motive relates to the need to have money to buy goods and services. Speculation motive
relates to the increased desire to hold bonds when interest rates are higher than normal, due to
expectations that interest rates will fall in the future. Therefore, as interest rates increase, an individual
is less likely to hold money balances.
5. Briefly describe the value-added approach to calculating GDP. Why don’t we use the value of
total sales in an economy to measure the level of output that has been produced?
Sum the value added at each stage in production. If we use the value of total sales, we double-count
intermediate goods when we count their value in final goods.
Name:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
Section Number:
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 in the Economist on February 14, 2008:
Rushing on by road, rail and air
“China's rapid economic growth and equally rapid integration into the global economic system is
putting huge strains on its infrastructure. This has led to a spate of spending on transport.
Between 2001 and the end of 2005 more was spent on roads, railways and other fixed assets than
was spent in the previous 50 years. According to the state media, investment will see doubledigit growth every year for the rest of the decade. Between 2006 and 2010, $200 billion is
expected to be invested in railways alone, four times more than in the previous five years.”
1.1 Define (using both words and standard letter abbreviations) planned aggregate expenditure in a closed
economy with a government. (1 point)
Planned aggregate expenditure is the sum of aggregate consumption, planned investment, and
government expenditures. In letters: AE = C + I + G.
1.2 Explain the crowding-out effect. (1 point)
The crowding-out effect is the tendency for increases in government purchases to cause a reduction in
private investment via the interest rate increases caused by the increase in aggregate expenditure and the
resulting shift in the money demand curve to the right.
1.3 Illustrate graphically how China’s response to strains on its public infrastructure will affect the goods
market, the money market, and the level of planned (private) investment. Do we observe crowding-out of
planned investment? (3 points)
We have G ↑ → Y ↑ →Md ↑ → r ↑ → I ↓, therefore crowding-out of private investment does occur.
Graphically:
Goods Market
Money Market
45° line
C+I0+G1
C+I1+G1
AE
r
MS
C+I0+G0
r1
MD’
r0
MD
Y0
Y2 Y1
Y
M0
M
Name:
First Prelim
ECON 102 – Professor Steven Kyle
February 28, 2008
Section Number:
Planned Investment Schedule
r
r1
r0
I
I1
I0
2. Read the following excerpt from an article which appeared in the Financial Times on February 20,
2008:
Jump in prices raises worry of US stagflation
“Prices in the US rose at an unexpectedly rapid rate last month, figures showed on Tuesday,
raising fears that the world's biggest economy was going through at least a temporary bout of
stagflation. The jump in inflation at a time of very weak growth highlights the dilemma facing
central bankers and the gamble the Federal Reserve has taken in cutting interest rates
aggressively to combat the risk of recession. Economists said stubbornly high inflation would
not stop the Fed from cutting interest rates next month, but could affect how far the US central
bank would go, and how long it would be prepared to keep rates low.”
2.1 Define stagflation. (1 point)
Stagflation occurs when the overall price level rises rapidly during period of recession or high and
persistent unemployment.
2.2 Define the discount rate. (1 point)
The discount rate is the interest rate that banks pay to the Federal Reserve to borrow from it.
2.3 Suppose the Federal Reserve cuts the discount rate from 6% to 5%. Other things equal, how would
we expect commercial banks to respond to this action? (1 point)
We would expect banks to increase their borrowing from the Federal Reserve.
2.4 Suppose commercial banks borrow $50 million from the Federal Reserve, and the required reserve
ratio is 20%. By how much will the money supply increase due to the increase in excess reserves if
we ignore the banks’ interest payments to the Federal Reserve? (2 points)
A required reserve ratio of 20% implies a money multiplier of 5. Banks can loan the entire $50 million
(since the additional reserves do not come from deposits) and will create an additional $50 million*5 =
$250 million. Therefore, the money supply increases by $250 million.