Download Eco 120 Tips and Exa..

Tips for preparing for the exam
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Practice. Do the problems in the back of the
book chapters. Do the problems on the book’s
website. Do the problems in the study guide.
Read the question. Read carefully.
Answer the question. Don’t answer the
question you think was asked. Answer the
question that actually was asked. Most exam
errors happen here. Remember to read the
question.
Tips for preparing for the exam
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Be sure to answer all of the question.
Don’t put down too much. Don’t provide a
whole background of a model unless the
question asks for it. If the question asks you to
analyse a scenario, go straight into the
scenario.
Don’t put down too little. In an essay
question, provide your reasoning and analysis.
Draw a relevant graph and talk about the
graph. Don’t just say “Yes.”
Final exam tip
• Don’t panic! Relax and breath. You do
not need to write for 3 hours to do well in
an economics exam. Often a well-ordered
sentence is worth more than 2 pages of
semi-coherent babbling. Stop and think
about your answer.
Answers to the sample exam
Question B.1: State whether the following
statements are true or false.
i) Net exports are equal to GDP – (G + I + G)
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ii)
Answer: True, as in an open economy, Y = C + I +
G + NX.
The marginal propensity to save (MPS) is the
change in consumption divided by the change
in income.
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Answer: False, the MPS is the change is savings
divided by the change in income.
iii) Changes in government expenditure (G)
and/or exports (X) can result in an increase in
GDP through the multiplier effect.
–
Answer: True, G and X are components of
autonomous spending. Changes in autonomous
spending will give rise to a larger change in GDP
through the multiplier effect.
iv) The unemployment rate is defined as the
number of unemployed divided by the total
population.
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Answer: False, the unemployment rate is defined
as the number of unemployed divided by the labour
force.
v)
The marginal propensity to consume is equal
to 1 minus the marginal propensity to save.
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Answer: True, the marginal propensity to consume
is the fraction of each new $1 in income that
consumers will devote to new consumption. As the
rest of the new $1 is saved, MPS = 1 – MPC.
vi) A recessionary gap is the amount by which
aggregate expenditure exceeds the full
employment level of GDP.
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Answer: False, a recessionary gap is the amount
by which aggregate expenditure is short of full
employment GDP.
vii) Aggregate expenditure in a closed economy is
equal to (C+I+G).
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Answer: True, in a closed economy, NX = 0, so
the only components of aggregate expenditure are
C, I and G.
viii) The aggregate demand curve shows the
relationship between real GDP and the price
level.
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Answer: True, the AD curve shows the relationship
between aggregate expenditure and the price level
in an economy.
ix) GDP excludes second-hand goods.
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Answer: True, as second-hand goods were goods
produced in a previous year. Only the services
involved in the sale of the second-hand goods are
goods or services produced in this year.
x)
The multiplier tells us that an increase in
investment by $100m will give rise to a smaller
than $100m increase in GDP.
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Answer: False, the multiplier is the factor by which
investment will give rise to a larger increase in
GDP.
Question B. 2: Briefly explain the concept of a
consumption function. Explain how changes
in net wealth and the price level alter the
consumption function.
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Answer: A consumption function is the relation
between consumer spending and GDP in an
economy. As net wealth rises, we would expect
consumers to consume more, so a rise in net
wealth will raise consumption spending for all levels
of GDP- the consumption function shifts up.
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Answer continued: A rise in the price level will
lower (the real value of) net wealth and so shift the
consumption function down.
Question B.3: The reserve ratio for the banks is
25%. ABC Bank has $20,000 in deposits and
$12,000 in reserves. Assume all other
commercial banks are loaned up.
a) What is the value of ABC Bank’s excess
liquidity?
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Answer: The ABC Bank has $20,000 in deposits,
so it must retain $5,000 in reserves. So the bank
has $7,000 in excess liquidity- reserves over and
above that required by law.
b) What is the value of the additional loans that
can be made by the commercial banking
system?
– Answer: As we have assumed all other banks are
loaned up, only the ABC Bank’s loans matter. So the
ABC bank can loan out the $7,000 in excess cash it
has.
c) What is the money multiplier?
– Answer: The money multiplier is 1/R = 1/0.25 = 4.
d) By how much will total deposits expand if this
bank lends all its excess reserves and there is
no leakage from the banking system?
– Answer: Total deposits will expand by the money
multiplier times the excess cash of the ABC bank:
Change in total deposits = 4 x $7,000 = $28,000
Question B. 4: What adverse internal effects
may follow from:
a) a depreciation of the exchange rate and
– Answer: If the exchange rate depreciates,
then the A$ becomes cheaper relative to other
currencies, so our exports become cheaper
overseas and foreign imports become more
expensive here. There are many possible
detrimental internal effects:
• If Australian producers require a lot of foreign
imports in production, this means the cost of these
foreign components rises
• If Australian debt is denominated in foreign
currency, then the total value of the foreign debt
rises
• If the economy is already at full employment, a
depreciation will increase NX and so also shift the
AD curve to the right. The economy will
experience a boom, and we will have inflation.
b) an appreciation of the exchange rate?
– Answer: If the exchange rate appreciates,
then the A$ becomes more expensive relative
to other currencies, so our exports become
more expensive overseas and foreign imports
become cheaper here. There are some
possible detrimental internal effects:
• Australian net exports will decline.
• If the economy is at full employment, an
appreciation of the exchange rate will lower NX
and so shift the AD curve to the left. The economy
will experience a recession, and until prices and
wages adjust, we will have unemployment.
Question C.1:
a) Use the AD-AS model to compare the
causes and policy implications of (i)
demand-pull and (ii) cost-push inflation in
both the short-run and the long-run.
– Answer: Demand-pull inflation is caused by
shocks to aggregate expenditure that push
aggregate demand above aggregate supply at
current prices. Cost-push inflation is caused
by price shocks that push aggregate supply
below aggregate demand at current prices.
See graphs from earlier in this session about
demand-pull and cost-push inflation.
Policy implications - demand-pull:
AD > potential output at current prices. If the
government cuts back on G in times of demand-pull
inflation, then the AD curve will be shifted left
following the AD shock. The cut in government
demand can completely negate the expansion from
the shock, so we are left with no rise in prices.
Policy implications- cost-push inflation:
AS < potential output at current prices. If the
government does nothing, wages and prices will fall
to return the economy to potential GDP. However this
usually involves an extended recession. If the
government increases G when the AS shock
happens, this will return the economy to the natural
rate of output without an extended recession, but at
higher prices.
b) In what way does the presence of costpush inflation make demand-management
policy ineffective?
– Answer: Cost-push inflation makes demandmanagement policy ineffective is the sense
that the government response does not
cancel inflation. In fact, the government
response of increasing spending after the
supply shock leads to more inflation.
Demand-management makes the inflation
worse after a supply shock.
Question C. 2:
a) Define the crowding-out effect.
– Answer: In the long-run, the economy always
returns to potential GDP. The crowding-out effect for
G is the idea that in the long-run, an increase in G will
come at the expense of other forms of aggregate
expenditure.
A particular concern is that an increase in G might
increase interest rates and so reduce investment
spending and so lower the long-run capital
accumulation and so growth in the economy. An
increase in interest rates will make the A$ more
desirable for investors, appreciate the A$ and so
reduce net exports- another form of crowding out.
b) Is the crowding-out effect likely to be larger
during a recession or when the economy is near
full employment? Use the AD-AS model to
substantiate your answer.
– Answer: The crowding-out effect will likely larger
when the economy is near full employment. During a
recession, the economy is below potential GDP, so an
increase in G can be met by increasing output.
However, as output gets closer to potential output, as
increase in G will result in higher output and higher
prices.
Draw a diagram based on the crowding-out diagrams
earlier in this session.
Question C. 3:
a) Define unemployment.
– Answer: To be considered unemployed a person
must be (1) not currently employed and (2) actively
looking for a job.
b) Outline the causes of frictional, structural and
cyclical unemployment.
– Answer: To be part of frictional unemployment, a
person must have left a job to search for a new job
that betters matches their skills, career path, etc. To
be part of structural unemployment, a person must
have left a job that was eliminated because of
changes in the structure of the economy- the types of
goods that we produce. To be part of cyclical
unemployment, a person must have left a job that
was eliminated because the economy was in a
recession, but that will likely be added again after the
economy returns to potential GDP.
c) What are the main policies for dealing with each
type of unemployment?
– Answer: To reduce frictional unemployment, the
government can reduce the costs of job search or
increase the speed at which job information flows
through the economy. To reduce structural
unemployment, the government can ease the
transition of workers out of industries that are closing
down into existing or new industries. Often this will
involve relocating and retraining workers. To reduce
cyclical unemployment, the government can use
demand-management policies to reduce the size and
duration of recessions.
Question C. 4:
a) What is the relationship between savings
and investment? Explain whether
Australia is a high or low-saver economy.
– Answer: There is no necessary link between
savings and investment in a country, as the
gap between I – S can be borrowed from
overseas. This borrowing will raise the level
of foreign debt.
Australia has a domestic savings rate about
equal to the rest of the developed world.
b) When is a country considered a ‘debtor’
or a ‘creditor’ country? Is Australia a net
debtor or a creditor country to the rest of
the world? Explain.
– Answer: A country is considered a ‘debtor’
country if residents of the country owe more
to residents of foreign countries than
residents of foreign countries owe to them. If
the reverse is true, the country is considered
a ‘creditor’ country. Australia is a net debtor
country to the rest of the world. However
recent government budget surpluses have
been used to drive down Australian public and
foreign debt.