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Practice Final Exam
Economics 503
Fundamentals of Economic Analysis
2:30-5:30PM
Write all of your answers on this white exam paper. Do not hand in the blue books.
Multiple Choices (2 points each)
1.
We observe in microeconomics that ____________, while in macroeconomics
______________:
a. the supply curve is more elastic in the short run than the long run; the
short-run aggregate supply curve is more elastic than the long-run
aggregate supply curve.
b. The supply curve is more elastic in the long run than the short run; the
short-run aggregate supply curve is more elastic than the long-run
aggregate supply curve.
c. the supply curve is more elastic in the short run than the long run; the
long-run aggregate supply curve is more elastic than the short-run
aggregate supply curve.
d. The supply curve is more elastic in the long run than the short run; the
long-run aggregate supply curve is more elastic than the short-run
aggregate supply curve.
______B___________
2.
You read an analysis that says that the Japanese yen is overvalued relative to the
US dollar. This would imply that
a. Japan’s real exchange rate is above 1; Japan’s PPP converted GDP is
larger than its exchange rate converted GDP.
b. Japan’s real exchange rate is above 1; Japan’s PPP converted GDP is
smaller than its exchange rate converted GDP.
c. Japan’s real exchange rate is below 1; Japan’s PPP converted GDP is
larger than its exchange rate converted GDP.
d. Japan’s real exchange rate is below 1; Japan’s PPP converted GDP is
smaller than its exchange rate converted GDP.
______D___________
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3.
The U.S. Federal Reserve announces that it is raising its target interest rate. We
would then observe that
a. The Federal Reserve would engage in an open market sale; the HKMA
would engage in a foreign currency purchase.
b. The Federal Reserve would engage in an open market sale; the HKMA
would engage in a foreign currency sale.
c. The Federal Reserve would engage in an open market purchase; the
HKMA would engage in a foreign currency purchase.
d. The Federal Reserve would engage in an open market purchase; the
HKMA would engage in a foreign currency sale.
___________ B ______
4.
The demand and supply for a product both increase (i.e. both curves shift out).
Which of the following statements is true:
a. the equilibrium price of the product must increase; the equilibrium
quantity of the product must increase.
b. the equilibrium price of the product may or may not increase; the
equilibrium quantity of the product must increase.
c. the equilibrium price of the product must increase; the equilibrium
quantity of the product may or may not increase.
d. the equilibrium price of the product may or may not increase; the
equilibrium quantity of the product may or may not increase.
________B_________
5.
Which of the following transactions would be included as part of the expenditure
method of calculating GDP in Japan.
a.
b.
c.
d.
e.
a German expatriate sells a used Toyota to his neighbor in Tokyo
a Japanese fisherman sells fresh fish to a sushi shop in Kyoto
a Japanese miller sells flour to a bakery in Los Angeles
a German expatriate buys shares in Toyota Motor Co.
none of the transactions would be counted.
__________C_______
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6.
Gadgets are a normal good. The supply curve of gadgets is not perfectly elastic.
Gadgets are substitutes for widgets. The income of gadget and widget customers goes up
by 10%. We should see:
a. The price of gadgets rise and the demand curve for widgets shifts out.
b. The price of gadgets rise and the demand curve for widgets shift in.
c. The price of gadgets fall and the demand curve for widgets shifts out.
d. The price of gadgets fall and the demand curve for widgets shift in.
__________A_______
7.
The income of gadget and widget customers goes up by 10%. The supply curve in
a market for widgets is perfectly elastic but the supply curve of gadgets is not. Widgets
are a luxury good while gadgets are a normal good. Gadgets are substitutes for widgets.
a.
b.
c.
d.
The equilibrium quantity of widgets increases by more than 10%.
The equilibrium quantity of widgets increase by less than 10%
The equilibrium quantity of widgets decrease by less than 10%
The equilibrium quantity of widgets decrease by more than 10%.
___________A_______
Income goes up by 10%, so demand for widgets will shift out by more than 10% at any
given price. Since supply for widgets is perfectly elastic, the price will stay constant and
the equilibrium quantity will increase by more than 10%. BUT gadget demand also goes
up, and since supply is not perfectly elastic, price of gadgets go up. Since widgets and
gadgets are substitutes, some of the demand for gadgets will switch to widgets, which will
further increase the demand for widgets.
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Calculation
1. [3 points] Calculate the elasticity of demand (using the midpoint method) and the
marginal revenue for a monopolist facing the following demand curve.
Price Quantity
20
Elasticity
Marginal
Revenue
50
-.555
-20
30
40
2. [4 points] HK’s GDP is HK$1.4 trillion. The population is 7 million. The exchange
rate with the US dollar is 7.8 HK$ per US dollar. The price of a market basket of
typical goods in HK is HK$12,000 and the price of that same market basket of goods
in the USA is US$2,000. Calculate the exchange rate converted GDP of HK in US$
and the PPP converted GDP. Calculate the real exchange rate. Is the Hong Kong
Dollar overvalued or undervalued?
PPP conversion factor is 6. HK GDP per Capita is HK$200000. In exchange rate
converted terms 33333.33. In PPP converted terms is US$33,333.33. 25641.03
REX is 1.3 and the HK dollar is undervalued.
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3. [4 points] The base year is 2000. The following table shows the hourly wages in
1997 and 2007 along with the CPI for those years. Calculate the wages measured in
2000 dollars. Which is higher in inflation adjusted terms?
Wages
1997
2007
CPI
10
12
Real Wages
90
110
11.11111
10.90909
4. [4 points] The demand curve in an industry is Q D  10  .1 P while the supply curve
is Q S  .15  P . Calculate the equilibrium price and quantity.
10  .1P  .15P  P  40
Q6
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Short Answer
1. [6 points] Americans feel very optimistic and their high animal spirits increase
demand in that country. The US Federal reserve follows a policy of countercyclical monetary policy.
a. Would the central bank in the USA respond with an open market purchase or an
open market sale of government bonds?
To raise interest rates, the Fed must shrink money supply. They would need an open
market sale.
b. Compare the effects of these events on the sales of two firms in Hong Kong. Firm
A is a real estate developer which builds residential housing. Firm B is a company
that makes watches for sale at the best department stores across the world. Which
type of firm is likely to experience the strongest increase in demand as a result of
the two events in the US? Explain the difference in 5 sentences or less.
The open market sale and the high animal spirits push up interest rates in the USA. This
raises interest rates in HK. The high interest rates will have negative impact on
borrowing for housing, but is also likely to have negative effects on consumer durable
purchases. However, the HK Watch company should also receive some additional
demand from the USA export market
2. [3 points] You have information on the income elasticity of demand for three
types of goods. Classify the goods by type: normal good, a luxury good or an
inferior good?
Good
Tomatoes
Plums
Spinach
Income
Elasticity of Demand
.5
-.5
-2.5
6
Type of Good
Normal
Inferior
Inferior
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Macroeconomics
3. [3 points] We observe the inflation rate in the US being 2% and the money market
interest rate being set at 3%. Assuming that the Federal Reserve sets the interest
rate target according to the Taylor rule, would we say that the Federal Reserve
believes the economy is in a recession or an expansion.
The Taylor rule suggests that i  .025    .5  (   TGT )  .5  Output Gap Given an
inflation target of 2%, we could say the inflation gap = 0. Then we could write this as
.03  i  .045  .5  Output Gap 
So that the only explanation is the Fed thinks there is a
Output Gap  .03
recession.
4. [2 points] List two costs of high expected inflation
a Shoe Leather Costs – Inconvenience costs from not holding money.
b. Menu Costs – Costs of changing price levels
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Graphing Questions
Since the mid-1990’s, the United Kingdom has followed a monetary policy of
“inflation targeting.” The way we might think of this policy, the central bank will
choose some price level P* and to set monetary policy to keep the equilibrium price
level in the economy near P*. When the price level threatens to go above P*, the
central bank will raise interest rates and cut interest rates when the price goes below
P*. Assume that the economy is in an initial equilibrium where the price level is P*
and the output level is equal to potential output. Assume that monetary policy will
impact the economy before the self-correcting mechanism activates.
1. [4 points] Use 1 graph to describe what would happen to GDP in the economy
when (A) the UK real estate market crashes; and (B) the central bank acts to
maintain the price level. Clearly mark (A) the equilibrium after the crash in asset
prices occurs and before monetary policy affects the economy; and (B) the
equilibrium after monetary policy has an effect.
YP
P*
SRAS
B
A
AD
AD’
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2. [4 points] Use 1 graph to describe what would happen to GDP in the economy (A)
when the price of oil rises sharply; and (B) the central bank acts to maintain the
price level. Clearly mark (A) the equilibrium after the rise in oil prices occurs and
before monetary policy affects the economy; and (B) the equilibrium after
monetary policy has an effect.
YP
SRAS
A
P*
B
AD
ADʹ
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A series of financial scandals suddenly makes the Australian stock market very attractive
(relative to other stock markets around the world) to both Australians and foreign
investors.
3. [4 points] Use a graph of the Australian Forex market to demonstrate the impact
of these events on the Australian Dollar exchange rate (i.e. the number of
Australian dollars needed to buy one US dollar).
YP
R
Supply
Supply′
1
R*
R**
Demand′′
2
Supply′′
Demand
Q
People want to buy oz dollar to buy oz stocks so they bring US dollars to oz forex market
(supply shifts out) and oz people keep their money home (demand shifts in).
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4. [4 points] The demand for watermelons is highest during summer and lowest
during winter. Yet, watermelon prices are normally lower in summer than in
winter. Use a demand and supply graph to demonstrate how this is possible. Be
sure to carefully label the curves in your graph and to clearly indicate the
equilibrium summer price and the equilibrium winter price.
Winter
Summer
S
D
The demand for watermelons is highest in summer which should make the demand
higher. Holding supply constant, this would make watermelon prices higher than in
winter. However, the supply of watermelons also rises in summer, perhaps more than
demand. This makes the equilibrium price of watermelon lower in summer.
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5. [4 points] Draw a graph showing what happened in Japan near the turn of the
millennium when the interest rate hit its zero lower bound.
Money
Supply
i
i*
i**
Money
At zero lower bound, money demand becomes perfectly elastic and extra liquidity
does not further reduce interest rates.
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6. [4 points] We see that real interest rates around the world are going up. Draw a
graph of the loanable funds market which shows what this would do to domestic
savings, domestic investment, the domestic real interest rate, the domestic capital
account and the domestic trade balance.
B
S+KA
rW
rW
AD
S
D
S* S**
D**D*
S↑,r↑,I↓,KA↓
When real interest rate goes up, the demand for loanable funds drops and supply
increases, the economy does not need to rely so much no foreign borrowing.
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