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Final exam: Introductory Macroeconomics Date: 12/14/05 Name: This exam is worth 200 points. Part 1: Multiple choice (Each question is worth 3 points) 1. In 1971, a bank worker could process 265 checks in 1 hour. By 1986, with advanced computer scanners, that figure had risen to 825 checks per hour. Economists describe this type of activity as a. exploitation of labor. b. an increase in labor productivity. c. comparative advantage. d. mutual gains from voluntary trade. 2. 3. 4. A ticket to an Eric Clapton concert costs $45. If you have a ticket, you can sell the ticket to an acquaintance for $75. To a ticket holder, the opportunity cost of actually attending the concert is a. $45. b. $50. c. $75. d. $120. The removal in 1966 of the requirement that Catholics not eat meat on Fridays was followed by a 12.5 percent fall in prices of fresh fish. From this it can be deduced that the a. demand curve for fish shifted to the left. b. demand curve shifted to the right. c. supply curve shifted to the left. d. supply curve shifted to the right. Technological change, such as the information technology revolution of the 1990s can shift the aggregate supply curve outward. If, at the same time, the government is decreasing spending, the most likely outcome of these two factors is a(n) a. increase in the price level. b. decrease in the price level. c. increase in real GDP. d. decrease in real GDP. ANSWER: ______ ANSWER: ______ ANSWER: ______ ANSWER: ______ 5. 6. 7. 8. Workers in country A receive an increase in wages of 10 percent at the same time the inflation rate in country A is 8 percent. Workers in country B receive an increase in wages of 3 percent and the inflation rate in country B is 1 percent In which country are workers better off? a. Country A because their real wages rise by 18 percent. b. Country A because their real wages rise by 10 percent. c. Country B because the inflation rate is lower. d. Neither country because the increase in real wages is the same. Which period of recent U.S. history shows the lowest rates of productivity growth? a. 1948-1973 b. 1973-1995 c. 1995-2000 d. All periods had similar growth rates. If consumer confidence falls, what happens to the consumption function? a. It will shift upward. b. It will shift downward. c. It will not shift, but people will move downward along the consumption function. d. It will not shift, but people will move upward along the consumption function. A major Internet service provider decides to spend $70 million to purchase new server equipment. If the marginal propensity to consume is 0.8, the eventual change in GDP will be a. $70 million. b. $84 million. c. $90 million. d. $350 million. ANSWER: ______ ANSWER: ______ ANSWER: ______ ANSWER: ______ 9. 10. 11. 12. A severe hurricane hits Florida, destroying large amounts of the citrus crop. What is the most likely effect of this on aggregate supply? a. No effect, the economy will move along the curve to a higher price level. b. No effect, the economy will move along the curve to a lower price level. c. It will increase. d. It will decrease. ANSWER: Suppose that the U.S. personal income tax (which is a percentage tax) was eliminated and replaced with a fixed tax that raised the exact same amount of revenue. The multiplier would be a. larger. b. unchanged. c. smaller. d. incalculable. ANSWER: An increase in the reserve ratio would tend to a. increase excess reserves and raise the money multiplier. b. decrease excess reserves and decrease the money multiplier. c. increase excess reserves and decrease the money multiplier. d. decrease excess reserves and raise the money multiplier. If the Fed were to increase the money supply at the same time the government was increasing taxes, we could expect a. an increase in interest rates and real GDP. b. a decrease in interest rates and real GDP. c. a decrease in interest rates but the effect on real GDP is indeterminant. d. an increase in interest rates but the effect on real GDP is indeterminant. ______ ______ ANSWER: ______ ANSWER: ______ 13. Which of the following will tend to increase the size of the government spending multiplier? a. Higher sensitivity of consumption to the price level b. Higher marginal tax rates c. Lower sensitivity of tax revenues to government spending d. Lower sensitivity of investment to interest rates ANSWER: ______ 14. If a budget deficit increases interest rates, it is possible that investment will a. b. c. d. 15. fall, leading to a larger capital stock. fall, so that there is a smaller capital stock. rise, because investment is directly related to interest rates. rise, because investment is more attractive when interest rates are higher. In what way do policy makers have to face a trade-off between inflation and unemployment? a. The cost of reducing inflation by restrictive fiscal and monetary policies is a temporary increase in unemployment. b. The cost of reducing inflation by restrictive fiscal and monetary policies is a permanent increase in unemployment. c. The cost of reducing unemployment by expansionary fiscal and monetary policies is virtually nonexistent. d. The cost of reducing unemployment by expansionary fiscal and monetary policies involves higher inflation during recessions. ANSWER: ______ ANSWER: ______ 16. Which of the following is most likely to result in inflation? a. b. c. d. Aggregate demand and aggregate supply grow at the same rate. Neither aggregate demand nor aggregate supply grow at all. Aggregate supply grows more rapidly than aggregate demand. Aggregate demand grows more rapidly than aggregate supply. ANSWER: ______ 17. 18. If two countries each are currently producing two goods, and each begins to specialize in the good in which it has a comparative advantage, what will happen to total (world) output? a. It will increase. b. It will decrease. c. It will be unchanged in both countries. d. It will rise in one country and fall in the other, but the total is unchanged. If Argentina has a large amount of farmland and Great Britain has many factories, a. the two nations have no reason to trade. b. Argentina will be willing to trade but Great Britain will not. c. Great Britain will be willing to trade but Argentina will not. d. the two nations can engage in mutually advantageous trade. ANSWER: ______ ANSWER: ______ 19. Everything else being equal, one can expect the euro to appreciate relative to the dollar if a. Americans decrease their travel to Germany. b. the Germans add to their holdings of U.S. Treasury bills. c. Americans purchase land in Germany and build factories. d. American exports to Germany increase. 20. In an open economy, the government deficit is 400 and investment exceeds saving by 300, so in equilibrium the trade deficit (IM – X) must be a. 100. b. 200. c. 300. d. 700. ANSWER: ______ ANSWER: ______ Part 2: Free-response questions Question 1 (40 points) Consider the market for jumping beans. Q is the quantity of jumping beans (in bushels) that are demanded and P is the price of jumping beans. Consumers want to consume more jumping beans when the price is lower and producers want to make more jumping beans when the price is higher. Demand: Q = 100 – 10P Supply: Q = 25 + 5P A) Find the equilibrium price and quantity of jumping beans. (10 points) B) Now suppose the government wants to ensure that producers of jumping beans get at least $8 for a bushel of jumping beans. To make that possible, the government agrees to buy whatever amount consumers don’t want to buy at a price of $8. How many bushels does the government have to buy? (10 points) C) Now suppose that the government changes its mind. Instead of making the law in part B), it decides to impose a tax of $2 on each bushel. This means that the price that consumers pay is $2 higher than the price that producers receive. Solve for the equilibrium price and quantity now. (10 points) D) In this example, the demand curve is downwards sloping; people demand fewer jumping beans when the price is higher. What would it mean if the demand curve was vertical? Discuss in terms of how sensitive consumers demand is to changes in price. (10 points) Question 2 (40 points) The table below describes Macronesia’s economy. Below is a series of questions relating to the Macronesian economy described in the table. GDP Consumption (C) Gov. spending (G) Investment (I) Net exports (X-IM) 300 200 -100 1000 640 300 200 -100 1100 300 200 -100 1200 300 200 -100 1300 300 200 -100 1400 300 200 -100 1500 A) Suppose the marginal propensity to consume is 0.80. Fill in the chart with the values of consumption at the different income levels. (5 points) B) Find total demand in Macronesia. (5 points) Total demand GDP 1000 1100 1200 1300 1400 1500 C) What is equilibrium output in Macronesia? (5 points) _____________ D) Graph total demand below. Label the demand line D0 and label the equilibrium E0. (5 points) Total demand / supply 2000 $6 1800 $5 Price (per barrel) 1600 $4 1400 $3 1200 $2 $1 1000 0 800 1200 1000 1,200 1400 1,600 1600 2,000 1800 2,400 2000 2,800 3,200 Quantity (in barrels) GDP E) Suppose that the government increases spending to 400. What is equilibrium output now if this is the only variable that changes? To answer this question, you should not need to use table. Use your understanding of the multiplier to answer the question. (10 points) F) Given what you know about the connection between investment and the interest rate, will output go actually go up by more or less than the amount that you calculated in part E), which assumed that investment did not change? Explain in two short sentences. (10 points) Question 3 (20 points) You are president of Macroland, a country that is struggling with a very high budget deficit. Output growth is relatively low, though. A) Suppose that you can work with the chairman of the central bank. Together, you can change government spending, taxes, and the money supply. The two of you want to lower the budget deficit without increasing unemployment. What combination of policies could achieve this goal? (10 points) B) Suppose that the combination of policies succeeds: the deficit falls and output stays the same. What will this combination of policies do to the interest rate? Illustrate on the graph below that shows money supply and money demand, by shifting any curve that needs to be shifted. (10 points) S D Interest rate D Ii 0i0 n t e r e s t r a S D S Quantity S of Quantity of Money Money D Question 4 (20 points) Suppose that we have an economy that starts at the natural rate of unemployment and that inflation is 8%. The natural rate of unemployment is 5%. Start by analyzing the effects of an increase in foreign countries’ demand for the goods that we produce. A) Show what this increase in foreign demand for our goods does to the AS-AD picture in the US. (10 points) S0 Price level D0 Output B) Circle one of the choices for each of the two questions below. (5 points each) Before the increase in foreign demand, unemployment in the US was 5%. Then unemployment falls to 3% because of the higher demand for the goods we produce. Suppose that inflation in the US after unemployment falls to 3% is one of the three numbers below. Which possibility makes the most sense? 6% 8% 10% After US unemployment falls to 3%, the economy gradually returns to normal. After unemployment has gone back from 3% to 5%, inflation is one of the five numbers below. Which possibility makes the most sense? 4% 6% 8% 10% 12% Question 5 (20 points) Suppose that the pictures below are the supply and demand curves in Macroland and Tradeland for bananas. Without trade, the equilibrium price in Macroland is $1 and the equilibrium price in Tradeland is $2. Macroland Tradeland S S Price $2 $1 D D Quantity Quantity A) Show on the graphs above what the equilbrium would be if we allow trade between the two countries. You should label three things carefully: 1) the equilibrium price, 2) the amount that one country is importing, and 3) the amount that one country is exporting. (9 points) B) Now show on the graphs below what equilibrium would look like if the importing country in part A) decided to put tariff of $0.30 on banana imports. Label: 1) equilibrium price in Macroland, 2) equilibrium price in Tradeland, 3) the amount being exported, and 4) the amount being imported. (11 points) S S Price $2 $1 D Quantity D Quantity