Download Recitation Material - Matthew H. Shapiro

Practice Midterm 2
Econ 1102
Name: ________________________________________________________(1 RP)
(+1 RP for writing name as it appears on onestop)
Section #:_________________(1 RP)
(+1 RP for section enrolled in)
TA Name:
(1RP)
(+1RP for correct TA name)
NO programmable calculators, NO cell phones
NO notes, NO collaboration with other students
Time limit: 50 minutes
Each page may have has its own directions. Follow the directions carefully.
Clearly indicate which question you are answering.
Replacement points are added to score of the page on which they are earned.
The only exception is the 3RP given for Name, Section and TA Name: these are added to your total
score.
For full credit, graphs must be completely LABELED and math work shown. Be sure to
justify your answers clearly and precisely for full credit,.
Rambling, incoherent or illegible responses shall be penalized even if correct.
Points are rewarded for answers consistent with those your instructor would give to the same
question.
This exam is 8 pages (including this front page), numbered 1-8.
2:______ 3:_______4:_______5:_______ RP:_______
Total:_______
PAGE 1 QUESTIONS (25 pts, 13 RP)
1. (4 pt) What are the four components of aggregate demand?
Consumption, Investment, Government Expenditure, Net Exports
2. (3 pts) What is crowding out, and how is it caused by expansionary fiscal policy?
Crowding out is the decrease in investment that results from decrease in public savings/expansionary
fiscal policy. With expansionary fiscal policy, the public savings decreases, therefore the supply of
loanable funds decreases. This results in a higher interest rate and a lower demand for loans in the
new equilibrium in the loanable funds market (full credit if explained with diagrams).
3. (2.5 pts) Define Fiscal Policy: Changes in government purchases and/or tax collections designed to
achieve full-employment and noninflationary domestic output. (Need the part in italics to get full credit)
4. (2.5 pts) What is the official name for the paper currency used in the USA? Is it commodity or
fiat currency? Explain
The paper currency used in the USA is called Federal Reserve Notes. It is an example of fiat currency,
because it is not backed up by the value of an underlying asset.
5. (2.5 pts) Define Fractional Reserve Banking: Banking system in which banks are required to keep a
percentage (fraction) of checkable deposits in cash or with the central bank.
6. (2.5 pts) What differentiates short run and long run aggregate supply?
In the short run input or output prices are sticky – they do not immediate respond to changes in
economic conditions. In the long run all prices are fully flexible and accurate reflect the value of inputs
and outputs.
7. (6 pt) In 2004, an undersea earthquake in the Indian Ocean generated a large tsunami. Explain
how each of the following changes the price level in the affected countries: the loss of life,
damage to roads and buildings, the inflow of monetary aid, and inflow of goods aid.
Cyclone kills a bunch of people => AD decreases => decrease local prices
Cyclone damages infrastructure => AS decreases =>Increase local prices
Inflow of monetary aid => AD increases =>Increase local prices,
Inflow of “goods” aid => AS increases =>decrease local prices
8. (2 pts) Expansionary Fiscal Policy: An increase in government purchases or a decrease in taxes (or
some combination of the two) for the purpose of increasing aggregate demand.
9. (2.5 RP) Economic investment: Payments for new additions to the nation's capital stock, whether
public (new roads and bridges) or private (new factories, homes, and equipment).
10. (2.5 RP) Financial investment: Buying or building an asset in expectation of earning financial gain
(new factories and homes, but also old buildings, plus stocks, bonds, and other financial assets).
11. (8 RP) What is money? Define any terms you use.
Money: Anything that performs the following functions:
1. Medium of Exchange: An item that buyers give sellers when they want to purchase goods and
services.
2. Unit of Account: The measure people use to post prices and record debts
3. Store of Value: An item that people can use to transfer purchasing power from present to the future.
1102 Practice Midterm 2
Page 2 of 6
PAGE 2 QUESTION (25 pts, 8 RP)
12. (2 pts)Draw an AD-AS diagram that shows an economy in AD-AS equilibrium.
AD
(14)
Prices
($)
(16)
(15)
(13)
Quantity
For the following four questions, show how the AD, SR-AS or the SR-AD line would shift your diagram above.
Assume you start at equilibrium, unless stated otherwise.
13. (2 pt) The government decides to build more roads and highways. (1 pt for AD, 1 pt for right)
14. (2 pt) Show how the economy returns from (13.) to an extended AD-AS equilibrium without government
intervention. (1 pt for AS, 1 pt for left)
15. (2 pt)There is a sudden decrease in oil prices.
16. (2 pt) Show how the economy returns from (15.) to an extended AD-AS equilibrium if the central bank
uses monetary policy. (1 pt for AD, 1 pt left)
17. (2 pt) What event could cause a decrease in the LR-AS?
A war (anything that decrease long run production is an acceptable answer)
18. (8 pts) Using the money market, loanable fund and AD-AS diagram, show how expansionary
monetary policy can end a recession.
Nominal
Interest
Rate
Nominal
Interest
Rate
Money
Loanable Fund
Quantity
19. (2 pts) Define Monetary Neutrality: The proposition that changes in the money supply do not affect
real variables
20. (3 pts) What are the cons of commodity money?
Limits amount of money that can be printed, Resources could be put to better use, Value of
resources need not be stable
21. (3 RP) Consider the following FOMC statement. Is the Fed using expansionary or contractionary
monetary policy, or neither? Is actual output above or below potential output?
The Federal Open Market Committee decided today to lower its target for the federal funds rate 50
basis points to 3 percent. Financial markets remain under considerable stress, and credit has tightened
further for some businesses and households. Moreover, recent information indicates a deepening of the
housing contraction as well as some softening in labor markets. The Committee expects inflation to
moderate in coming quarters, but it will be necessary to continue to monitor inflation developments
carefully. Today’s policy action, combined with those taken earlier, should help to promote moderate
growth over time and to mitigate the risks to economic activity.
Expansionary monetary policy. Actual Output is below potential output.
22. (5 RP) List 5 costs of inflation
Shoeleather costs, menu costs, relative price-variability and the misallocation of resources, confusion
and inconvenience, inflation-induced tax distortions, unexpected inflation causes redistributions of wealth.
1102 Practice Midterm 2
Page 3 of 6
PAGE 3 QUESTIONS (25 pts)
23. (8 pt) Gina has $100 to spend today. She could:
a. Spend $100 on a 1 year Tbill that pays 3% real interest
b. Buy $100 of stocks in a company, BigBubble for a year. There is a 40% chance that BigBubble
collapses and she loses all her money, a 30% chance that it gives her a 2% real return, and a
30% chance that it gives her a 5% real return.
c. Buy a really good coffee machine that she could sell for $105 a year from now .
Which option would give her the highest expected yield a year from now?
(a) After 1 year: 100*(1.03) = $103
(b) After 1 year: 0.40(0)*100+0.30*(1+0.02)*100+0.30*(1+0.05)*100 =0 + 30.6+31.5= $62.5
(c) After 1 year: $105
Of the three options, buying a coffee machine gives the highest value.
Use the data from Econland to answer the remaining questions.
24. (5 pts) What is CPI inflation from 1982 to 2000?
COL_1982=4*3.25+7*1=20
COL_2000=4*3.50+7*1.2 = 14+8.4=22.4
CPI_2000=(22.4/20)x100=1.12x100=112
CPI_1982=100 Base year CPI is 100)
Inflation=([112-100]/[100])*100=12
25. (3 pts) Suppose someone earns $5000 in 1982, and $5768 in 2000. Are they richer or poorer in
2000?
5768x[100/112]=5150 (Richer)
26. (2 pt) Suppose someone in Econland saves $2500 in 1982 by putting burying money in their
back yard. How much is that money worth in nominal terms in 2000?
$2500
27. (2 pts) Suppose someone in Econland invests $2500 in 1982 and earn a nominal interest rate of
20% from 1982 to 2000. What is the real interest rate they earn?
20%-12%=8%
28. (3 pts) What is the Money Supply in Econland in 2008?
Money Multiplier = 1/RR = 1/(0.05) = 20
Money Supply = (20)x(100)=$2000
29. (2 pts) What is the velocity of money in Econland in 2008?
V=P*Y/M = ($2.00*4000)/$2000 = 4
1102 Practice Midterm 2
Page 4 of 6
PAGE 4 QUESTIONS (25 pts)
30. (3 pts) How much does Initial Spending in the Output Market need to change to return the
Econland to equilibrium?
Need to increase GDP by $4500-$4000=$500.=>Change GDP=$500
Change GDP=(1/(1-MPC)*(ChangeInitialSpending)
$500 = 5*ChangeInitialSpending
ChangeInitialSpending = $100
Consider the following four plans separately. You may use your answers from earlier questions.
31. (4pts)If the Government decides to change government purchases, what will the new level of
government purchases be?
ChangeG =ChangeInitia=$100
$100=Gnew-Gold
Gnew=$200+$100=$300
32. (4 pts) If the Government decides to change taxes, what will the new level of taxes be?
ChangeInitial=ChangeConsumption= $100
ChangeConsumption=MPC*ChangeTax
$100=MPC*ChangeTax
ChangeTax=$125
$125=TaxOld-TaxNew
Taxnew=$200-$125 = $75
(decreases net taxes by $125, new tax revenue = $75)
33. (6 pts) If the Central Bank decides to implement monetary policy, what will the new level of the
money supply be? (You may use your answer from question 28).
Money Demand = Money Supply
2000 = 2500-10000i => i=5% (Using MS from Question 27, MS=MD)
Loanable Funds Demand = 1000-10000(0.05)=$500
New Loanable Funds Demand = $500+$100=$600
$600=1000-10000i
i=0.04 (Interest rate has to be 4%)
Money Demand = 2500 – 10000(0.04) = $2100 = Money Supply
34. (4 pts) If the Central Bank decides to use OMO to return the economy to equilibrium, what value
of bonds will the Fed buy/sell to close the GDP gap?
ChangeInvestment=ChangeInitialSpending=$100
$2100 = 20 * InitialDeposits
Initial Deposits = $105
Fed buys $105-$100 = $5 of Bonds.
35. (4 pts) If the Central Bank decides to change the reserve requirement, what will the new reserve
requirement be?(Round your answer to 2 decimals).
Money Supply=Initial Deposits*(1/RR)
$2100=100*(1/RR) => (1/RR) = 21 => RR=0.0476
1102 Practice Midterm 2
Page 5 of 6
Econland’s Economic Data
Market Basket = 4 Loaves of Bread, 7 gallons of gas
Year
Loaves of Bread Produced Nominal Price of Bread
Base Year=1982
Units of Gas Produced Nominal Price of Gas
1982
120
$3.25
30
$1.00
2000
140
$3.50
25
$1.20
Econland in 2008
RGDP: $4000
Natural Rate of Output: $4500
Money Demand =2500-10,000i
Loanable Funds Demand = 1000 –10,000i
Initial Deposits=$100
MPC=0.8
Reserve Ratio: 0.05
Government Purchases: $200
Price Level: $2.00
Tax Revenue: $200
1102 Practice Midterm 2
Page 6 of 6