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Transcript
Multiple Choice 1. Which of the following involves a trade-off: A) B) C) D) the decision to further your education. the choice of which breakfast cereal you eat in the morning. whether a nation should encourage an increase in spending or saving all of the above 2. All of the following are illustrated by the production possibilities frontier except: A) B) C) D) the trade-off associated with the problem of scarcity. the opportunity cost of the chosen activity. the flow between households and firms. the maximum combination of goods and services that an economy can produce with the existing level of technology 3. The purchase of a new microwave oven to assist in the preparation of food in a cafe would be included in: A) B) C) D) the consumption component of GDP adding to GDP. the investment component of GDP adding to GDP. the net exports component of GDP reducing GDP. both a and b. 4. Technological knowledge is: A) B) C) D) an understanding of the best ways to produce goods and services. often protected by patents. different from human capital. all of the above. 5. Suppose the government changes the tax laws to encourage greater saving. The effects on the money market are as follows: A) (1) decrease in supply of loanable funds; (2) increase in equilibrium interest rate; (3) decrease in equilibrium quantity of loanable funds. B) (1) increase in supply of loanable funds; (2) decrease in equilibrium interest rate; (3) increase in equilibrium quantity of loanable funds. C) (1) increase in supply of loanable funds; (2) increase in equilibrium interest rate; (3) increase in equilibrium quantity of loanable funds. D) (1) increase in supply of loanable funds; (2) increase in equilibrium interest rate; (3) increase in equilibrium quantity of loanable funds. 1 6. An increase in tax on savings will: A) B) C) D) shift the demand for loanable funds curve to the right. shift the demand for loanable funds curve to the left. shift the supply of loanable funds curve to the right. shift the supply of loanable funds curve to the left. 7. The unemployment rate is: A) B) C) D) the percentage of the adult population unemployed. the percentage of the adult population discouraged from actively seeking a job. the percentage of the adult population looking for work. the percentage of the labour force that is unemployed. 8. If the RBA purchased government securities, then: A) B) C) D) the money supply would decrease. the money supply would increase. the money supply would not change. the money supply would decrease first then increase. 9. According to the quantity theory of money, an increase in the money supply causes: A) B) C) D) prices to fall, lowering inflation. the value of money to rise. a reduction in demand for money. a fall in the value of money and higher inflation. 10. If the nominal exchange rate is 70 yen per dollar, and a tonne of wheat sells for $100 in Australia and for 14,000 yen in Japan, then the real exchange rate is: A) B) C) D) 0.5 0.7 140 20,000 11. If the government decides to impose a tariff to protect the local car industry: A) B) C) D) net exports will increase. net foreign investment will increase. the real exchange rates will depreciate. the real exchange rates will appreciate. 2 12. According to the Keynesian sticky price theory, the short-run AS curve is upward sloping as: A) B) C) D) wages are slow to adjust causing real wages to be higher than nominal wages. firms see the increase in prices as only an increase in relative prices. firms are slow to adjust prices due to high menu costs. firms hire more workers as real wages rise. 13. If the government cuts income taxes the effect on AD depends on: A) B) C) D) the multiplier effect. the crowding-out effect. whether or not households view the change in taxes as temporary or permanent. all of the above. 14. There is a _________ trade-off between __________ and ___________. A) B) C) D) long-run, inflation, unemployment short-run, inflation, the money supply short-run, inflation, unemployment short-run, prices, interest rates 15. An increase in the price of oil raises the cost of producing goods and services and in turn: A) B) C) D) lowers the inflation-unemployment trade-off. shifts the short-run AS curve to the right. causes the short-run Phillips curve to shift to the left. all of the above. 3 Short Answer Questions Question 1: this question relates to the monetary system (A) How does the Reserve Bank of Australia (RBA) conduct open market operations? [2 marks] (B) Suppose the RBA buys government bonds in the open market. Show the effects of this on the following with the use of a money market and aggregate demand diagram: (i) money supply; (ii) equilibrium interest rate; (iii) aggregate demand. [6 marks] Answer: (A) Open-market operations involve the RBA purchasing or selling Australian government bonds. (B) To increase the money supply, the RBA buys government bonds to financial institutions. When the RBA buys government bonds, it injects cash into the system. The money supply is therefore ↑ and the cash rate ↓. (b) The aggregate-demand curve (a) The money market Interest rate r 2. ... the equilibrium interest rate falls ... Money supply, MS Price level MS2 1. When the RBA increases the money supply ... P r2 AD2 Money demand at price level P 0 Quantity of money Aggregate demand, AD 0 Y Y Quantity of output 3. ... which increases the quantity of goods and services demanded at a given price level. 16 Copyright © 2004 South-Western 4 Question 2: this question is about real exchange rates and purchasing power parity Assume the following: The price of French corn is 45 € (Euro) per bushel (foreign price in foreign currency). The price of Australian corn is AUD$8 (Australian Dollars) per bushel (domestic price in domestic currency). The nominal exchange rate is AUD$1 = 9 € (A) What is the real exchange rate? (bushels of French corn to bushels of Australian corn) [3 marks] (B) A can of coca cola costs AUD$1.75 in Australia and 0.65 € in Germany. What would the Euro-Dollar nominal exchange rate be if purchasing power parity holds? [2 marks] (C) If the price of a can of coca cola increases to AUD$1.90 in Australia and remains unchanged in France, what happens to the Euro-Dollar nominal exchange rate? [3 marks] Answer: (A) Real exchange rate = (9 €/$1) x ($8/bushel of Australian corn) 45 €/bushel of French corn Real exchange rate = 72 €/45 € or 1.6 bushels of French corn/bushel of Australian corn. (B) If purchasing-power parity holds, then 0.65 Euro per can of Pepsi divided by $1.75 per can of Pepsi equals the exchange rate of 0.37 Euros per dollar. (C) If the price level rises in Australia relative to France, the Australia dollar depreciates. The Euro-dollar exchange rate is now: 0.65/1.9 or 0.34 Euros per dollar. 5 Question 3: this question relates to open-economy macroeconomics (A) Suppose that American investors believe that Australia is a risky place to keep their savings and move their capital back to America. Illustrate the effects of this on the open-economy equilibrium diagrams from chapter 15 of the textbook. [3 marks] What happens to the following variables in Australia? (B) Real interest rate [1 mark] (C) Demand for loanable funds [1 mark] (D) Net foreign investment [1 mark] (E) Supply of Australian dollars [1 mark] (F) Value of the Australian dollar [1 mark] Answer: (a) The market for loanable funds in Australia Real interest rate (b) Australian NFI Real Interest Rate Supply r2 1. An increase in NFI r2 r1 r1 D2 3. ... which increases the interest rate. D1 2. ... increases the demand for loanable funds ... NFI Quantity of loanable funds NFI2 NFI Real exchange rate E 5. ... which causes the AUD to depreciate. S S2 4. At the same time, the increase in NFI increases the supply of AUD E Demand Quantity of AUD (c) The market for foreign-currency exchange 29 Copyright©2003 Southwestern/Thomson Learning (B) Real interest rate rises (C) Demand for loanable funds rises (D) NFI increases (E) Supply of AUD increases (F) Value of AUD falls 6 Question 4: this question relates to Aggregate Demand & Aggregate Supply Suppose that the economy begins in long-run equilibrium, and the aggregate supply curve does not shift. Suppose investors feel anxious about the economic future. (A) Using an aggregate demand/aggregate supply diagram, show the effects of this anxiety on the short-run levels of prices and output. (B) Suppose the government choose to reverse the effects of this anxiety by using a fiscal stimulus. What happens to prices and output? Explain. (A) If people feel anxiety about the future, then for any given price level, households and firms want to buy a smaller quantity of goods and services. The economy moves from point A to Point B as aggregate demand shifts to the left: AD 1 to AD 2. Prices fall and output falls. The economy is in a recession. (B) If the government acts with sufficient speed, it may increase government spending &/or cut taxes to offset the initial shift in aggregate demand, return the aggregate demand curve to AD1, and bring the economy back to point A. Price level LRAS SRAS 1 A Equilibrium price B AD 1 AD 2 0 Natural rate of output Quantity of output Copyright © 2004 South-Western 7 Question 5: this question relates to how fiscal policy influences aggregate demand (A) Assume that the Australian economy is in recession. How might the government use fiscal policy to influence aggregate demand? Illustrate with a diagram. [1 mark] (B) What role does the multiplier effect play? Illustrate with a diagram. [1 mark] Suppose the government reduces taxes by $30 million, that there is no crowding out, and that the marginal propensity to consume is 0.85. (C) What is the initial effect of the tax reduction on AD? [1 mark] (D) What is the multiplier? [1 mark] (E) What is the total effect of the tax cut on AD? [1 mark] (F) How does the total effect of this $30 million tax cut compare with the total effect of a $30 million increase in government purchases? [2 marks] (G) What impact does the ‘crowding out’ effect have on fiscal policy? Illustrate on a new diagram. [1 mark] Answer: (A) Fiscal policy refers to the government’s choices regarding the overall level of government purchases or taxes. In a recession, this would involve higher levels of government spending &/or tax cuts. (B) Government purchases are said to have a multiplier effect on aggregate demand. Each dollar spent by the government can raise the aggregate demand for goods and services by more than a dollar. The multiplier effect refers to the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending. 8 Price level 2. ... but the multiplier effect can amplify the shift in aggregate demand. $20 billion AD3 AD2 Aggregate demand, AD1 0 1. An increase in government purchases of $20 billion initially increases aggregate demand by $20 billion ... Quantity of output 29 Copyright © 2004 South-Western (C) The initial effect of the tax reduction of $30 million is to increase aggregate demand by $30 million x 0.85 (the MPC) = $25.5 million. (D) With an MPC of 0.85, the multiplier is 1/(1 – 0.85) = 6.67 (E) So the total effect is $25.5 million x 6.67 = $170.09 million. (F) Government purchases have an initial effect of the full $30 million, since they increase aggregate demand directly by that amount. The total effect of an increase in government purchases is thus $30 million x 6.67 = $200.1 million. So government purchases lead to a bigger effect on output than a tax cut does. (G) This reduction in demand that results when a fiscal expansion raises the interest rate is called the crowding-out effect. The crowding-out effect tends to dampen the effects of fiscal policy on aggregate demand. The crowding-out effect works in the opposite direction to the multiplier. 9 (a) The mone y market Interest rate (b) The shift in aggregate de mand Price level Money supply 2. ... the increase in spending increases money demand ... $20 billion 4. ... which in turn partly offsets the initial increase in aggregate demand. r2 3. ... which increases the equilibrium interest rate ... AD2 r AD3 M D2 Aggregate demand, AD1 Money demand, MD 0 Quantity fixed by the RBA Quantity of mone y 0 1. When an increase in government purchases increases aggregate demand ... Quantity of output 33 Copyright © 2004 South-Western 10