mt2_b - Economics 102 Principles of Macroeconomics Fall...

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Unformatted text preview: Economics 102, Principles of Macroeconomics Fall 2008 Midterm 2 November 11, 2008 Form 2(B) Student Name: __________________________________________ Student ID #: ____________________________________________ Section #: _______________________________________________ INSTRUCTIONS: Please do not start turn this page over and start the test before you are instructed to do so. You will have 1 hour and 45 minutes to complete this test. If you have finished the test before the 5‐minutes‐ remaining announcement, you can walk to the front of the class and turn your test in. If you have finished your test after the 5‐minutes‐remaining announcement, you must remain seated until the proctor collects your test. You must stop writing once a proctor has announced that the test time is up. You must present your Michigan student ID to the proctor when you turn in the test. Failure to cooperate with these instructions will result in the score of 0 assigned to your midterm grade. If you feel that several choices may be the correct response, please select the best one. 1. Your test’s form is: a) A b) B c) C d) D e) E 2. Company XYZ announces today that its current dividend is $10 and that it will grow at the annual rate of 3%. Investors currently require a 7% return for holding stocks of companies with XYZ’s characteristics. According to the Gordon Model, what should be the price of XYZ’s stock? A. $100 B. $242.50 C. $250 D. $257.50 E. $300 3. Suppose that the marginal propensity to consume is 0.5. Now suppose that government spending increases by 10 dollars. Assume there are no taxes. What happens to the level of GDP? A. B. C. D. E. Decreases by 10 dollars. Increases by 10 dollars. Increases by 20 dollars. Decreases by 20 dollars. There is no change. 4. Suppose the marginal propensity to consume is 0.75 and the marginal tax rate is 0.3. If the government wants GDP to increase by $10 million, by how much must they change autonomous taxes? A. B. C. D. E. +10.33 million +6.33 million +3.00 million ‐3.00 million ‐6.33 million 5. According to the Taylor Rule (MR schedule), if inflation falls and the target inflation rate increases what happens to the nominal interest rate? A. B. C. D. E. The nominal interest rate increases The nominal interest rate falls The nominal interest rate remains unchanged Indeterminate The nominal interest rate initially falls and then increases back to its starting value 6. When the IS and MR curves intersect at i=0 and actual output is below potential output, which of the following is NOT true? A. For inflation rates below the inflation level associated with the current intersection of the IS and MR curves, AD is upward sloping. B. The demand for money is perfectly elastic, as the opportunity cost of holding it is zero. C. Expansionary fiscal policy cannot help the economy out of its current recession. D. Expansionary monetary policy cannot help the economy out of its current recession. E. The economy is in a liquidity trap. 7. Suppose the economy is initially in the long‐run equilibrium. Assume two exogenous shocks occur at the same time: consumer confidence goes up due to nice weather and the central bank lowers its inflation target (π*). Which of the following CANNOT occur in the short run? A. Output gap becomes negative. B. Output gap becomes positive. C. Nominal interest rate increases. D. Nominal interest rate decreases. E. Consumption increases. 8. Suppose that the economy is currently producing at the level of potential output and the Federal Reserve enacts a discretionary (non‐systematic) monetary policy that will create a negative output gap. Which of the following happens to the MR curve? A. There is movement along the MR curve toward the northeast. B. There is movement along the MR curve toward the southwest. C. The MR curve shifts up. D. The MR curve shifts down. E. None of the above. 9. Suppose that current output (YSR) is equal to 12 trillion dollars and that potential output (YP) is equal to 15 trillion dollars. What is the output gap? A. Positive 3 trillion dollars B. Negative 3 trillion dollars C. Negative 25% D. Positive 25% E. Negative 20% 10. Assume country ABC’s economy is in equilibrium at zero output gap. Suppose ABC is deciding between using either contractionary fiscal policy or contractionary monetary policy. (Note: it might want to do this in order to reduce the fiscal deficit or lower inflation.) Which of the following statements, comparing these two policies, is (are) true? [Assume that liquidity trap is not an issue.] I. Contractionary fiscal policy yields a negative output gap and the same inflation in the short run. Contractionary monetary policy does the same thing. II. Contractionary fiscal policy yields a lower nominal interest rate in the long run, while contractionary monetary policy yields a higher nominal interest rate in the long run. III. Contractionary fiscal policy yields a lower nominal interest rate in the short run, while contractionary monetary policy yields a higher nominal interest rate in the short run. A. I only B. II only C. I and II only D. I and III only E. I, II, and III 11. Which of the following statements concerning fiscal/monetary policy is (are) true? I. In a liquidity trap, monetary policy is more effective than fiscal policy at bringing a country out of recession. II. Contractionary fiscal policy and contractionary monetary policy shift the aggregate demand (AD) curve in opposite directions. III. When used to close a recessionary gap, expansionary fiscal policy and expansionary monetary policy differ in their effect on interest rates. A. III only B. II only C. I and II D. I, II, and III E. none of the statements are true 12. Which of the following statements is true about open market operations by the Fed (Federal Reserve)? A. An open market purchase of bonds by the Fed decreases liquidity in the money market. B. An open market sale of bonds can be termed as 'contractionary' monetary policy. C. An open market sale of bonds by the Fed stimulates the purchases of goods and services by lowering interest rates. D. An open market purchase of bonds by the Fed increases interest rates. E. An open markets sale of bonds shifts the demand curve for bonds to the right. 13. Suppose that pecan pies have a demand curve of Q = 32 − 4 P . Currently, buyers are paying $6 a pie and getting 8 pies. Based on your knowledge of elasticity, how should the firm adjust its output in order to maximize profit? A. Elasticity is negative, so the firm should increase its price. B. The absolute value of the elasticity is less than one, so the firm should increase its price. C. The absolute value of the elasticity is greater than one, so the firm should decrease its price. D. The elasticity is equal to ‐1, so the firm should not change its price E. The answer cannot be determined from the information given. 14. Which of the following points indicates an infeasible or “impossible” production possibility? A) A B) B C) C D) D E) E 15. Assume that the demand elasticity of a good X is ‐4/3. If the slope (ΔP/ΔQ) of the inverse demand curve is ‐5 and the equilibrium quantity is 6, what is the equilibrium price? A) 45/2. B) 40. C) 24/15. D) 24/3. E) 24. 16. In the Malthusian model, which of the following will change the long run steady state level of consumption per capita: I. A change in the amount of land II. A change in the birth rate III. A change in the death rate A. B. C. D. E. I only II only I and II II and III I, II, and II 17. In country ASDFGH, real GDP is growing slightly faster than nominal GDP (let’s say by 1 percentage point). Which of the following statements about prices best characterizes the situation in ASDFGH? A. ASDFGH is experiencing mild deflation. B. ASDFGH is experiencing mild inflation. C. ASDFGH is experiencing hyperinflation. D. ASDFGH is experiencing disinflation. E. none of the above 18. Suppose that the State of Michigan levies an excise tax gasoline to correct the negative externalities associated with pollution. The size of the tax is exactly equal to the size of the negative externality, as in the picture below. Which of the following statements is true? Price Spub (Marginal Public Cost) G A F B C E D Spvt (Marginal Private Cost) Demand Quantity A. B. C. D. E. The tax will generate a deadweight loss of C+D The tax will increase consumer surplus by A+B+C The tax will increase producer surplus by F+E+D The tax will result in a net increase is total social surplus of G None of the above. 19. Which of the following does not necessarily happen in the Solow model in response to a technological improvement? A. output per capita increases B. consumption per capita increases C. capital per capita increases D. savings per capita increases E. none of the above (i.e., all of the above happen due to a technological improvement) 20. Suppose that we start in a long‐run equilibrium and OPEC cuts production of crude oil for the entire year, raising oil prices in the U.S. According to our AS/AD model, which of the following scenarios is true at the new long‐run equilibrium (relative to the initial one)? A. Inflation is higher and output gap becomes positive. B. Inflation is unchanged and output gap is unchanged. C. Inflation is higher and output gap is unchanged. D. Inflation is higher and output gap becomes negative. E. Inflation is unchanged and output gap becomes negative. 21. Which of the following is NOT a cognitive bias that undermines the decision‐making effectiveness? A. B. C. D. E. Myopic loss aversion Time inconsistency of optimal policy Non‐rational escalation of commitment False consensus House‐money effect 22. Let r be the real interest rate, i be nominal interest rate, π be inflation, π* be target inflation, and x be the output gap. Which of the following expressions is true in equilibrium? A. B. C. D. E. 23. Assume that the AE curve currently puts us at a balanced‐budget equilibrium with Y = 1000. MPC =½, taxes are entirely autonomous, i.e. t=0. Then if autonomous consumption rises by 600, government expenditure rises by 150, and the budget remains balanced, what is the new equilibrium level of Y? A. 1600 B. 1750 C. 2200 D. 2350 E. 2500 24. Which of the following statements are true? I. Inflationary expectations decrease if the output gap is negative II. Inflationary expectations decrease if the output gap is positive III. Inflationary expectations are equal to the current inflation rate if the output gap is zero A. I only B. II only C. III only D. I and III E. II and III i = r ‐ π i = r + π x = (π ‐ π*)/π* x = (π* ‐ π)/π x = i ‐ r 25. Suppose the economy is in a recession. Which of the following policies will not help reduce the magnitude of the output gap? A. B. C. D. E. An increase in the money supply An increase in taxes An increase in government spending A decrease in the target interest rate None of the above 26. Which of the following choices has a different effect than the others on the IS curve? A. a decrease in tax rates B. a decrease in stock prices C. a decrease in consumer confidence D. a decrease in wealth E. they all have the same effect 27. Which of the following choices has a different effect than the others on the position of the MR curve? A. An increase in the output gap B. An increase in the actual inflation rate C. A decrease in the target inflation rate D. An discretionary (exogenous) increase in the target interest rate E. None of the above. They all have the same effect on the MR curve. 28. Which of the following does not shift the AD curve? A. a negative shock in the stock markets B. an increase in government spending C. a decrease in consumer confidence D. an increase in the actual inflation rate E. an increase in the target inflation rate 29. If real GDP is below potential GDP, which of the following can eliminate the output gap? A. a decrease in government spending B. a decrease in tax rates C. an increase in the level of technology D. a decrease in the target inflation rate E. none of the above. They all exacerbate the output gap 30. Which of the following is not true in the short run? A. a crash in the stock markets shifts AD left B. higher inflation does not shift AD C. a discretionary increase in nominal interest rate shifts AD right D. a decrease in real interest rate shifts AD right E. an increase in government spending shifts AD right 31. Which of the following is not true? A. the Fed can raise the federal funds rate by buying bonds B. money demand is positively related to income C. money demand is negatively related to nominal interest rate D. the Fed will raise the federal funds rate when inflation increases E. a decrease in the money supply will increase the nominal interest rate. 32. Which of the following statements concerning the aggregate demand (AD) curve is FALSE? A. A flatter AD curve means the central bank’s main concern is stabilizing inflation. B. A steeper AD curve means the central bank does not want to see huge changes in unemployment. C. An upward‐sloping AD curve is destabilizing. D. A rise in inflation causes a movement along the AD curve. E. None of the above. All of these statements are correct. 33. The TED spread is the difference between A. B. C. D. E. LIBOR and T‐bill Federal funds rate and T‐bill LIBOR and federal funds rate Federal funds rate and S&P500 rate of return 30‐year treasury bond yield and federal funds rate 34. Suppose that you purchase a bond for $500 and you know that the bond will promise to pay $650 one year from now. What is the interest rate paid on this bond? A. B. C. D. E. 15% 23% 30% 35% 135% 35. Consider the Solow Model (a description of the long‐run macroeconomic evolution) and the Keynesian Cross model (a description of the short‐run dynamics). In the Solow Model, the fixed savings rate, s, corresponds to (1‐MPC)=MPS “marginal propensity to save” in the Keynesian Cross Model. What do these two models predict happens to output (y in Solow and Y in Keynesian Cross) when the savings rate increases? A. B. C. D. E. Output decreases in both the Solow and KC models. Output increases both the Solow and KC models. Output increases in the Solow model but decreases in the KC model. Output decreases in the Solow model but increases in the KC model We cannot tell what happens in either model 36. Suppose the government decides to increase government spending and the Fed increases the nominal interest rate using discretionary monetary policy. What would be the effects on IS/MR and AD? A. B. C. D. E. IS shifts up, MR shifts up, slide up along AD. IS shifts up, MR shifts up, AD shifts up. IS shifts down, MR shifts down, slide down along AD. IS shifts down, MR shifts down, AD shifts down. IS shifts up, MR shifts up, AD shift is uncertain. 37. Consider the IS/MR and AS/AD models. Suppose that the Federal Reserve responds to a percentage increase in inflation by raising the nominal interest rate by 0.5%. Which of the following statements is true? A. B. C. D. E. The aggregate demand curve will be upward sloping Monetary policy has a stabilizing effect on the economy The aggregate demand curve will be downward sloping Expansionary fiscal policy will lower output At least two of the above answers are true 38. Consider the AE (Keynesian Cross) model. Suppose that taxes are exogenous, that is, the marginal tax rate is zero. An increase in taxes by $1, while keeping the government's budget balanced, will lead to which of the following changes? Assume that MPC lies between 0 and 1. A. B. C. D. E. It will reduce output by $1 It will reduce output by $1/(1‐MPC) It will reduce output by $MPC/(1‐MPC) It will increase output by $1 Will leave output unchanged 39. Consider the current financial crisis, where banks are unwilling to lend money due to uncertainty regarding who will be able to pay back. As a result, output might drop because businesses are finding it difficult to invest and keep production rolling. Which of these could be a policy prescription to keep output at full‐employment level in the short run? A. B. C. D. E. Reduce the fiscal budget deficit. Raise income taxes. Raise real interest rates through open market operations. Increase the required reserve ratio for banks. None of the above. 40. Suppose that you observe the following changes: interest rates are rising in the short run, output gap is falling in the short run, inflation is falling in the medium run. Which of the following scenarios is consistent with these dynamics? A. B. C. D. E. The Fed is trying to achieve a lower inflationary target The Fed is trying to engage in a monetary expansion The federal government is trying to engage in a fiscal expansion The real estate prices decrease sharply The economy experiences a surge in the rate of technological growth 41. Suppose that you have purchased a two‐year coupon bond with a 5% yield at face value; investors have been expecting that over the next two years i1=i2=0.05. At the end of the first year, interest rates decrease unexpectedly, i.e. i2 decreases. Which of the following will be true? I. The holding period return for the first year will be more than 5% II. The bond price after 1 year will decrease together with the interest rate III. At the end of the second year, the bond’s price will be less than face value IV. The holding period return for the second year only will be less than 5% A. B. C. D. E. I and II I and IV II and III III and IV II and IV 42. Jelly and peanut butter are complements. Suppose that a global drought dramatically reduces the supply of peanuts. Ceteris paribus then: A. B. C. D. E. the price of peanuts will rise and the price of jelly will rise the price of peanuts will fall and the price of jelly will rise the price of peanuts will fall and the price of jelly will fall the price of peanuts will rise and the price of jelly will fall none of the above 43. The economic environment of the Stone Age is best characterized by the Malthusian growth model. The invention of the wheel must have: A. B. C. D. E. initially increased consumption per capita and decreased population growth initially increased consumption per capita and increased population growth initially decreased consumption per capita and increased population growth initially decreased consumption per capita and increased population growth initially decreased the birth rate and increased the death rate 44. Suppose the economy is in equilibrium at zero output gap. If there is a sudden and major drop in the stock market (which lowers people’s wealth), then which of the following happens to the IS curve according to our short‐run/long‐run analysis? A. The IS curve shifts right to reach its short‐run equilibrium, then shifts further right to reach its long‐run equilibrium. B. The IS curve shifts right to reach its short‐run equilibrium, then shifts left to reach its long‐run equilibrium. C. The IS curve shifts left to reach its short‐run equilibrium, then shifts further left to reach its long‐run equilibrium. D. The IS curve shifts left to reach its short‐run equilibrium, then shifts right to reach its long‐run equilibrium. E. The IS curve shifts left to reach its short‐run equilibrium, then does not shift again in the economy’s transition to its long‐run equilibrium. 45. Suppose the economy is in equilibrium at zero output gap. If the Federal Reserve thinks inflation is too high and undergoes a policy of disinflation, then which of the following happens to the monetary rule (MR) curve according to our short‐run/long‐run analysis? A. The MR curve shifts up to reach its short‐run equilibrium, then shifts up further to reach its long‐run equilibrium. B. The MR curve shifts up to reach its short‐run equilibrium, then shifts down to reach its long‐run equilibrium. C. The MR curve shifts down to reach its short‐run equilibrium, then shifts down further to reach its long‐run equilibrium. D. The MR curve shifts down to reach its short‐run equilibrium, then shifts up to reach its long‐run equilibrium. E. The MR curve does not shift at all when the FED pursues a policy of disinflation. ...
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This note was uploaded on 11/14/2009 for the course ECON 102 taught by Professor Rossana during the Fall '08 term at University of Michigan.

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