Econ - Business & Economics Assignments and Practice...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Business & Economics Assignments and Practice Exams ECON 201: Principles of Macroeconomics Assignments and Practice Exams ECON 201 Principles of Macroeconomics 401108 Credits Edition: Second edition Course Writer: Peter Kennedy Course Designer: Ted Keating Curriculum Editor: Wendy Stephenson Interim Academic Director, Business & Economics: Gordon Tarzwell Program Coordinator, Business & Economics: John Bryant ISBN 0‐7790‐0584‐5 (set) revised 2nd ed., 2007 This set contains: Course Manual, ISBN 0‐7790‐0585‐6 Course Modules (and Canadian Views), ISBN 0‐7790‐0586‐4 Assignments (and Practice Exam), ISBN 0‐7790‐0587‐2 Copyright © 2005, 1999 Thompson Rivers University All rights reserved. No part of this work may be reproduced in any form by any means without permission in writing from the Intellectual Property office of Thompson Rivers University, Open Learning. Printed in Canada by www.openlearning.tru.ca Thompson Rivers University, Open Learning Box 82080 Burnaby, British Columbia V5C 6J8 Contents Assignments............................................................................ 1 Assignment 1A......................................................................... 1 Assignment 2A......................................................................... 1 Assignment 3A......................................................................... 2 Assignment 4A......................................................................... 2 Practice Midterm Exam ............................................................. 3 Practice Final Exam ................................................................ 11 Answers to Economics 201 Practice Midterm Exam ................... 24 Answers to Practice Final Exam.............................................. 28 ECON 201: Assignments and Practice Exams 1 Assignments and Practice Exams This section of the course materials contains the assignments, the midterm exam, and a practice final exam with its answers. Assignments Assignment 1A Except for the word problems appearing here, the questions are located in the text’s media exercises and numerical exercises. Remember that marks are given for explanations, so be sure to explain your answer, and for the numerical questions, explain how you obtained your answer. 1. Show on a supply‐and‐demand diagram and explain in words what will happen to the Canadian exchange rate compared to the foreign exchange rate when the world demand for lumber, wheat, and paper increases. Ignore interactions with other sectors. Hint: Be sure to label your axes clearly! (5 marks) 2. Chapter 2, #1 (10 marks), N15 (5 marks) 3. Chapter 3, #15 (10 marks), N3 (5 marks) 4. Chapter 4, #13 (10 marks), #15 (5 marks), N5 (10 marks), N9 (5 marks) 5. Chapter 5, #5 (10 marks), #9 (10 marks) 6. Chapter 6, #23 (10 marks), N1 (5 marks) Assignment 2A Remember that marks are given for explanations, so be sure to explain your answer, and for the numerical questions, explain how you obtained your answer. 1. 2. 3. 4. 5. Chapter 7, N1 (5 marks) Chapter 8, N1 (10 marks) Chapter 9, #3 (10 marks), #9 (10 marks), #17 (10 marks), N3 (10 marks) Chapter 10, #13 (5 marks), N5 (5 marks), N7 (5 marks) Chapter 11, #11 (5 marks), #21 (10 marks), #25 (10 marks), N3 (5 marks) TRU Open Learning 2 ECON 201: Assignments and Practice Exams Assignment 3A Remember that marks are given for explanations, so be sure to explain your answer, and for the numerical questions, explain how you obtained your answer. 1. Chapter 12, #7 (10 marks), #13 (5 marks), #19 (5 marks), #27 (10 marks), N1 (5 marks) 2. Chapter 13, #1 (10 marks), #7 (10 marks), #19 (5 marks), N1 (5 marks) 3. Chapter 14, #1 (10 marks), #9 (10 marks), #17 (5 marks) 4. If seigniorage is $6 billion, the current deficit is $40 billion, the structural deficit is $10 billion, the money supply is $600 billion, the publicly‐held national debt is $400 billion, real growth is 2 percent, and the economy is at its long‐run average unemployment rate, what is the inflation rate? (10 marks) Assignment 4A Remember that marks are given for explanations, so be sure to explain your answer, and for the numerical questions, explain how you obtained your answer. 1. 2. 3. 4. Chapter 15, #7 (10 marks), #9 (10 marks), N1 (5 marks) Chapter 16, #7 (10 marks), #19 (10 marks), #29 (5 marks) Chapter 17, #9 (10 marks), #23 (10 marks), N5 (5 marks) Chapter 18, #3 (10 marks), #13 (5 marks), N1 (5 marks), N7 (5 marks) TRU Open Learning ECON 201: Assignments and Practice Exams 3 Practice Midterm Exam This is a two‐hour, closed‐book exam. In addition to the short‐answer questions on the following two pages, there are 23 multiple‐choice questions worth two marks each with no marks deducted for incorrect answers. The total number of marks available is 100; allocate approximately one minute per mark. 1. Explain why and in what direction the value of ʺtheʺ multiplier will change if consumption and investment demand become more strongly affected by the interest rate. (4 marks) 2. Answer the following. a) What is national saving? (2 marks) b) Why is it of interest? (2 marks) 3. Provide a one‐line answer for each of the following (2 marks each). a) If 1991 nominal GDP is $600 billion and the price index is 120.0 (1986 = 100), then what is 1991 GDP measured in 1986 dollars? What name would economists give to this figure? b) If agg D for g&s exceeds output by $130 million, how does the national accounts statistician ensure that this discrepancy does not create a misleading estimate of GDP? c) If GDP calculated by adding up expenditures is $800b and calculated by adding up income payments is $810b, then what is the statistical discrepancy and how is it used to reconcile these two different figures? Be explicit. d) The NRU can be calculated by adding together what three different types of unemployment? 4. Suppose an increase in income of a dollar elicits an increase in consumption of 50 cents, an increase in saving of 10 cents, an increase in investment of 5 cents, and an increase in imports of 5 cents. After three rounds of the multiplier TRU Open Learning 4 ECON 201: Assignments and Practice Exams process, by how much should GDP have increased in response to an increase in government spending of $400 million? Explain your reasoning. (4 marks) 5. By means of a flowchart, explain the reaction of the interest rate to an increase in the money supply. (6 marks) 6. “Countercyclical policy is about filling in holes and shaving off peaks ‐ exactly what John Maynard Keynes prescribed.” (4 marks) a) What is meant here by ʺfilling in holes and shaving off peaks”? b) How does this differ from the monetaristsʹ prescription? 7. “Yesterday, the Bank appeared to make no attempt to influence the results of the weekly auction of federal government treasury bills. Earlier in the week the Bankʹs traders intervened aggressively in the money market to push the yield on last weekʹs bills sharply higher.” (4 marks) a) How would the Bank influence the results of the weekly auction? b) Exactly what kind of intervention is being referred to in the last sentence? (Note that this intervention occurs after the auction.) 8. “A smaller‐than‐expected decrease in the U.S. money supply dealt the North American capital market a hard blow, as bond prices sagged across a broad front.” Explain why bond prices sagged. (4 marks) 9. “There is little doubt that the key reason for this slide toward ever more inflation was an effort by public policy in most countries to achieve and maintain more output and employment from their economies than was consistent with price stability.” Explain in your own words the “key reason for this slide toward ever more inflation,” and note briefly how your explanation would be reflected on an AS/AD diagram. (4 marks) 10. Consider an economy for which the current GDP is $800 billion, ʺtheʺ multiplier is 3, the income multiplier with respect to the money supply is 4, the money multiplier is 5, the marginal tax rate is 20 percent, the real interest rate is 3 percent, the current budget deficit is $30 billion, the long‐run real rate of growth is 2 percent, the current money supply is $200 billion, the rate of money supply growth is 10 percent, and financial innovations are decreasing money demand by 1 percent per year. Marks are given for your explanations, not the final answer. TRU Open Learning ECON 201: Assignments and Practice Exams 5 a) Disregarding growth and inflation, what would the budget deficit become if the central bank bought $3 billion of bonds? (4 marks) b) What is current velocity? (1 mark) c) What should be the long‐run rate of inflation? (2 marks) d) What should be the nominal interest rate? (2 marks) e) What should be the price of a T‐bill due to mature in six months at its face value of $1,000? (3 marks) Midterm Multiple‐Choice Questions 1. Goods and services are valued at market prices when calculating GDP. Because the ʺoutputsʺ of government are not sold, they have no market prices. When calculating GDP a) they are valued at zero b) they are valued at the cost of producing them c) their value is estimated from a survey of recipients of these services d) their value is estimated from the market prices of similar market‐ provided services 2. ʺLabour‐force growth has, in the past, tended to reflect the economic situation. In almost all post‐war recession years the participation rate fell slightly, with the result that .....ʺ a) the rate of unemployment fell by more b) the rate of unemployment rose by more c) the rate of unemployment didnʹt rise by as much d) the rate of unemployment didnʹt fall by as much 3. Suppose the non‐institutionalized population over age 15 is 25 million, the participation rate is 80 percent, the number of discouraged workers is one million, the number of people with full‐time jobs is 16 million, and the number of people with part‐time jobs is two million. What is the measured unemployment rate? a) 10% or less b) more than 10% but less than 11% c) 11% or more but not more than 12% d) more than 12% TRU Open Learning 6 ECON 201: Assignments and Practice Exams 4. ʺBut in a loose sense, we are all Keynesians now, in the sense that we reject the notion that a sick economy heals itself by ʹnaturalʹ recuperative powers, without government action.ʺ This suggests that faced with a sick economy we all would recommend a) doing nothing b) increasing taxes c) increasing the money supply d) either or both of b) or c) above 5. ʺAlthough initially the news looked good, with growth of 4.2 per cent in the final three months of the year, closer examination showed a sharp drop in consumer spending and a large expansion in inventories.ʺ This news is not good because a) firms will cut output to lower inventories b) higher inventories will decrease aggregate demand c) although aggregate demand is higher by 4.2 percent, this is not sustainable d) a drop in consumer spending decreases saving which lowers aggregate demand 6. ʺA $4 billion tax cut was accompanied by a $6 billion increase in consumer spending in the same year.ʺ The most probable reason why consumer spending increased by more than the amount that taxes were reduced is that a) the tax cut reduced interest rates which in turn stimulated consumer spending by others b) lower taxes required lower government spending which in turn encouraged private spending by others c) spending by those with higher take‐home pay in turn generated additional production and spending by others d) the tax cut induced more transfer payments which in turn caused an increase in consumer spending by others 7. Suppose current income is $600 billion, ʺtheʺ multiplier is 4, the marginal tax rate is 20 percent, and the current budget deficit is $20 billion. If government spending is changed to lower income to $580 billion, once equilibrium is attained the budget deficit will be a) $15b or less b) more than $15b but less than $17.5b c) at least $17.5b but less than $20b d) $20b or more TRU Open Learning ECON 201: Assignments and Practice Exams 7 8. ʺWith the economy mired in recession, it is almost a classic case of room for government stimulus without damage.ʺ This means that the government can increase spending with no resulting increase in a) inflation b) income c) tax receipts d) unemployment 9. If you know that investment is quite volatile and you would prefer to see the economy with smaller rather than larger swings in economic activity, then a) you would prefer a small MPM (marginal propensity to import ) b) you would prefer a large MPM c) the value of the MPM is not relevant because the problem is investment behaviour d) the value of the MPM is not relevant because policy authorities can smooth out cycles with appropriate policy action 10. If we are in an area where the aggregate supply curve is completely flat, a) ʺtheʺ multiplier when expressed in real terms should be exactly the same number as when it is expressed in nominal terms b) ʺtheʺ multiplier when expressed in real terms should be a bigger number than when expressed in nominal terms; c) ʺtheʺ multiplier when expressed in real terms should be a smaller number than when expressed in nominal terms; d) there is not enough information given to determine the relative sizes of the real and nominal multipliers 11. An important ingredient in the debate over supply‐side economics is that a) the cost of supplying goods and services is rising b) programs that increase production often increase economic inequality c) economic theory can give no guidance to policy‐makers about the effects of an untried policy d) the gap between ʺwinnersʺ and ʺlosersʺ must be narrowed if society is to provide incentives for success 12. ʺOver the longer term business may be shooting itself in the foot by taking a hard line against government taxing and spending policies if this hard line causes a decline in public spending on the economyʹs infrastructure ‐ roads, sewers, bridges, and other public works.ʺ The essence of this argument is that a decline in infrastructure leads to a) higher taxation b) lower inflation c) lower productivity d) lower national saving TRU Open Learning 8 ECON 201: Assignments and Practice Exams 13. Suppose the multiplier is 3, the marginal tax rate is 25%, and the marginal propensity to consume out of disposable income is 0.9. If government spending increases by $20 billion, then national saving a) increases b) decreases by $2b or less c) decreases by more than $2b but not more than $4b d) decreases by more than $4b 14. In the long run, the rate of growth of real wages is approximately equal to the rate of a) inflation b) growth of labour productivity c) growth of labour productivity plus inflation d) growth of labour productivity minus inflation 15. ʺOne question is whether the government can steel itself to bring its fiscal policy into line with the central bankʹs monetary policy. Will the government be able to borrow the funds it will need to cover this yearʹs deficit out of the existing money supply, which the Bank of Canada is trying to restrict?ʺ If the government tries to borrow more funds than are available there will be a rise in a) bond prices b) inflation c) interest rates d) unemployment 16. ʺThe bang from a buck of direct government spending—say, highway construction—is far greater than the punch from a tax cut of equal dollar magnitude.ʺ This happens because a) some of the taxes are avoided b) a tax cut only increases aggregate demand by the marginal propensity to save times the tax cut c) a tax cut only increases aggregate demand by the marginal propensity to consume times the tax cut d) higher government spending sets the multiplier in motion whereas a tax cut does not 17. ʺIn the process, the money multiplies, since the banks are allowed to lend more money than they actually have. The Bank tries to anticipate how much the money will multiply as this process unfolds. If its calculations are right, just enough money will be created to accommodate the growth it desires for the economy. If the calculations are wrong, it would make them right by pumping some money into the economy or pumping some out.ʺ [The next 3 questions refer to this quote.] TRU Open Learning ECON 201: Assignments and Practice Exams 9 What money is being multiplied here? a) the money you and I hold as cash b) the money the government receives in taxes c) the money obtained by the Bank of Canada when it sold bonds d) the money spent by the Bank of Canada when it bought bonds 18. What technical terminology do economists use to refer to ʺhow much the money will multiply as this process unfolds? a) the multiplier b) the money multiplier c) required reserve ratio d) open market operations 19. The Bank of Canada pumps money out of the economy by a) buying bonds b) selling bonds c) creating cash d) lowering the reserve requirements 20. ʺThe eagerly awaited weekly money stock figures measure more than just the supply of money. The weekly number measures money demand as much as it does supply. The evidence now suggests the alarming growth rate of the money stock mainly reflects an upsurge in money demand, rather than an overly expansive money supply policy.ʺ Monetary policy appears to be a) restrictive b) anti‐inflationary c) targeting on the interest rate d) targeting on the money growth rate 21. ʺThe Governor of the Bank of Canada added that the principal misunderstanding about the Bankʹs role in the present situation is that the Bank could achieve more or less immediately a low level of interest rates if it wanted to.ʺ Why canʹt it achieve immediately a low interest rate if it wanted to? a) because velocity is unstable b) it could—this is just Bank rhetoric c) because it requires lowering inflation, which takes time d) because the Bankʹs control over the money supply is incomplete TRU Open Learning 10 ECON 201: Assignments and Practice Exams 22. If the rate of money growth increases in a fully employed economy, you should a) wait to see what happens b) sell bonds because their price should fall c) buy bonds because their price should rise d) not worry because bond prices should not change 23. Suppose real growth is 2 percent, velocity is constant, the money supply is $200 billion, and the money multiplier is 4. If the monetary authorities want to maintain an inflation of 5%, how many billions of dollars of bonds should the central bank buy this year? a) 2 or less b) more than 2 but not more than 3 c) more than 3 but not more than 4 d) more than 4 TRU Open Learning ECON 201: Assignments and Practice Exams 11 Practice Final Exam This is a three‐hour, closed‐book exam. You are permitted a basic calculator and a dictionary. In addition to the short‐answer questions below, there are 44 multiple‐choice questions worth one mark each. Marks sum to 100; allocate about one and one‐half minutes per mark. 1. (8 marks) Trace out, step by step, the impact on the economy of an increase in the money supply in the context of a flexible exchange rate and comment on whether monetary policy is stronger or weaker than in a closed economy. 2. (4 marks each) Explain a) What are discouraged workers and how they can cause paradoxical movements in measured unemployment? b) What is the monetarist rule, the main argument in favor of adopting it, and the main argument against? c) What is the current account and how it is affected by the budget deficit? d) What are the two main circumstances in which a budget deficit could be viewed as placing a burden on future generations, and why. 3. Be sure that it is clear what reasoning you used to obtain your numerical answers. a) Suppose for the Canadian economy ʺtheʺ multiplier is 3, the income multiplier with respect to the money supply is 4, and the money multiplier is 5. If the government decreases its spending by $6 billion and directs the Bank of Canada to buy $2 billion of bonds, what will happen to the income level? (4 marks) b) Suppose the Canadian economy, on a fixed exchange rate, is at a full employment equilibrium in which the long‐run real rate of growth is 2 percent, and the real interest rate is 4 percent. In the United States, which you can consider to be the ʺrest‐of‐the‐world,ʺ long‐run real growth is 2 percent, the nominal interest rate is 8 percent, and the risk premium (Canada is riskier) is 1 percent. (6 marks) i) What is Canadaʹs inflation rate? ii) What is Canadaʹs nominal interest rate? TRU Open Learning 12 ECON 201: Assignments and Practice Exams iii) Suppose now you are told that the exchange rate is flexible and that the value of the Canadian dollar is falling by 6 percent per year. What is Canadaʹs inflation rate now? c) Suppose the sum of consumption, investment, and government spending is $620 billion; the sum of income payments is $500 billion, including transfer payments of $5 billion; we imported $3 billion more than we exported; subsidies are $2 billion; depreciation is $70 billion; and indirect taxes are $62 billion. From this information, what is measured GDP? (4 marks) 4. (3 marks each) a) ʺRunning an economy is a balancing act. Itʹs frustrating to have to keep a whole lot of things in balance and it would be nice if it could be reduced to a simple formula such as that of the monetarists.ʺ i) What is the simple formula referred to? ii) How does this formula ʺkeep things in balance?ʺ b) ʺSeveral bond issues will raise $400 million, with the Bank of Canada picking up at least $200 million. The Bank of Canada can also be counted on to take down more of the bonds than the planned $200 million it has announced if they seem to be selling badly.ʺ i) What are the implications for the Canadian money supply of the Bank of Canada picking up $200 million of these bonds? ii) What does the second sentence imply about the Bank of Canadaʹs monetary policy? c) ʺReacting to Thursdayʹs flash second‐quarter news that the U.S. economy has grown three whole percentage points, people were headed for the bond market exits.ʺ Explain why people would react this way to this news. d) ʺThe realistic alternative to higher interest rates is not lower interest rates (except temporarily) but even higher interest rates and a monetary inflation that would make our heads spin.ʺ (4 marks) i) Describe a scenario that could bring this about. ii) Why has the qualification ʺexcept temporarilyʺ been added? e) ʺWhy has Mr. Crow argued for a stable Canadian dollar and zero inflation? Arenʹt these inconsistent goals?ʺ TRU Open Learning ECON 201: Assignments and Practice Exams 13 Explain why these goals are consistent or are inconsistent. f) ʺThe Governor of the Bank of Canada was telling everyone to slow down when he announced a hefty increase in the Bank rate to 9 per cent from 8.25 per cent. Clearly, Ottawaʹs thinking is that what the economy needs now is not a speedy recovery from recession, but one that is slow, drawn out and, in many respects, painful.ʺ What rationale can be offered for this approach? Multiple-Choice Questions for Practice Final Exam 1. ʺThe government insists that the CPI measures consumer prices, not the cost of living. But donʹt shoot the CPI—whether bringing good news or bad, itʹs the best messenger weʹve got.ʺ During a typical inflation a) the CPI rises by less than the cost of living b) the CPI rises by more than the cost of living c) the CPI and the cost of living rise by the same amount d) there is no consistent relationship between rises in the CPI and in the cost of living 2. If inventories fall by $2 billion, consumption increases by $10 billion, unemployment insurance payments decline by $4 billion, and imports rise by $1 billion, then measured GDP should rise by a) $5b b) $7b c) $9b d) $11b 3. The CPI (base year 1989) for 1990 is 110, for 1991 is 120, and for 1992 is 130. If the base year is changed from 1989 to 1992, what does the CPI for 1990 become? a) 90 or less b) above 90 but not above 100 c) between 100 and 110 d) more than 110 4. ʺThat is why the jump in Mayʹs unemployment rate—from 7.2 percent to 7.5 percent, the highest during this business cycle—caused dismay. Yet this may be missing the point. The number of people in the labour force in the month of May jumped by 43,000.ʺ The higher unemployment rate was probably caused by a) a fall in employment b) an increase in the participation rate c) an increase in the number of discouraged workers d) all of the above TRU Open Learning 14 ECON 201: Assignments and Practice Exams 5. ʺNationally, the monthly survey of households found 37,000 more people at work in February than in January, but many of the new jobs were only part time, Statistics Canada reported.ʺ From this information we can conclude that a) unemployment has risen b) unemployment has fallen c) unemployment has remained constant d) nothing can be said about unemployment 6. Suppose the population over age 15 is 20 million, the participation rate is 60 percent, and the unemployment rate is 10 percent. If the labour force grows by 0.2 million and employment grows by 0.15 million, what does the unemployment rate become? a) 10% or less b) more than 10% but not more than 10.2% c) more than 10.2% but less than 10.4% d) 10.4% or more 7. ʺWhat cannot be done, various reformers notwithstanding, is to impose on any government the obligation to balance its budget annually. Consider the consequences. If it did work, it would introduce a major destabilizing element.ʺ Forcing the government to balance its budget would be destabilizing because a movement towards recession would a) increase unemployment which would prompt a decrease in tax rates or an increase in government spending, both of which would create inflation b) increase unemployment which would prompt an increase in tax rates or a decrease in government spending, both of which would create inflation c) decrease tax receipts causing a budget deficit requiring an increase in tax rates or a decrease in government spending both of which would worsen the recession d) decrease tax receipts causing a budget surplus requiring an increase in government spending or a decrease in tax rates, both of which would worsen the recession TRU Open Learning ECON 201: Assignments and Practice Exams 15 8. ʺThe extent of the downturn surprised many analysts. According to the Council, the real gross domestic product fell at an annual rate of 4 percent. If an apparently unplanned build‐up of inventories is taken into account, the rate of decline is estimated at 7.6 percent.ʺ What has happened here? a) aggregate supply and aggregate demand have fallen by 4% b) aggregate supply and aggregate demand have fallen by 7.6% c) aggregate supply has fallen by 7.6% and aggregate demand has fallen by 4% d) aggregate supply has fallen by 4% and aggregate demand has fallen by 7.6% 9. Suppose that the income multiplier with respect to government spending is 3 and the marginal tax rate is 20 percent. If the government increases spending by $8 billion, the budget deficit will a) decrease or be unaffected b) increase by $3b or less c) increase by more than $3b but less than $8b d) increase by $8b or more 10. Suppose an economy at full employment begins to experience a fall in inventories. Which policy reaction is most appropriate? a) increase taxes b) increase transfer payments c) increase the money supply d) increase government spending 11. If we are at the natural rate of unemployment, an increase in aggregate demand will lower unemployment in the short run a) regardless of workersʹ price rise estimate b) if workers overestimate the consequent price rise c) if workers underestimate the consequent price rise d) if workers perfectly anticipate the consequent price rise 12. ʺDomestic investment did not fall as sharply as did national saving because .......ʺ Complete this clipping. a) private saving increased b) the government deficit shrank c) businesses borrowed at higher cost d) businesses borrowed from foreigners TRU Open Learning 16 ECON 201: Assignments and Practice Exams 13. Over the long run the most important determinant of our standard of living is a) judicious use of fiscal policy to prevent recessions b) increases in productivity due to technological change c) avoiding the unemployment caused by technological change d) keeping money supply growth approximately equal to the real rate of growth 14. ʺThe Bank of Canada based its monetary policy in the 1980s on the assumption that velocity would continue its upward trend. Had they assumed a constant velocity, money growth would have been ______ and inflation would have been ________ than what we actually experienced.ʺ Fill in the blanks. a) higher; higher b) higher; lower c) lower; higher d) lower; lower 15. Suppose ʺtheʺ multiplier is 3, the money multiplier is 6, and the income multiplier with respect to the money supply is 4. The government increases spending by $12 billion, but because the economy is operating at full capacity it wants to use monetary policy to offset the impact this will have on income. The central bank should a) buy $1.5b bonds b) buy $9b bonds c) sell $1.5b bonds d) sell $9b bonds 16. Suppose velocity is increasing at 1% per year, the real rate of growth of the economy is 2 percent, the real interest rate is 3 percent, and the rate of growth of the money supply is 4 percent. The nominal interest rate should be approximately a) 4% or less b) 5% c) 6% d) 7% or more 17. ʺSeveral government bond issues will raise $400 million, with the central bank picking up at least $200 million. The central bank can also be counted on to take down more of the bonds than the planned $200 million it has announced if they seem to be selling badly.ʺ This suggests that monetary policy is a) flexible b) inconsistent c) targeting on a fixed interest rate d) targeting on a fixed growth rate of the money supply TRU Open Learning ECON 201: Assignments and Practice Exams 17 18. ʺThe average yield at this weekʹs auction of $17.8 billion of 91‐day treasury bills was 11.17 percent, up from 10.95 percent last week. The average bid price was $97.290.ʺ Compared to last week, the average bid price a) has risen b) has fallen c) is unchanged d) cannot tell 19. ʺBonds rallied sharply yesterday, cheered on by the news that the recession isnʹt over yet. Prices climbed by as much as $8.75 for each $1,000 face amount in the U.S. government securities market after the Commerce Department reported that GDP fell by 0.1 percent in the second quarter.ʺ Bad news rallies bonds because it a) may cause the government to lower taxes b) is usually accompanied by higher interest rates c) may cause the central bank to decrease the money supply d) may cause the central bank to decrease interest rates 20. A bond due to mature and pay $1,000 in one yearʹs time has a coupon of $85 and a current price of $1,025. The interest rate is a) below 6% b) 6% or more, but not more than 8% c) more than 8% but less than 8.5% d) 8.5% or more 21. ʺNews of economic weakness last week cleared the way for higher bond prices. The New York market moved quickly to capitalize on this good bad news: prices shot up more than a point in minutes.ʺ Bond prices rose because a) inflation expectations fell b) unemployment is expected to fall c) the Fed is expected to lower interest rates d) both a) and c) above 22. ʺA decline in the rate of inflation is the one sure route to lower interest rates, the central bank told us two years ago. Inflation is now only about one‐third of what it was two years ago, but interest rates are higher. How come?ʺ The promised results have not materialized because a) the demand for money has fallen b) the supply of money has increased c) inflation expectations have not fallen d) none of the above TRU Open Learning 18 ECON 201: Assignments and Practice Exams 23. If monetary policy targets on an unemployment level less than the natural rate of unemployment, then over time a) the interest rate should rise b) the exchange rate should rise c) both real and nominal wages should fall d) the interest rate and GDP should remain roughly constant 24. The real interest rate is the a) nominal interest rate less the expected rate of inflation b) nominal interest rate plus the expected rate of inflation c) observed interest rate less the expected rate of inflation d) both a) and c) above 25. ʺWeʹre not likely to see a really tight monetary policy; he made clear that the central bank is following an ʹintentionally moderateʹ monetary policy in order to ʹminimize the strains involved in adjusting to a less inflationary economy.ʹ He points to the ʹawkward economic fact that in the short run anti‐inflationary policies tend to restrain output more than pricesʹ.ʺ In plain language this means that the central bank is adopting a policy of a) raising interest rates markedly to cut back on output b) gradually reducing the rate of growth of the money supply c) attacking unemployment with a policy of gradually increasing the money growth rate d) increasing the money supply at a low steady rate equal approximately to the real rate of growth of the economy. 26. ʺThe evidence of the 1970s and beyond is that whenever governments stepped in to administer stimulative medicine, they triggered runaway inflation which finally had to be stopped with strong, painful doses of recession.ʺ This clipping is consistent with a) frequent underestimation of the NRU b) an asymmetric short‐run Phillips curve c) inflation expectations rising quickly but falling slowly d) all of the above TRU Open Learning ECON 201: Assignments and Practice Exams 19 27. The asymmetry of the short‐run Phillips curve gives rise to what policy conclusion? a) Policy cannot decrease the unemployment level below the NRU b) Any policy to decrease the unemployment rate below the NRU will accelerate inflation c) The cost of reducing inflation is greater than the benefit gained from raising inflation d) The only effective policies for lowering unemployment are policies reducing the NRU 28. ʺBut monetary policy cannot be tuned to real economic variables like growth or employment, not only because policy takes effect with long and uncertain lags, but because any commitment to real growth targets simply invites workers and business to increase wages and prices at will, in the knowledge that the central bank will ratify their demands via the money supply.ʺ Ratifying demands via the money supply means that money growth will be a) fixed at a low, steady rate b) whatever is needed to prevent inflation c) whatever is needed to maintain full employment d) whatever is needed to maintain a desired interest rate 29. Suppose the money multiplier is 5, the real interest rate is 3 percent, the long‐ run real rate of growth is 2 percent, the current money supply is $200 billion, velocity is constant, and the nominal interest rate is 10 percent. Seigniorage is a) less than or equal to $5b b) between $5b and $10b c) between $10b and $20b d) greater than or equal to $20b 30. ʺIf we canʹt borrow all of the funds we need to finance expenditures which we are going to make in any event, we should at least look at the advisability of the central bank itself financing some of those expenditures simply by creating the money.ʺ This suggestion is a) unadvisable, because it creates inflation b) advisable, because it means lower taxes c) unadvisable, because it creates unemployment d) advisable, because it minimizes interest costs TRU Open Learning 20 ECON 201: Assignments and Practice Exams 31. Suppose currently an economy is experiencing $3 billion of extra taxes and $2 billion lower unemployment insurance payments than what would be the case at its long‐run average rate of unemployment. There is a budget deficit of $40 billion, a publicly‐held national debt of $400 billion, a money supply of $600 billion, a nominal growth rate of 5 percent, and an annual seigniorage of $4 billion. Its structural deficit is a) $10b or less b) more than $10b but not more than $15b c) more than $15b but not more than $20b d) more than $20b 32. ʺEconomists and important figures in the U.S. government have been debating whether it is government spending deficits, restrictive monetary policy, capital inflows, or anticipated inflation that is the real culprit for interest‐rate increases in the U.S.ʺ Which of these could definitely not have caused high interest rates? a) capital inflows b) anticipated inflation c) restrictive monetary policy d) government spending deficits 33. Suppose the central bank has intervened in the foreign exchange market to fix the exchange rate by buying $4 billion. If the current account deficit is $10 billion, the capital account balance is a surplus of a) $4b b) $6b c) $10b d) $14b 34. ʺThe response has been to search out the middle ground. The central bank has a simple operating formula: Some of the adjustment will be taken through the exchange rate, some through interest rates, and the rest through a loss of international reserves.ʺ This policy involves a) a fall in the exchange rate and a fall in the interest rate b) a fall in the exchange rate and a rise in the interest rate c) a rise in the exchange rate and a fall in the interest rate d) a rise in the exchange rate and a rise in the interest rate TRU Open Learning ECON 201: Assignments and Practice Exams 21 35. ʺAs interest rates rose by record leaps this week, the dollar continued its slide.ʺ What is going on here? a) the rise in interest rates is causing the dollar to fall b) the rise in interest rates is decreasing capital inflows c) the slide in the dollar must be causing the central bank to increase interest rates d) both a) and b) above 36. ʺCanadaʹs official international reserves rose to an all‐time high in October as the Bank of Canada acquired close to U.S.$600 million trying to ......ʺ Complete this clipping. a) prevent a fall in the Canadian dollar b) prevent a rise in the Canadian dollar c) deal with a balance of payments surplus via foreign exchange market intervention d) both b) and c) above 37. ʺThis is the reason why the fixed exchange rate system was scrapped in 1971. The U.S. had been pursuing an inflationary monetary policy to help pay for the Vietnam war and new social programs, and its trading partners did not all want to participate in it.ʺ To avoid participating in this inflation, a trading partner would have to adopt a flexible exchange rate and a) raise its money growth rate and allow its currency to appreciate steadily b) raise its money growth rate and allow its currency to depreciate steadily c) lower its money growth rate and allow its currency to appreciate steadily d) lower its money growth rate and allow its currency to depreciate steadily TRU Open Learning 22 ECON 201: Assignments and Practice Exams 38. ʺThe Bank of Canada began easing monetary conditions in response to the recession and the resulting substantial reduction in inflationary pressures. While the Fed was also easing, the pace of easing in Canada exceeded that in the United States, resulting in a 300 basis point narrowing in the Canada‐U.S. short‐term interest rate spread. Surprisingly, this did not result in a decline in the value of the Canadian dollar; in fact, it strengthened. a) inflation in Canada must have been falling faster than in the U.S. b) inflation in the U.S. must have been falling fasterthan in Canada c) the 300 point narrowing must have caused a widening of the real interest rate spread d) both a) and c) above 39. Suppose the U.S. and Canadian economies, on a flexible exchange rate, are both experiencing a real growth rate of 3 percent, but that the Canadian money supply growth rate is 10 percent compared to only 6 percent in the U.S. Currently, 1 U.S. dollar buys 1.2 Canadian dollars. How many Canadian dollars would you guess 1 U.S. dollar will buy two years from now? a) 1.2 or less b) more than 1.2 but not more than 1.25 c) more than 1.25 but not more than 1.3 d) more than 1.3 40. In countries experiencing hyperinflation we should see a) low interest rates and a depreciating currency b) high interest rates and a depreciating currency c) low interest rates and an appreciating currency d) high interest rates and an appreciating currency 41. ʺThe Bank of Canada has made occasional attempts to lower interest rates and accept some lowering of the dollar as a tradeoff. Sometimes it works, and sometimes, like last summer, we end up with the worst of all possible worlds— higher interest rates and a lower dollar.ʺ This worst of all possible worlds most likely happened because the Bank of Canadaʹs effort to lower interest rates a) increased inflation which increased the nominal interest rate and depreciated the dollar b) caused capital inflows to fall, lowering the exchange rate which raised costs and thus increased the interest rate c) caused a balance of payments surplus which automatically increased the money supply, causing inflation which lowered the exchange rate and increased the nominal interest rate TRU Open Learning ECON 201: Assignments and Practice Exams 23 d) increased the money supply which under a flexible exchange rate depreciated the dollar requiring a higher interest rate to attract capital inflows for international balance 42. ʺWhile the chartered banks have so far refrained from raising their rates, the finance minister warned reporters that this situation cannot last. The Canadian and U.S. economies are so interrelated, he said, that it will be impossible for Canadian interest rates to remain much lower than U.S. rates for an extended period of time.ʺ This politicianʹs statement is a) false because if the exchange rate is fixed, Canada can have a lower nominal interest rate if its inflation rate is lower b) false because if the exchange rate is flexible, Canada can have a lower nominal interest rate if its inflation rate is lower c) true because so long as Canada is riskier than the U.S., its interest rate must in the long run be higher than that of the U.S. d) true because international arbitrage forces will ensure that Canadian and U.S. real interest rates are roughly the same except for a risk premium 43. ʺOne question is whether the government can steel itself to bring its fiscal policy into line with the central bankʹs monetary policy. Will the government be able to borrow the funds it will need to cover this yearʹs deficit out of the existing money supply, which the Bank of Canada is trying to restrict?ʺ If the government tries to borrow more funds than are available there will be a rise in a) bond prices b) inflation c) interest rates d) unemployment 44. ʺThe bang from a buck of direct government spending ‐ say, highway construction ‐ is far greater than the punch from a tax cut of equal dollar magnitude.ʺ This happens because a) some of the taxes are avoided b) a tax cut only increases aggregate demand by the marginal‐propensity‐ to‐save times the tax cut c) a tax cut only increases aggregate demand by the marginal‐propensity‐ to‐consume times the tax cut d) higher government spending sets the multiplier in motion whereas a tax cut does not TRU Open Learning 24 ECON 201: Assignments and Practice Exams Answers to Economics 201 Practice Midterm Exam 1. Explain why and in what direction the value of ʺtheʺ multiplier will change if consumption and investment demand become more strongly affected by the interest rate. (4 marks) 1 mark for smaller; 2 marks for a story that gets a rise in the interest rate accompanying the stimulus (higher income increases demand for money, or government needs to sell bonds so increases the interest rate) plus 1 mark for higher interest rate decreases agg D. Alternatively, 3 marks for just saying that crowding out is stronger. 2. a) What is national saving? (2 marks) 2 marks for private saving less the government deficit; or 2 marks for the amount of saving available to finance private investment b) Why is it of interest? (2 marks) 2 marks for it determines the amount of private investment which in turn is the primary determinant of growth (1 mark for either one of these) 3. Provide a one‐line answer for each of the following. (2 marks each) a) If 1991 nominal GDP is $600 billion and the price index is 120.0 (1986 = 100), then what is 1991 GDP measured in 1986 dollars? What name would economists give to this figure? 2 marks for real GDP b) If aggD for g&s exceeds output by $130 million, how does the national accounts statistician ensure that this discrepancy does not create a misleading estimate of GDP? 2 marks for subtracting 130 from the investment category “investment in inventories” c) If GDP calculated by adding up expenditures is $800 billion and calculated by adding up income payments is $810 billion, then what is the statistical discrepancy and how is it used to reconcile these two different figures? Be explicit. 1 mark for $5b; 1 mark for add to 800 and subtract from 810 TRU Open Learning ECON 201: Assignments and Practice Exams 25 d) The NRU can be calculated by adding together what three different types of unemployment? 2 marks for frictional, structural, and institutionally‐induced; 1 mark if only have two of these 4. Suppose an increase in income of a dollar elicits an increase in consumption of 50 cents, an increase in saving of 10 cents, an increase in investment of 5 cents, and an increase in imports of 5 cents. After three rounds of the multiplier process, by how much should GDP have increased in response to an increase in government spending of $400 million? Explain your reasoning. (4 marks) 1 mark for stating that an increase in GDP of a dollar elicits an increase in agg D of 50 cents; 1 mark for saying this comes from 50 cents consumption increase plus 5 cents investment increase less 5 cents imports increase; 1 mark for second round increase of $200; 1 mark for total after third round of $700 5. By means of a flowchart, explain the reaction of the interest rate to an increase in the money supply. (6 marks) ↑ M ⇒ open market operations ⇒ B of C buys bonds ⇒ bid up price of bonds ⇒ decrease in interest rate (1 mark for each of these four steps; 1 mark for saying but if the up money supply increases inflation expectations; 1 mark for higher inflation expectations increase the interest rate) 6. “Countercyclical policy is about filling in holes and shaving off peaks—exactly what John Maynard Keynes prescribed.” (4 marks) a) What is meant here by ʺfilling in holes and shaving off peaks”? 1 mark for stimulating in recession; 1 mark for contracting in boom b) How does this differ from the monetaristsʹ prescription? 2 marks for monetarists would do nothing, or 2 marks for they would keep the money supply growth at a low, steady rate 7. “Yesterday, the Bank appeared to make no attempt to influence the results of the weekly auction of federal government treasury bills. Earlier in the week the Bankʹs traders intervened aggressively in the money market to push the yield on last weekʹs bills sharply higher.” (4 marks) a) How would the Bank influence the results of the weekly auction? TRU Open Learning 26 ECON 201: Assignments and Practice Exams 2 marks for by buying more or less than they usually buy; only one mark for buying, zero marks if mention selling bonds b) Exactly what kind of intervention is being referred to in the last sentence? (Note that this intervention occurs after the auction.) 2 marks for the Bank sold bonds on the open market 8. “A smaller‐than‐expected decrease in the U.S. money supply dealt the North American capital market a hard blow, as bond prices sagged across a broad front.” Explain why bond prices sagged. (4 marks) 2 marks for a smaller‐than‐expected decrease increasing inflation expectations 1 mark for this causes the nominal interest rate to rise 1 mark for this causes bond prices to fall 9. “There is little doubt that the key reason for this slide toward ever more inflation was an effort by public policy in most countries to achieve and maintain more output and employment from their economies than was consistent with price stability.” Explain in your own words the “key reason for this slide toward ever more inflation,” and note briefly how your explanation would be reflected on an AS/AD diagram. (4 marks) 2 marks for “an underestimation of the NRU” or words to that effect 2 marks for a diagram in which the SRAS curve continually shifts upward and the AD curve continually shifts rightward 10. Consider an economy for which the current GDP is $800 billion, ʺtheʺ multiplier is 3, the income multiplier with respect to the money supply is 4, the money multiplier is 5, the marginal tax rate is 20 percent, the real interest rate is 3 percent, the current budget deficit is $30 billion, the long‐run real rate of growth is 2 percent, the current money supply is $200 billion, the rate of money supply growth is 10 percent, and financial innovations are decreasing money demand by 1 percent per year. Marks are given for your explanations, not the final answer. a) Disregarding growth and inflation, what would the budget deficit become if the central bank bought $3 billion of bonds? (4 marks) money supply increases by 3*5=15 income increases by 15*4=60 taxes increase by 60*0.2=12 so deficit becomes 30‐12=18 TRU Open Learning ECON 201: Assignments and Practice Exams 27 1 mark for each step b) What is current velocity? (1 mark) 1 mark for 800/200=4 c) What should be the long‐run rate of inflation? (2 marks) 1 mark for 10 ‐ 2 = 8, but 2 marks for 10 equals 2 + inflation ‐ 1, so inflation = 9 d) What should be the nominal interest rate? (2 marks) 2 marks for 3 + 9 = 12 [Here is a good example of how a wrong answer can get full marks—if the logic of nominal interest rate equals real interest rate plus inflation is correct, do not deduct marks if an incorrect answer from part c) above is used for inflation.] e) What should be the price of a T‐bill due to mature in six months at its face value of $1,000? (3 marks) 1 mark for .12=(1000‐P)/P but 3 marks for .06=(1000‐P)/P or for .12=(1000‐P)/P)*2 Answers to multiple‐choice questions (2 marks each) 1b, 2c, 3a, 4d, 5a, 6c, 7c, 8a, 9b, 10a, 11b, 12c, 13b, 14b, 15c, 16c, 17d, 18b, 19b, 20c, 21c, 22b, 23c TRU Open Learning 28 ECON 201: Assignments and Practice Exams Answers to Practice Final Exam 1. Up Ms ‐ open market operations ‐ B of C buys bonds ‐ bids up p of bonds ‐ interest rate falls ‐ up agg D – Keynesian multiplier process operates ‐ income increases ‐ imports increase ‐ B of P deficit, strengthened by interest rate fall causing capital inflows to decrease ‐ fall in exchange rate ‐ increase in export demand and increase in demand for domestically‐produced goods and services that compete against imports ‐ so increase in agg D, further stimulating the economy ‐ monetary policy stronger 2a) Unemployed who have become so discouraged in their search for employment that they give up actively looking for work and so are no longer counted as officially unemployed. When the economy moves out of a recession and employment picks up, these discouraged workers become encouraged and begin actively looking for work. This creates a paradoxical increase in measured unemployment as the economy moves out of a recession. 2b) Increase the money supply at a low, steady rate approximately equal to the economyʹs real rate of growth. Main argument in favour is that this should keep inflation at a low rate in the long run. Main argument against is that it prevents the judicious use of discretionary monetary policy. 2c) Difference between exports and imports of goods and services. A budget deficit pushes up the interest rate as bonds are sold to finance the deficit. This attracts capital inflows which creates a balance of payments surplus, bidding up the exchange rate. The rise in the exchange rate decreases exports and increases imports, creating a current account deficit. 2d) When incurred at full employment, it implies that the government gets more and others, most notably business investment demand, gets less. This reduces capital accumulation, implying that the future generation will be passed on a smaller capital stock. If the deficit spending is on productive things such as infrastructure it could cause future generations to be sufficiently more productive that they can easily pay off the principle and interest; if not, a burden is passed. TRU Open Learning ECON 201: Assignments and Practice Exams 29 3a) Down G by 6b causes down income by 6x3=18b; buy 2b bonds causes money supply to increase by 2x5=10b. This causes up income by 10x4=40, so net impact on income is 40‐18=22b. 3bi)Fixed ex rate so Canadaʹs inflation same as US. Real interest rate in US is Canadian real rate less risk premium, 4‐1=3%. US expected inflation is nominal interest rate less real interest rate = 8‐3=5%. 3bii) Canadaʹs nominal interest rate is its real rate plus its expected inflation = 4+5=9% 3biii) If the ex change rate is falling by 6% per year, Canadaʹs inflation rate must be 6% higher than US inflation. So Canadian inflation = 5+6=11% 3c) By adding up expenditure GDP is C+I+G+ net exports=620‐3=617b By adding up income payments GDP is incomes less transfer payments plus indirect taxes less subsidies plus depreciation=500‐5+70‐2+62=625b measured GDP is their average $621b 4ai) Increase the money supply at a low, steady rate approximately equal to the real rate of growth of the economy 4aii) If the economy goes into recession income growth slows and so demand for money growth slows, falling below the fixed money supply growth rate. This creates excess money which automatically stimulates the economy. The opposite occurs when the economy goes into a boom 4bi) Increase by $200b times the money multiplier 4bii) The B of C appears to be fixing the interest rate 4c) This unexpected growth increases inflation expectations, raising the interest rate and thus lowering bond prices 4di) B of C increases money supply to push down interest rate, but if at full employment soon will increase inflation expectations, raising interest rate. This may prompt further money supply increases, etc. leading to ever higher inflation 4dii) Extra money supply increases should lower the interest rate initially, until higher inflation expectations develop 4e) A stable Canadian dollar implies a fixed exchange rate, which implies that Canada is forced to adopt the monetary policy/inflation of her trading partners. Only if her trading partners have zero inflation would these two goals be consistent. TRU Open Learning 30 ECON 201: Assignments and Practice Exams 4f) A speedy recovery from recession via monetary policy would rekindle inflationary expectations. By taking a slower, painful route these expectations will be wrung out of the economy, permitting a movement to full employment at a low rate of inflation. Answers to Multiple‐Choice Questions for Practice Final Exam (1 mark each) 1b, 2b, 3a, 4b, 5d, 6c, 7c, 8d, 9c, 10a, 11c, 12d, 13b, 14a, 15c, 16c, 17c, 18b, 19d, 20a, 21d, 22c, 23a, 24d, 25b, 26d, 27c, 28c, 29a, 30a, 31d, 32a, 33b, 34b, 35c, 36d, 37c, 38d, 39c, 40b, 41a, 42b, 43c, 44c TRU Open Learning ...
View Full Document

This note was uploaded on 12/27/2009 for the course ECE Coen 243 taught by Professor Drlajam during the Winter '07 term at Concordia Canada.

Ask a homework question - tutors are online