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Unformatted text preview: ©Prep101 www.prep101.com/freestuff Solutions to Practice Macro Exam Use the following information, collected by Statistics Noland, to answer question 1: Government Expenditures Net Taxes Private Saving Investment $600 billion $700 billion $300 billion $350 billion Q1. What is national saving? a) $400 billion b) $300 billion c) $200 billion d) $650 billion e) $50 billion Solution: a) $400 billion National saving = private saving (S) + government saving (NT - G) = 300 + (700 - 600) = 400 Q2. Which of the following is likely to result in cost-push inflation? a) If there is a decrease in aggregate supply and the Keynesian activists are in charge of the macroeconomic policymaking b) If there is a decrease in aggregate supply and the monetarists are in charge of the macroeconomic policymaking c) If there is an increase in aggregate demand and the Keynesian activists are in charge of the macroeconomic policymaking d) If there is an increase in aggregate demand and the monetarists are in charge of the macroeconomic policymaking e) All of the above Solution: a) If there is a decrease in aggregate supply and the Keynesian activists are in charge of the macroeconomic policymaking Supply shock SAS shifts leftward real GDP falls and the price level increases. Keynesians will stimulate economy by increasing the AD the AD curve shifts right real GDP returns to its initial level, but the price level rises further cost-push inflation Page 1 of 25 ©Prep101 www.prep101.com/freestuff Q3. An art collector sold a painting for $20,000 in 2005. He had purchased it for $15,000 in 2002. How will this sale affect 2005 GDP? a) b) c) d) e) 2005 GDP will increase by $20,000. 2005 GDP will increase by $15,000. 2005 GDP will increase by $5,000, but 2002 GDP must be adjusted downwards. 2005 GDP will not change. 2005 GDP will increase by $5,000. Solution: d) 2005 GDP will not change. This painting was not produced in 2005 and therefore 2005 GDP does not change. Q4. Suppose that the country of Musicland produces only stereos and CDs. Goods Stereos CDs 2004 Quantity 20 100 2004 Price $200 $4 2005 Quantity 30 200 2005 Price $220 $6 Using the base-year prices method, what was real GDP in 2005 (the base year is 2004)? a) b) c) d) e) $7,800 $6,800 $4,400 $6,000 $5,200 Solution: b) $6,800 Value of Stereos = 30 X $200 = $6,000 Value of CDs = 200 X $4 = $800 Real GDP = $6,800 Page 2 of 25 ©Prep101 www.prep101.com/freestuff Use the following graph to answer question 5: Price (plums) Quota Export supply of oranges 7 5 Import demand for oranges 0 5 7 Quantity (oranges) Q5. If there is a trade quota of 5 oranges, orange importers can import only 5 oranges. By importing 5 oranges and selling them in the domestic market, a) b) c) d) e) Importers make a profit of 10 plums Importers make a profit of 35 plums Importers make a profit of 25 plums Importers make a profit of 42 plums Importers make a profit of 30 plums Solution: a) Importers make a profit of 10 plums Orange exporters ask 5 plums per orange when 5 oranges supplied Orange importers pay 5 plums per orange and buy 5 oranges. In the domestic market, buyers are willing to pay 7 plums per orange importers pay 25 plums for 5 oranges and sell these oranges for 35 plums profit of 10 plums Page 3 of 25 ©Prep101 www.prep101.com/freestuff Use the following information about Tinyland to answer question 6 (assume the economy is at full employment): Real Wage Rate 3 4 5 6 7 9 Labour Demand (thousands of workers) 30 25 20 15 10 5 Labour Supply (thousands of workers) 5 10 20 25 30 35 Q6. If 5 thousand workers are unemployed, what is the natural unemployment rate? a) b) c) d) e) 25 % 20% 18% 15% 10% Solution: b) 20% Number of people employed= 20 thousand Number of people unemployed= 5 thousand Labour force= 25 thousand Natural unemployment rate = 5 / (5+20) * 100= 20%. Use the following job market information collected by Statistics Greatland (figures are in millions) to answer question 7: 2001 40 4 22 5 Working Age Population Unemployed Employed Working part-time Labour Force Q7. Labour force participation rate a) b) c) d) e) Decreased from 71.43% in 2002 to 70.45% in 2003 Increased from 70.45% in 2002 to 71.43% in 2003 Did not change from 2002 to 2003 Increased from 76.67% in 2002 to 83.87% in 2003 Decreased from 83.87% in 2002 to 76.67% in 2003 Solution: a) Decreased from 71.43% in 2002 to 70.45% in 2003 Page 4 of 25 2002 42 23 4 30 2003 44 5 31 ©Prep101 www.prep101.com/freestuff 2002 Labour Force participation rate = (labour force / working-age population) *100 = (30 / 42)*100= 71.43% 2003 Labour Force participation rate = (31 / 44)*100 = 70.45% Q8. All else the same, a lower value of the exchange rate lowers the quantity of Canadian dollars supplied, because a) b) c) d) e) Canadian imports fall Expected profits from selling Canadian dollars fall Canadian imports increase Expected profits from selling Canadian dollars increase Both a) and b) Solution: e) Both a) and b) Lower exchange rate foreign produced goods and services become more expensive imports fall the quantity of foreign currency purchased falls the quantity of Canadian dollars supplied falls Lower exchange rate Expected profits from selling Canadian dollars fall the quantity of Canadian dollars supplied falls Q9. If the price index in 2000 was 100, in 2001 was 110, and in 2002 was 90, the economy experienced a) 10 % inflation between 2000 and 2001 and 18 % inflation between 2001 and 2002 b) 10 % inflation between 2000 and 2001 and 18 % deflation between 2001 and 2002. c) 10 % inflation between 2000 and 2001 and 0 % inflation between 2001 and 2002 d) 10 % deflation between 2000 and 2001 and 18 % deflation between 2001 and 2002. e) 10 % deflation between 2000 and 2001 and 18 % inflation between 2001 and 2002 Solution: b) 10 % inflation between 2000 and 2001 and 18 % deflation between 2001 and 2002. Inflation between 2001 and 2000 = (110- 100)/ 100 * 100 = 10% Inflation between 2002 and 2001 = (90- 110)/ 110 * 100 = -18% A famous baseball player, Sam Bazeball, made $500,000 in 1972. His son, Pat Bazeball, also a well-known baseball player, made $1.5 million in 2004. Use this information (and the fact the price index in 1972 was 40 and the price index in 2004 was 125) to answer question 10: Page 5 of 25 ©Prep101 www.prep101.com/freestuff Q10. What was Sam’s income in 2004 dollars? a) b) c) d) e) $156,250 $1,562,500 $1,125,000 $1,300,000 none of the above Solution: b) $1,562,500 Inflation rate between 1972 and 2004 = (125 – 40) / 40 *100= 212.5% Income in 2004 dollars = 500,000 * 312.5/100 =1,562,500 Q11. Suppose interest rates are 5 percent in Japan and 6 percent in Germany. The current value of the exchange rate is 80 Japanese yen per mark, and it is generally expected that in one year the exchange rate will be 79.2 yen per mark. However, new information is released that changes everyone’s expectations, and they think the exchange rate in one year will still be 80 yen per mark. As a result of this change, a) b) c) d) e) People will sell their savings in yen and will buy marks to lend in Germany People will borrow in Japan and lend in Germany The demand for the German marks will rise Nothing will change. a), b), and c) Solution: e) a), b), and c) Investment in Japan has a lower return, but the Japanese currency is expected to appreciate by 1% to compensate for this loss interest rate parity holds; With the release of new information, investing in German interest-bearing assets promises higher returns, because the yen is not going to appreciate borrow yen at 5% and buy marks to lend in Germany Q12. When real GDP is greater than potential GDP the economy ____, and when real GDP equals potential GDP the economy ____. a) Has an inflationary gap, is in a full-employment equilibrium. b) Has a recessionary gap, is in a full-employment equilibrium. c) Is in a below full-employment equilibrium, is in a full-employment equilibrium. d) Is in an above full-employment equilibrium, is in a below full-employment equilibrium. e) Is in full employment equilibrium, has a recessionary gap. Solution: a) Has an inflationary gap, is in a full-employment equilibrium Page 6 of 25 ©Prep101 Real GDP > Potential GDP Real GDP = Potential GDP Real GDP < Potential GDP www.prep101.com/freestuff above full-employment equilibrium and inflationary gap full employment below full-employment equilibrium and recessionary gap Q13. Assume in Tinyland, the economy is at full employment. What will happen in the long run if aggregate demand decreases (assume prices of productive resources can vary)? a) b) c) d) e) The price level will increase and the real GDP will decrease. The price level will increase and the real GDP will be unaffected. The price level will decrease and the real GDP will decrease. The price level will decrease and the real GDP will be unaffected. The price level will increase and the real GDP will increase. Solution: d) The price level will decrease and the real GDP will be unaffected. When AD decreases, the economy moves downward along the SAS curve. Temporarily, real GDP falls and the price level falls. Prices of resources fall. Short-run supply increases (SAS shifts rightward), This continues until SAS=AD=LAS. At the new long-run equilibrium, prices are lower than the original level and real GDP is unaffected. Q14. Which of the following statements cannot be true about the Cooland economy in the long run? a) b) c) d) e) The economy is at full employment, but there is still some unemployment. If the money supply increases, the price level will increase. If there are technological advances, the real GDP will increase. If the money supply decreases, the real GDP will fall. If human capital decreases, the real GDP will decrease. Solution: d) If the money supply decreases, the real GDP will fall. Changes in money supply do not have long lasting effects. The price level will rise, but the real GDP will not change. Q15. If the United States (a country that imports goods from Canada) experienced decrease in income, in Canada a) b) c) d) e) The aggregate demand would shift left as a result of a decrease in exports. The aggregate demand would shift right as a result of a decrease in exports. The aggregate demand would shift left as a result of an increase in exports. The aggregate demand would shift left as a result of a decrease in imports. The aggregate demand would shift right as a result of an increase in imports. Solution: a) The aggregate demand would shift left as a result of a decrease in exports. Page 7 of 25 ©Prep101 www.prep101.com/freestuff The world economy can affect the domestic AD thru two channels: change in foreign income and change in the foreign exchange rate. When foreign income falls, foreigners demand fewer Canadian goods and the AD shifts to the left. Use the following figure to answer question 16: Price level LAS1 LAS0 LAS2 F E C D A I B H AD2 G AD1 AD0 Real GDP Q16. Assume an economy initially is in full-employment equilibrium at point A. Assume there is a productivity slowdown. If real business cycle theory is correct, under feedback-rule policy, a) b) c) d) e) The economy will move from point A to point C and then to point F The economy will move from point A to point B and then to point G The economy will move from point A to point E The economy will move from point A to point H The economy will move from point A to point H and then to point I Solution: a) The economy will move from point A to point C and then to point F A productivity slowdown decrease in aggregate supply and real (potential) GDP LAS moves leftward, the economy moves from A to C. Under feedback-rule, the government and the central bank increase AD the AD curve shifts right, the economy moves from point C to F. Assume in Noland, there are no imports, no exports, and no taxes. Use this information about Noland to answer questions 17 and 18: Q17. If the government plans to shift the AD curve rightward by $10 billion (and the MPC is 0.8), the government should increase its expenditures by a) b) c) d) e) $1 billion $2 billion $3 billion $5 billion $10 billion Page 8 of 25 ©Prep101 www.prep101.com/freestuff Solution: b) $ 2 billion Multiplier = 1 / (1- 0.8) = 5 Change in equilibrium Exp = Multiplier * change in autonomous expenditure. Change in autonomous expenditure= Change in equilibrium Exp / Multiplier Change in autonomous expenditure= 10 / 5 = 2 Q18. If the government increases expenditures by $5 billion and the AD curve shifts rightward by $10 billion, what is the marginal propensity to save? a) b) c) d) e) 1.2 0.2 0.5 0.8 0.75 Solution: c) 0.5 The multiplier is 10 / 5 =2 Multiplier = 1 / (1- MPC) MPC = 1 – 1/ multiplier = 1 -1/2 = 0.5 MPS= 1 – MPC = 0.5 Use the following figure to answer question 19: C 45 degree line 100 1000 YD Q19. The consumption function is given by a) b) c) d) e) C = 100 + .75YD C = 1000 + .8YD C = 100 + 0.5YD C = 100 + 0.9YD C = 1000 + .6YD Page 9 of 25 ©Prep101 www.prep101.com/freestuff Solution: d) C = 100 + 0.9YD When YD=0, Consumption = 100. The 45 degree line tells us that when YD=1000, C=1000. When YD increases by 1000, C increases by 1000 -100= 900. MPC=900/1000=0.9 The slope of the consumption function is 0.9 Thus, C = 100 + 0.9YD Q20. Consider the aggregate expenditure model and the aggregate demand-aggregate supply model. What will happen if exports increase? a) The aggregate planned expenditure curve shifts rightward and the aggregate demand curve shifts rightward. b) The aggregate planned expenditure curve shifts upward and the aggregate demand curve shifts rightward. c) The aggregate planned expenditure curve shifts upward and the aggregate demand curve is unaffected. d) The aggregate planned expenditure curve shifts upward and the aggregate demand curve shifts leftward. e) The aggregate planned expenditure curve shifts downward and the aggregate demand curve shifts rightward. Solution: b) The aggregate planned expenditure curve shifts upward and the aggregate demand curve shifts rightward. Recall that AE = C+I+G+X-M. So, when X increase, AE increases. The aggregate demand curve shifts rightward, because at each level of price the quantity of goods and services demanded increases. Q21. All else constant, an increase in the marginal tax rate will result in a) b) c) d) e) A downward parallel shift in the aggregate planned expenditure curve An upward parallel shift in the aggregate planned expenditure curve A downward non-parallel shift in the aggregate planned expenditure curve A rightward movement along the aggregate planned expenditure curve An upward non-parallel shift in the aggregate planned expenditure curve Solution: c) A downward non-parallel shift in the aggregate planned expenditure curve AE=autonomous expenditure + b*{(1-t)-m}*Y, where b is a slope of the Consumption function and t is a marginal tax rate. When t increases, (1-t) falls and thus the slope of the AE curve decreases. As a result, AE shifts down. But this is not a parallel shift, because the slope has changed. Page 10 of 25 ©Prep101 www.prep101.com/freestuff Use the following figure to answer questions 22 and 23: Outlays, revenues, and deficit Revenues 340 260 220 180 140 100 Outlays 800 900 1100 1300 Real GDP Q22. If potential GDP is $1,100 billion, what is the structural deficit or surplus? a) b) c) d) e) There is a structural deficit of $120 billion. There is a structural surplus of $120 billion. There is a structural surplus of $200 billion. There is a structural deficit of $200 billion. There is a structural surplus of $300 billion. Solution: b) There is a structural surplus of $120 billion. Structural deficit (surplus) is the budget balance at potential GDP. Structural deficit = outlays - revenues= 140 - 260 = -120. There is a structural surplus of $120 billion. Q23. If potential GDP is $1,100 billion, but current real GDP is $900 billion, what is the cyclical deficit or surplus? a) b) c) d) e) There is a cyclical surplus of $120 billion. There is a cyclical deficit of $200 billion. There is a cyclical deficit of $120 billion. There is a cyclical surplus of $50 billion. There is a cyclical surplus of $500 billion. Solution: c) There is a cyclical deficit of $120 billion. Cyclical deficit = actual deficit – structural deficit Actual deficit = outlays - revenues (at real GDP=900) = 180-180=0. The structural deficit (at potential GDP= $1,100) = outlays -revenues = 140-260= -120. Cyclical deficit = 0 – (-120) = 120 Use the following figure to answer question 24: Page 11 of 25 ©Prep101 www.prep101.com/freestuff ● Price of automobiles (thousands of $) ● USA export supply (with tariff) USA export supply 32 28 24 ● 20 ● 16 ● 12 Canadian import demand 8 4 4 5 6 7 8 9 10 11 Quantity of automobiles (in millions) Q24. Suppose the Canadian government imposes a tariff on imported US cars equal to $4,000 per automobile. The imposition of the tariff raises the price of automobiles in Canada by a) b) c) d) e) $2,000 $4,000 $18,000 $20,000 Cannot be determined with given information Solution: a) $2.000 Before tariff, 7 million are sold at $20,000 each After tariff, 6 million are sold at $22,000 each (exporter gets $18,000 and the gov. collects $4,000—the consumer pays $22,000) Q25. Assume there is a county on an isolated island and it does not trade with foreign countries. Further assume this country has only autonomous taxes and no induced taxes. The formula for the autonomous tax multiplier is___ and the formula for autonomous transfer payments multiplier is ___ a) b) c) d) e) - MPC / (1- MPC), MPC / (1- MPC) MPC / (1- MPC), - MPC / (1- MPC) - 1 / (1- MPC), 1 / (1- MPC) 1 / (1- MPC), -1 / (1- MPC) none of the above Page 12 of 25 ©Prep101 www.prep101.com/freestuff Solution: a) - MPC / (1- MPC), MPC / (1- MPC) Autonomous tax multiplier (ATM) = -b / (1-[b*(1-t)-m]). In this economy t=0 and m=0. ATM= - b / (1-b) = - MPC / (1- MPC) Autonomous transfer payment multiplier = - autonomous tax multiplier = MPC / (1MPC) Q26. If real GDP is below potential GDP and the budget is balanced, then there must be a) b) c) d) e) a structural deficit and a cyclical deficit. a structural surplus and a cyclical surplus. a structural surplus and a cyclical deficit. a structural deficit and a cyclical surplus. An actual deficit and a cyclical surplus. Solution: c) a structural surplus and a cyclical deficit. Compared to real GDP, at potential GDP revenues are higher and outlays are lower: Outlays – revenues < 0, There is a structural surplus. Cyclical deficit = Actual deficit - structural deficit There must be a cyclical deficit. Use the following information on real GDP and the aggregate planned expenditures to answer question 27. Assume investment and government expenditures are constant, all taxes are autonomous, and there are no exports or imports. Real GDP per year 100 200 300 400 500 Q27. Aggregate Planned expenditure per year 120 180 240 300 360 The autonomous transfer payments multiplier is a) b) c) d) e) 1.5 2.5 3 4. None of the above Solution: a) 1.5 Page 13 of 25 ©Prep101 www.prep101.com/freestuff In the absence of foreign trade, AE= C+I+G. Since I and G are constant, change in AE equals change in Consumption. In the absence of induced taxes, change in disposable income equals change in income (or real GDP). MPC = (180 – 120) / (200-100) = 0.6 The autonomous transfer payments multiplier = MPC / (1-MPC) = 0.6 / (1-0.6) = 1.5 Q28. A decrease in the marginal propensity to consume a) Decreases the government expenditures multiplier resulting in a smaller effect of government expenditures on aggregate demand. b) Decreases the government expenditures multiplier resulting in a larger effect of government expenditures on aggregate demand. c) Increases the government expenditures multiplier, so that changes in government expenditures have a larger effect on aggregate demand. d) Increases the government expenditures multiplier, so that changes in government expenditures have a smaller effect on aggregate demand. e) None of the above Solution: a) Decreases the government expenditures multiplier resulting in a smaller effect of government expenditures on aggregate demand. The Government expenditure multiplier = 1 / (1-[b*(1-t)-m]). When b falls, denominator increases and the multiplier decreases. Government expenditures have smaller effect on aggregate demand. Q29. Assume in a country, there are no banks and people hold all their money in currency. If a bank is established (assume this bank plans to make loans) and people transfer most of their currency into demand deposit accounts, all else constant, a) b) c) d) e) The money supply will decrease immediately. The money supply will increase immediately. The money supply will decrease eventually. The money supply will increase eventually. The money supply will not change. Solution: d) The money supply will increase eventually. Initially, there is no change in the money supply--transferring currency simply changes the composition of money (increase in demand deposits is offset by a decrease in currency). When banks start making loans, however, it increases deposits and the money supply increases. Page 14 of 25 ©Prep101 www.prep101.com/freestuff Use the following balance sheet of the Best Bank to answer questions 30 and 31: Assets Reserves Loans Total $300 $1,200 $1,500 Liabilities Deposits $1,500 Total $1,500 Q30. Assume a new client deposits $100 in deposit account at the Best Bank. If all the banks in the banking system have the same desired reserve ratio, the total change in deposits resulting from depositing $100 is a) b) c) d) e) $0. $150 $500 $400. $100. Solution: c) $500 Deposit multiplier = 1/(desired reserve ratio) = 1/(reserves/deposits) = 1/(300/1500) = 1/0.2 = 5. Change in deposits = demand multiplier * change in reserves = $100*5 = $500. Q31. Assume the Best Bank is the only bank in the banking system. Assume a new client deposits $200 with the Best Bank. Loans will increase by a) b) c) d) e) $2,000. $1,500 $1,000 $800. $500. Solution: d) $800 Reserves will increase to 300+ 200 =500. Deposit multiplier = 1/(desired reserve ratio) = 1/(reserves/deposits) = 1/(300/1500) = 1/0.2 = 5. Change in deposits = demand multiplier * change in reserves = $200*5 = $1000. Total deposits = 1000+ 1500= 2500 Loans = deposits – reserves = 2500 – 500 = 2000. Initial loans = 1200. Increase in loans = 2000- 1200= 800. Page 15 of 25 ©Prep101 www.prep101.com/freestuff Q32. If the nominal interest rate is 8 percent, the inflation rate is 4 percent, and the tax rate is 30 percent, then the real after-tax interest rate is a) b) c) d) e) 5.6% 4% 2% -2% 1.6% Solution: e) 1.6% After-tax nominal interest rate= 8*(1-0.30) = 5.6% After-tax real interest rate = after-tax nominal interest rate – rate of inflation = 5.6% - 4% = 1.6% Q33. Assume in a country, the banks have deposits of $500 million and keep $25 million in reserves. Assume there are no coins and the monetary base is $100 million. What is the money multiplier (assuming assets of chartered banks consist of reserves and loans, and liabilities consist of deposits)? a) b) c) d) e) 4.0 5.75 6.5 7.0 5.0 Solution: b) 5.75 Monetary base = currency in circulation + actual reserves Currency in circulation = Monetary base - actual reserves = 100 – 25 = 75 Money supply = demand deposits + currency in circulation = 500 + 75 = 575 Money multiplier= money supply /monetary base = 575 / 100 = 5.75 Page 16 of 25 ©Prep101 www.prep101.com/freestuff Use the following balance of payments accounts information to answer question 34. Item Imports of goods Imports of services Exports of goods Exports of services Net interest payments Net transfers Foreign investment in Greatland Greatland’s investment abroad Official settlements account millions of dollars -345 -250 550 270 0 8 200 -410 ? Q34. What is the capital account balance? a) b) c) d) e) $200 million -$200 million -$210 million $210 million Cannot be determined with given information Solution: c) -$210 million Capital account balance = Foreign investment in Greatland + Greatland’s investment abroad = 200 – 410 = -210 Q35. Assume real GDP is below potential GDP. In order to reduce___, the Bank of Canada is likely to___ a) b) c) d) e) Unemployment, increase the money supply Unemployment, decrease the money supply Inflation, increase the money supply Inflation, decrease the money supply None of the above Solution: a) Unemployment, increase the money supply The economy is at below full-employment equilibrium. Unemployment is above its natural rate. To reduce unemployment, AD must shift right. This can be achieved by an increase in the money supply. When money supply increases, interest rates fall and as a result, investment, consumption and exports increase. Page 17 of 25 ©Prep101 www.prep101.com/freestuff Q36. If the Bank of Canada buys securities from the public, the money supply___, and the aggregate demand___ a) b) c) d) e) increases, shifts right increases, shifts left decreases, shifts right decreases, shiftsleft increases, is not affected Solution: a) increases, shifts right When the Bank of Canada buys securities from the public, money gets deposited in a chartered bank. The reserves of the chartered bank increase lending increases money supply increases. When money supply increases, interest rates fall and thru increase in I, C and NX, the AD curve shifts right. Q37. If the Bank of Canada increases the money supply, other things remaining the same, the value of Canadian dollar will__, and the exports will__ a) b) c) d) e) Rise, fall Rise, rise Fall, fall Fall, rise Rise, not be affected Solution: d) Fall, rise Money supply increases interest rates fall Canadian interest bearing assets become less attractive buy foreign currency to invest abroad Canadian dollar becomes cheaper exports increase Q38. As a result of an increase in government expenditures, in the short run, the interest rate___, and the exchange rate___ a) b) c) d) e) Increases, falls Decreases, falls Increases, rises Decreases, rises Cannot be determined with given information Solution: c) Increases, rises Government expenditures increase Aggregate demand increases GDP and Price level increase Interest rates increase both because of the increase in demand for money and decrease in the quantity of real money Canadian interest-bearing assets become more attractive the exchange rate rises Page 18 of 25 ©Prep101 www.prep101.com/freestuff Q39. Which of the following best describes the process of international crowding out? a) Expansionary fiscal policy lowers interest rates, leading to an increase in the exchange rate, leading to a decrease in net exports b) Expansionary fiscal policy raises interest rates, leading to a decrease in the exchange rate, leading to an increase in net exports c) Expansionary fiscal policy raises interest rates, leading to an increase in the exchange rate, leading to a decrease in net exports d) Expansionary fiscal policy raises interest rates, leading to an increase in the exchange rate, leading to an increase in net exports e) Expansionary fiscal policy raises interest rates, leading to an increase in the exchange rate, but does not affect net exports Solution: c) Expansionary fiscal policy raises interest rates, leading to an increase in the exchange rate, leading to a decrease in net exports Expansionary fiscal policy interest rates rise Canadian interest-bearing assets become more attractive the exchange rate rises exports fall and imports increase net exports fall Q40. Assume in a country, there are no taxes and no foreign trade. Assume the marginal propensity to consume (MPC) is 0.75 and there is no crowding in effect. If government expenditures increase by $20 billion and the crowding out effect is $15 billion, the AD curve will a) b) c) d) e) Shift right by $65 billion. Shift right by $80 billion. Shift right by $5 billion. Shift left by $95 billion. Shift left by $5 billion. Solution: a) Shift right by $65 billion. Multiplier = 1 / (1-MPC) = 4; Shift in AD with no crowding out effect= 20*4=80. Shift in AD with the crowding out effect=80-15=65 Page 19 of 25 ©Prep101 www.prep101.com/freestuff Q41. According to an extreme Monetarism a) Both fiscal and monetary policy affect aggregate demand b) Neither fiscal policy nor monetary policy have an effect on aggregate demand c) A change in government expenditures or in taxes has no effect on AD and a change in the quantity of money has a large effect on AD. d) A change in government expenditures or in taxes has a large effect on AD and a change in the quantity of money has no effect on AD. e) A change in government expenditures or in taxes has no effect on AD and a change in the quantity of money has a small effect on AD. Solution: c) A change in government expenditures or in taxes has no effect on AD and a change in the quantity of money has a large effect on AD. If the interest rate has no effect on the quantity of money demanded or if expenditure is highly sensitive to the interest rate, fiscal policy is impotent an increase in government expenditures raises interest rate increase in government expenditures is completely crowded out by decrease in interest rate sensitive expenditures. Use the following graph to answer question 42: LAS SAS0 P 200 A SAS1 175 170 160 C B AD0 AD1 AD2 Real GDP Q42. Suppose an economy initially is in equilibrium at point A. If the money supply is expected to decrease by 20 percent, what is likely to happen to real GDP and the price level in the short run if the money supply actually decreases by 30 percent? a) b) c) d) e) A decrease in GDP and a decrease in the price level No change in GDP and a decrease in the price level No change in GDP and an increase in the price level A decrease in GDP and no change in the price level No change in GDP and no change in the price level Page 20 of 25 ©Prep101 www.prep101.com/freestuff Solution: a) A decrease in GDP and a decrease in the price level An anticipated decrease in the money supply AD is expected to fall from AD0 to AD1 money wages fall SAS shifts rightward from SAS0 to SAS1. However, AD shifts to AD2. The intersection of AD2 and SAS1 (point C) is below potential GDP A decrease in GDP and lower prices. Use the following graph to answer question 43: Inflation rate 4.5 LRPC 4 3.5 3 ● 2.5 ● 2 1.5 SRPC 1 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 Unemployment rate Q43. What will happen if the natural rate of unemployment decreases, but the expected inflation rate does not change? a) b) c) d) e) The LRPC shifts left and the SRPC does not shift The LRPC shifts left and the SRPC shifts right The LRPC shifts left and the SRPC shifts left The LRPC shifts right and the SRPC shifts left The LRPC shifts right and the SRPC shifts right Solution: c) The LRPC shifts left and the SRPC shifts left Since the LRPC is vertical at the natural rate of unemployment, when the natural rate of unemployment decreases the LRPC shifts to the left. The SRPC shows unemployment-inflation relationship for fixed levels of expected inflation and natural rate of unemployment. No change in the expected inflation rate and a decrease in the natural rate of unemployment shift the SRPC to the left. LRPC and SRPC intersect where the natural rate of unemployment is at its new lower level and inflation is 2% Page 21 of 25 ©Prep101 www.prep101.com/freestuff Q44. Assume in a country the money supply and the velocity of circulation of money do not change. If the price level is observed to decreases by a factor of two, real GDP must have a) b) c) d) e) Increased by a factor of two Decreased by a factor of two Increased, but by less than a factor of two More than doubled None of the above Solution: a) Increased by a factor of two According to the quantity theory of money, P*Y = M*V. M is constant and V is constant M*V is constant P*Y must be constant. Since P decreased 2 times, to keep P*Y constant, Y must increase two times (P/2)*(Y*2)=P*Y Use the following graph to answer question 45: PC2 Real GDP per hour of labour 3 4 PC1 2 5 1 Capital per hour of labour Q45. Assume the economy is at point 1. According to the classical growth theory, what is the effect of an advance in technology on productivity? a) Productivity increases and the economy moves from point 1 to point 4 and then to point 5 b) Productivity increases and the economy moves from point 1 to point 4 and then to point 3 c) Productivity increases and the economy moves from point 1 to point 2 and then to point 3 d) Productivity increases and the economy moves from point 1 to point 2 e) Productivity increases and the economy moves from point 1 to point 4 Page 22 of 25 ©Prep101 www.prep101.com/freestuff Solution: a) Productivity increases and the economy moves from point 1 to point 4 and then to point 5 Advances in technology increase productivity the productivity curve shifts upwards economy moves from point 1 to point 4 at point 4, people earn more than subsistence wage people live longer and have more children population grows the number of workers grow and capital stock per hour of labour falls movement along the productivity curve from point 4 to point 5, where the real wage returns to the subsistence level. Q46. What are the primary sources of economic growth? a) b) c) d) e) Investment in human capital Investment in physical capital Investment in new technologies All of the above None of the above Solution: d) All of the above Investment in physical capital Capital per hour of labour increases labour productivity increases Investment in human capital skills and knowledge increase labour productivity increases Investment in new technologies discovery of new ways to become more efficient and productive Use the following table to answer question 47: Real wage rate 6 7 8 9 10 Labour demand 110 100 90 80 70 Labour supply 20 40 60 80 100 Q47. Which of the following is correct if currently the real wage rate is $7? a) b) c) d) e) There is a shortage of labour and the real wage rate will increase There is a shortage of labour and the real wage rate will decrease There is a surplus of labour and the real wage rate will increase There is a surplus of labour and the real wage rate will increase Cannot be determined with given information Solution: a) There is a shortage of labour and the real wage rate will increase When real wage rate =$7, quantity of labour demanded is 100, quantity of labour Page 23 of 25 ©Prep101 www.prep101.com/freestuff supplied is 40 The firms would like to hire more, but at the rate of $7, there is a shortage of labour the real wage rate will rise until it becomes $9. Q48. According to the Keynesian theory of the business cycle, the main source of economic fluctuations is a) b) c) d) e) Volatile expectations about future sales and profits Fluctuations in productivity growth Growth rate of the quantity of money a) and b) a) and c) Solution a) Volatile expectations about future sales and profits According to the Keynesian theory of the business cycle, the main impulse leading to fluctuations in the economy are the changes in expected future sales and profits (or animal spirits). Changes in animal spirits change investment and bring changes to real GDP. Use the following figure to answer question 49: Price level LAS 140 SAS1 SAS0 B D 130 C A 120 AD1 110 AD0 100 200 300 400 500 600 Real GDP Q49. Assume the economy is at point A. According to the monetarist theory of the business cycle, an increase in the growth rate of the quantity of money a) b) c) d) e) Will move the economy from point A to point C Will move the economy from point A to point C and then to point B Will move the economy from point A to point D and then to point B Has no effect on the economy None of the above Solution: b) Will move the economy from point A to point C and then to point B Growth rate of money increases quantity of money increases interest rate and exchange rate increases I, C, and net exports increase aggregate demand increases and Page 24 of 25 ©Prep101 www.prep101.com/freestuff the AD curve shifts right real GDP increases and the price level increases, the economy moves from point A to point C at above full employment level, money wage decreases SAS shifts left real GDP returns to potential GDP (assuming the economy was at potential GDP before the shock) and the price level increases at point B, the new equilibrium. Use the following figure to answer question 50: LAS Price level SAS A AD1 AD0 Real GDP Q50. Assume the economy experiences an unanticipated, temporary increase in aggregate demand. The aggregate demand curve shifts from AD0 to AD1. Which of the following is likely to happen under a fixed rule policy? a) b) c) d) e) A rightward shift in the SAS curve. A rightward shift in the LAS curve. A leftward shift in the AD curve. A rightward shift in the AD curve. None of the above Solution c) A leftward shift in the AD curve. Under the fixed rule policy, actions are pursued independent of the state of the economy neither fiscal nor monetary policy respond to this change the AD curve eventually returns to its original level. Page 25 of 25 ...
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This note was uploaded on 03/12/2010 for the course ECON 203 taught by Professor Islam during the Winter '08 term at Concordia Canada.

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