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Unformatted text preview: ©Prep101 www.prep101.com/freestuff Solutions to Practice Macro Exam #2
Q1. Suppose in Highland, it takes 6 hours to produce 1 litre of milk and 2 hours to
produce1 lbs of fish, whereas in Lowland, it takes 2 hours to produce 1 litre of milk and 1
hour to produce1 lbs of fish. Both countries would be better off by trading at a relative
price of milk ranging
a)
b)
c)
d)
e) Between 2 and 3 lbs of fish per litre of milk
Between 1/3 and 1/2 lbs of fish per litre of milk
Between 1 and 3 lbs of fish per litre of milk
Between 1/2 and 3 lbs of fish per litre of milk
Between 1/3 and 2 lbs of fish per litre of milk Solution: a) Between 2 and 3 lbs of fish per litre of milk
Both countries are better off if relative price of milk is in between the two domestic
prices.
Highlanders can spend 6 hours producing 1 litre of milk or 6/2=3 lbs of fish the
opportunity cost of milk in Highland = 3 lbs of fish
Lowlanders can spend 2 hours producing 1 litre of milk or 2/1=2 lbs of fish the
opportunity cost of milk in Lowland = 2 lbs of fish Q2. Assume the government pays a statistician at the Statistics Canada $60,000 in salary
in 2004, and $40,000 in retirement benefits in 2005.
a)
b)
c)
d)
e) 2004 GDP will increase by $60,000 and 2005 GDP will increase by $40,000
2004 GDP will increase by $60,000 and 2005 GDP will increase by $100,000
2004 GDP will increase by $60,000 and 2005 GDP will not change
2004 GDP will increase by $60,000 and 2005 GDP will decrease by $40,000
None of the above Solution: c) 2004 GDP will increase by $60,000 and 2005 GDP will not change
Retirement benefits are transfers and are not included in GDP. Q3. All else equal, a decrease in the US interest rates would
a)
b)
c)
d)
e) Increase demand and decrease supply of Canadian dollars
Increase demand and supply of Canadian dollars
Decrease demand and supply of Canadian dollars
Decrease demand and increase supply of Canadian dollars
Increase demand for Canadian dollars and leave supply unaffected Solution: a) Increase demand and decrease supply of Canadian dollars
All else equal, a decrease in US interest rates increase in the Canadian interest rate
differential Canadian interestbearing assets become relatively more Page 1 of 26 ©Prep101 www.prep101.com/freestuff profitable investors move funds to Canada
CAD falls demand for CAD increases and supply of Q4. If a country reported nominal GDP of 200 billion in 2005 and 150 billion in 2004
and reported a GDP deflator of 125 in 2005 and a GDP deflator of 120 in 2004 then
from 2004 to 2005,
a)
b)
c)
d)
e) Real GDP decreased and prices increased.
Real GDP increased and prices decreased.
Real GDP and prices both increased.
Real GDP and prices both decreased.
Cannot determine with given information Solution: c) real GDP and prices both increased.
Real GDP in 2004 = (Nominal GDP / GDP deflator) X 100 = 125 billion
Real GDP in 2005 = (Nominal GDP / GDP deflator) X 100 = 160 billion Use the following information about Tinyland to answer question 5 (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 Q5. If 3 thousand workers are unemployed and 10 thousand people are out of the labour
force, what is the labour force participation rate?
a)
b)
c)
d)
e) 50%
60%
65%
68%
70% Solution: e) 70%
Number of people employed= 20 thousand
Number of people unemployed= 3 thousand
Labour force= 20+3=23 thousand Page 2 of 26 ©Prep101 www.prep101.com/freestuff Workingage population= 23+10=33 thousand
labour force participation rate = (23 / 33) * 100 = 70%. Use the following job market information collected by Statistics Greatland (figures are in
millions) to answer question 6 and 7:
2001
40
4
22
5 Working Age Population
Unemployed
Employed
Working parttime
Labour Force 2002
42
23
4
30 2003
44
5 31 Q6. If 2 million of those unemployed in 2001 were cyclically unemployed, what was the
natural rate of unemployment?
a)
b)
c)
d)
e) 5%
5.5 %
7.7 %
10 %
None of the above. Solution: c) 7.7 %
Labour force = employed + unemployed = 22 + 4 = 26.
Natural rate of unemployment =
ActualUnemployed − CyclicalUnemployed
4−2
* 100 =
*100 = 7.7%
LabourForce
26
Q7. If 20 % of the employed in 2003 were parttime workers and 40 % of those working
parttime wished to work fulltime, what was the involuntary parttime rate? a)
b)
c)
d)
e) 5%
6.1 %
6.7 %
8%
10.8% Solution: c) 6.7 %
Employed = Labour force – unemployed = 31 – 5 = 26.
Working parttime= employed * 0.2 = 26 * 0.2 = 5.2
# of involuntary parttime workers = 5.2 * 0.4 = 2.08
Involuntary parttime rate = (# of involuntary parttime workers / labour force) * 100=
(2.08 / 31) * 100 = 6.7 %. Page 3 of 26 ©Prep101 www.prep101.com/freestuff Assume in Foodland, the CPI basket contains only two goods. Use the following
information collected by the Statistics Foodland to answer question 8:
2004 2005 Price
2
5 Potatoes
Fish Quantity
50
100 Price
3
8 Quantity
60
200 Q8. Using 2004 as the base year, calculate the CPI for 2005. a) 158.3
b) 167.1
c) 170.4
d) 152.9
e) 110.5
Solution: a) 158.3
CPI (2005; 2004 as base year) =
(2005 prices * 2004 quantities)/(2004 prices * 2004 quantities) * 100 =
(3*50 + 8*100) / (2*50 + 5*100) * 100 = (950 / 600)*100=158.3 Use the following to answer question 9. Assume Canada and the USA produce only two
goods: fish and milk. Production possibilities are given by the following schedule:
Output
Country
Canada
USA Milk (litres)
200
400 or
or Fish (lbs)
500
300 Q9. Which country has a comparative advantage in milk production? a)
b)
c)
d)
e) USA
Canada
Both countries
Neither country
Cannot be determined with given information Solution: a) USA
The opportunity cost of milk (opportunity cost of producing 1 litre of milk) in Canada =
500/200= 2.5 lb of fish
The opportunity cost of (1 litre of) milk in the USA = 300/400= 0.75 lb of fish
Milk is more expensive in Canada USA should specialize in milk production Page 4 of 26 ©Prep101 www.prep101.com/freestuff Q10. Who would not be included in the labour force? a)
b)
c)
d)
e) David, who retired three weeks ago and is not looking for work
Tara, who quit her parttime job last week and is searching for a fulltime job
Susan, who is on a temporary layoff
All three are included in the labour force
None of the above are included in the labour force Solution: a) David, who retired three weeks ago and is not looking for work.
To be included in the labour force one has to be employed or unemployed. David does
not have a job, so he is not employed.
To be unemployed one has to search for a job. David is not looking for a job, so he is not
unemployed.
Q11. Discouraged workers a) Are included in the working–age population and are included in the labour
force.
b) Are not included in the working–age population, but are included in the labour
force.
c) Are not included in the working–age population and are not included in the
labour force.
d) Are counted as unemployed and included in the labour force
e) Are included in the working–age population, but are not included in the labour
force.
Solution: e) Are included in the working–age population, but are not included in the
labour force.
Discouraged worker is a workingage individual who does not have a job (not employed)
and is not actively looking for one (not unemployed).
Q12. Bonnie and Clyde graduated from a law school two weeks ago and started looking
for a job. As a result, the employment rate___, and the labourforce participation
rate ___. a)
b)
c)
d)
e) Increases; increases
Increases; is unaffected
Decreases; increases
Is unaffected; decreases
Is unaffected; is unaffected Solution: c) Decreases; increases
Bonnie and Clyde enter unemployment
increases. Unemployment increases Page 5 of 26 Labour force ©Prep101 www.prep101.com/freestuff Employment rate = employed / labour force. Employment does not change, but labour
force increases employment rates decreases.
Labourforce participation rate = labour force / workingage population.
Workingage population does not change, but labour force increases labourforce
participation rate increases.
Use the following figure to answer question 13:
120 AD LAS SAS 460 500 110
100
90
80
70 340 380 420 Q13. Consider statements (1) and (2) and select the correct answer: (1) Actual unemployment is below the natural rate of unemployment.
(2) Longrun aggregate supply curve will gradually shift leftward until
LAS=SAS=AD.
a)
b)
c)
d)
e) (1) is true; (2) is false
(1) and (2) are false
(1) is false; (2) is true
(1) and (2) are true
none of the above Solution: b) (1) and (2) are false
At below fullemployment equilibrium, there is cyclical unemployment in the economy
actual unemployment > than natural rate of unemployment.
SAS will shift rightward, not LAS.
Q14. Despite an apparent superiority of the feedbackrule, why do many economists
prefer a fixedrule policy over a feedbackrule policy? a) It is not possible to say whether real GDP is below or above potential GDP; so,
the policymakers cannot tell for sure whether they should pursue expansionary
policy or contractionary policy
b) Feedbackrule policies are less predictable than fixedrule policies
c) Under feedbackrule policies, the economy remains in recession for a long time
d) Both a) and c)
e) Both a) and b) Page 6 of 26 ©Prep101 www.prep101.com/freestuff Solution: e) both a) and b)
Under fixedrule policies, the economy remains in recession for a long time. The
feedbackrule seems to be superior, because it puts the economy right back into fullequilibrium. There are three problems with feedbackrule policies, however: 1) Potential
GDP is not known, 2) policy lags are longer than the forecast horizon, and 3) Feedbackrule policies are less predictable than fixedrule policies. Use the following information about a country to answer question 15:
Price Level LAS
SAS
A
D B
C
AD Real GDP Q15. Assume the economy is at point B. If no action is taken by the Central Bank or the
Government, in the long run the economy will a)
b)
c)
d)
e) Move to point C
Move to point A
Stay at point B
Move to point D
Move to point C and then to A Solution: b) Move to point A
There in an inflationary gap at point B. SAS will shift to the left until LAS=SAS=AD,
where prices are higher and real GDP=potential GDP. Page 7 of 26 ©Prep101 www.prep101.com/freestuff 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 fullemployment equilibrium at point A.
Assume there is a sudden increase in aggregate supply. In response to this shock,
the central bank cuts the money supply by 50 %. Right after the cut in the money
supply, there is another supply shock—this time, the productivity decreases and the
effect on the economy is much stronger than the initial supply shock. If real
business cycle theory is correct, where will the economy move? a)
b)
c)
d)
e) The economy will move from point A to point F
The economy will move from point A to point I
The economy will mover from point A to point D
The economy will mover from point A to point G
None of the above Solution: b) The economy will move from point A to point I
Initial shock LAS0 to LAS2, move from A to B
Money cut AD0 to AD1, move from B to G
Second shock LAS2 to LAS1, move from G to I
Feedbackrule policy makes price level fluctuations more severe Page 8 of 26 ©Prep101 www.prep101.com/freestuff Use the following graph to answer question 17 (assume there are no exports or imports in
the economy):
Aggregate
Planned
Expenditure 45 degree line AE=C+I+G Real GDP
Y1 Y2 Y3 Q17. Currently real GDP is equal to Y1. Which of the following describes best how the
aggregate expenditure will converge to equilibrium? a) Inventories will decrease, firms will increase output and real GDP will increase
from Y1 to Y2.
b) Inventories will decrease, firms will increase output and real GDP will increase
from Y1 to Y3.
c) Inventories will increase, firms will increase output and real GDP will increase
from Y1 to Y2.
d) Inventories will increase, firms will increase output and real GDP will increase
from Y1 to Y3.
e) At Y1, the economy is in equilibrium and no changes in aggregate expenditure
will take place.
Solution: a) Inventories will decrease, firms will increase output and real GDP will
increase from Y1 to Y2.
When real GDP is less than the aggregate planned expenditure, there is an unplanned
decrease in inventories. Firms increase production and GDP increases. This continues
until real GDP equals the aggregate planned expenditure at Y2 and the unplanned
inventory changes are zero. Page 9 of 26 ©Prep101 www.prep101.com/freestuff Q18. Suppose the exchange rate is 80 Japanese yen per Canadian dollar. If a Sony
DVD recorder sells for 16,000 yen in Tokyo, what is the dollar price of the DVD
recorder? a)
b)
c)
d)
e) $100
$120
$140
$165
$200 Solution: e) $200
1 CAD=80 yen 16,000 yen = 16,000 / 80 =200 CAD Q19. If income decreases by $400 as a result of a decrease in investment by $50, then
the
a) Slope of the aggregate planned expenditure curve is 0.5
b) Slope of the aggregate planned expenditure curve is 0.75
c) Slope of the aggregate planned expenditure curve is 0.125
d) Slope of the aggregate planned expenditure curve is 0.875
e) None of the above
Solution: d) Slope of the aggregate planned expenditure curve is 0.875
Change in Income = {1/ (1slope of AE)} * change in Investment
{1/ (1slope of AE)} = Change in Income / change in Investment
Slope of AE =1  1 / (Change in Income / change in Investment) = 1  1/ 8=0.875 Q20. If the price level falls and the aggregate planned expenditure curve shifts up, what
will happen to the aggregate demand curve?
a)
b)
c)
d)
e) There will be a rightward movement along the aggregate demand curve
There will be a leftward movement along the aggregate demand curve
The aggregate demand curve will shift to the right
The aggregate demand curve will shift to the left
The aggregate demand curve will shift to the right and then to the left Solution: a) There will be a rightward movement along the aggregate demand curve
Recall that the AD curve depicts a relationship between the price level and the quantity
demanded. When prices fall, more goods and services are demanded—a rightward
movement along the AD curve. Assume a country has a consumption function of C = 5 + 0.4Y, and an import function of
M = 0.2Y. Further assume that investment is 5, government expenditure is 14, and
exports is 2. Use this information to answer questions 21 and 22. Page 10 of 26 ©Prep101 www.prep101.com/freestuff Q21. What is the aggregate expenditure function? a)
b)
c)
d)
e) AE = 19 + 0.4Y
AE = 26 + 0.2Y
AE = 21 + 0.6Y
AE = 30 + 0.8Y
AE = 42  0.2Y Solution: b) 26 + 0.2Y
AE = C + I + G + (X – M) = 5 + 0.4Y + 5 + 14 + 2 – 0.2Y= 26 + 0.2Y Q22. If the marginal propensity to consume increases by a factor of two (twofold
increase), what is the new aggregate expenditure function? a)
b)
c)
d)
e) AE = 26 + 1.1Y
AE = 30 + 0.8Y
AE = 21 + 0.7Y
AE =26 + 0.6Y
AE = 26  0.7Y Solution: d) 26 + 0.6Y
C=a +b*YD= a+b*(Yt*Y)= a+ b*(1t)*Y
If b increases 2 times, b*(1t) increases 2 times.
C = 5 + 0.4Y changes to C = 5 + 0.8Y
AE = C + I + G + (X – M) = 5 + 0.8Y + 5 + 14 + 2 – 0.2Y= 26 + 0.6Y Q23. If the structural deficit is $20 billion, potential GDP is a)
b)
c)
d)
e) $100 billion.
$200 billion.
$550 billion.
$650 billion.
$750 billion. Solution: d) $650 billion.
At potential GDP, structural deficit = outlays – revenues (taxes).
20 = 200 – (50 + .2 * potential GDP) = 150  0.2 * potential GDP.
Potential GDP = (150 – 20) / 0.2 = 650 Page 11 of 26 ©Prep101 www.prep101.com/freestuff Use the following information to answer questions 24 and 25.
In a country, the marginal propensity to consume is 0.5, the marginal tax rate is 0.2, and
the marginal propensity to import out of real GDP is 0.2.
Q24. The government expenditures multiplier is a)
b)
c)
d)
e) 1.25
2.5
0
2.8
4 Solution: a) 1.25
The Government expenditure multiplier (GEM) = 1 / (1[b*(1t)m]), where b is MPC, t
is marginal tax rate, and m is marginal propensity to import.
GEM = 1 / (1 – [0.5*(10.2)0.2]) = 1.25 Q25. The autonomous tax multiplier is a)
b)
c)
d)
e) 0.625
3.525
3.255
3
2 Solution: a) 0.625
The autonomous tax multiplier (ATM) = b / (1[b*(1t)m]), where b is MPC, t is
marginal tax rate, and m is marginal propensity to import.
ATM = 0.5 / (1 – [0.5*(10.2)0.2]) =  0.625 Page 12 of 26 ©Prep101 www.prep101.com/freestuff Use the following figure to answer question 26:
LAS
Price level
SAS1 C 120
110 SAS0 D B
A 100 AD1 AD0
400 500 600
Real GDP Q26. Assume an economy initially is in equilibrium at point C. If government
expenditures decrease, in the long run the economy will move to a)
b)
c)
d)
e) Point B
Point C
Point A
Point D and then Point C
Point B and then Point C Solution: c) Point A
A decrease in government expenditures shifts AD curve leftward and the short run
equilibrium is at point D. At point D, real GDP is lower than potential GDP (there is a
recessionary gap) resulting in lower money wage rates. Decrease in resource prices shifts
the SAS curve rightward. Long run equilibrium is at point A. Use the following balance of payments accounts information to answer question 27:
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 Page 13 of 26 millions of dollars
345
250
550
270
0
8
200
410
? ©Prep101 www.prep101.com/freestuff Q27. What is the current account balance? a)
b)
c)
d)
e) $225 million
$233 million
$205 million
$180 million
$205 million Solution: b) $233 million
Current account balance = Exports of goods and services + Imports of goods and services
+Net interest payments +Net transfers=550+270–345–250+ 0+8=233 Q28. Suppose initially the economy of Fineland is at full employment equilibrium.
Assume two events happen: 1) foreign countries increase their export orders from
Fineland and 2) expectations of firms change and now they expect higher future
profits. Which of the following statements is true?
a) The countercyclical fiscal policy response will result in long run equilibrium
that has a higher inflation rate than if no policy action were taken.
b) The countercyclical fiscal policy response will result in long run equilibrium
that has a lower inflation rate than if no policy action were taken
c) In the long run, inflation rate will always be same whether or not
countercyclical fiscal policy is implemented.
d) Both a) and b) are possible
e) None of the above Solution: b) The countercyclical fiscal policy response will result in long run equilibrium
that has a lower inflation rate than if no policy action were taken
Both events increase aggregate demand and shift the AD curve rightward. In the short
run, real GDP increases. If no policy action is taken, eventually, money wage rate
increase and the short run aggregate supply curve shifts leftward. Real GDP returns to
its full employment level, but the price level increases.
When AD curve shifts right, the countercyclical fiscal policy response can move the
aggregate demand curve back to the left. As a result, initial demand shocks are partially
(or fully) offset and the new price level is lower compared to the price level without any
policy action. Page 14 of 26 ©Prep101 www.prep101.com/freestuff Use the following table to answer question 29:
Currency in circulation $3,000 Total demand deposits $15,000 Actual reserves in the banking system $3,750 Q29. What is an immediate effect on the money supply if $200 in new coins are injected
into the economy? a)
b)
c)
d)
e) The money supply will not be affected
The money supply will decrease by $200
The money supply will increase by $200
The money supply will increase by $400
The money supply will decrease by $100 Solution: c) The money supply will increase by $200
Money supply = demand deposits + currency in circulation
Currency in circulation = notes + coins.
Currency in circulation will increase by $200
Money supply = 3,200 + 15,000 = 18,200 Q30. If the fixed income (coupon) of a perpetual bond is $20 and the interest rate
increases from 8 percent to 10 percent, then the price of the bond a)
b)
c)
d)
e) will fall from $300 to $250
will increase from $250 to $300
will remain unchanged
will fall from $250 to $200
will increase from $200 to $250 Solution: d) will fall from $250 to $200
Price of a perpetual bond = dollar payment per year/interest rate
Price before interest rate increase= 20 / 0.08= 250
Price after interest rate increase= 20 / 0.10= 200 Q31. Assume the money supply is fixed. If the quantity of money demanded is higher
than the quantity of money supplied, the quantity of money demanded will __,
and the interest rate will__.
a)
b)
c)
d)
e) Decrease, increase
Decrease, decrease
Increase, increase
Increase, decrease
Decrease, not change
Page 15 of 26 ©Prep101 www.prep101.com/freestuff Solution: a) Decrease, increase
People demand more money sell financial assets to have more money demand for
financial assets falls and the price of these assets falls lower prices (of bonds) imply
higher interest rates. Higher interest rates result in lower money demand. Use the following table to answer question 32. Assets
Reserves
Loans
Total Liabilities
$50,000 Deposits
$150,000
$200,000 Total $200,000
$200,000 Q32. If the bank is holding $20,000 in excess reserves, desired reserve ratio is a)
b)
c)
d)
e) 25%
18%
20%
10%
15% Solution: e) 15 %
Desired reserves = actual reserves – excess reserves = 50,000 – 20,000= 30,000
Desired reserve ratio = desired reserves / deposits = 30,000 / 200000 = 0.15 Use the following table to answer question 33:
Currency in circulation $3,000 Total demand deposits $15,000 Actual reserves in the banking system $3,750 Q33. What is money multiplier? a)
b)
c)
d)
e) 2.2
2.67
4.00
4.5
2.78 Solution: b) 2.67
Money multiplier= money supply /monetary base
Monetary base = currency in circulation + actual reserves = 3,000 + 3,750 = 6,750 Page 16 of 26 ©Prep101 www.prep101.com/freestuff Money supply = demand deposits + currency in circulation = 3,000 + 15,000 = 18,000
Money multiplier= money supply /monetary base = 18000 / 6750 = 2.67 Q34. If the Bank of Canada buys government securities in the open market, the real
money supply curve will__, and the interest rate will__. a)
b)
c)
d)
e) Shift right, fall
Shift left, rise
Not be affected, fall
Not be affected, rise
Shift left, fall Solution: a) Shift right, fall
The Bank of Canada buys securities and pays money chartered banks’ reserves
(deposits at the BoC) increase. Banks make more loans money supply increases and
interest rate falls. Use the following information on the banking system of Highland to answer questions 35
and 36. Assume that the actual reserves equal desired reserves.
Actual reserves in the banking system
Total demand deposits
Currency in circulation $1000
$5,000
$600 Q35. If the Bank of Highland sells $500 worth of government securities, the money
supply will a)
b)
c)
d)
e) Increase by $1,750
Decrease by $1,750
Not change
Increase by $3,500.
Decrease by $2,000 Solution: b) Decrease by $1,750
Money supply = demand deposits + currency in circulation = 5000 + 600 = 5600.
Monetary base = Reserves + currency in circulation = 1000 + 600 = 1600.
Money multiplier = Money supply/Monetary base= 5600/1600 = 3.5
Government sells securities
reserves fall.
Change in reserves =  500.
Change in Money supply = MM * change in reserves = 3.5 * (500) = 1750 Page 17 of 26 ©Prep101 www.prep101.com/freestuff Q36. If the Bank of Highland buys $300 worth of government securities, the money
supply will a)
b)
c)
d)
e) Increase by $3,000
Decrease by $1,500
Increase by $1,050.
Not change
Decrease by $2,500 Solution: c) Increase by $1,050.
Money multiplier = Money supply/Monetary base= 5600/1600 = 3.5
Government buys securities reserves increase.
Change in reserves = +300
Change in Money supply = MM * change in reserves = 3.5 * (300) = 1050
Q37. When the Bank of Canada purchases the government securities in an open market,
bank reserves__ and the monetary base__ a)
b)
c)
d)
e) Decrease, decreases
Increase, increases
Decrease, increases
Increase, decreases
Increase, does not change Solution: b) Increase, increases
The Bank of Canada purchases securities bank reserves increase monetary base
increases (monetary base = currency in circulation + reserves).
Q38. As a result of an increase in the money supply, in the short run, investments___,
and the aggregate planned expenditure ___ a)
b)
c)
d)
e) Decrease, decreases
Does not change, increases
Increase, decreases
Increase, increases
Decrease, does not change Solution: d) Increase, increases
Money supply increases interest rates fall investments (and other interest sensitive
expenditures) increase AE (C + I + G + NX) increases. Page 18 of 26 ©Prep101 www.prep101.com/freestuff Q39. Suppose the government expenditures increase and as a result real GDP and the
price level start to increase. What are the second round effects of the increasing real
GDP and the rising price level on the aggregate demand curve? a) The increasing real GDP shifts the AD curve to the left and the rising price
level brings a movement up along the AD curve.
b) The increasing real GDP shifts the AD curve to the right and the rising price
level brings a movement up along the AD curve.
c) The increasing real GDP shifts the AD curve to the left and the rising price
level shifts the AD curve to the right.
d) The increasing real GDP brings a movement up along the AD curve and the
rising price level shifts the AD curve to the right.
e) The increasing real GDP brings a movement up along the AD curve and the
rising price level brings a movement down along the AD curve.
Solution: a) The increasing real GDP shifts the AD curve to the left and the rising price
level brings a movement up along the AD curve.
Real GDP increases demand for money increases interest rate increases I, C, and
NX fall AD falls fall in AD at given prices shifts the AD curve to the left.
Price level increases with fixed nominal money supply, real money supply decreases
interest rate increases I, C, and NX fall AD falls. Fall in AD as a result of an in
increase in the price level results in a movement along the AD curve. Q40. Suppose the economy initially operates at fullemployment. In the longrun, the
expansionary fiscal policy will __real GDP and will __ the price level, while the
expansionary monetary policy will __ real GDP and will __the price level. a)
b)
c)
d)
e) Not change, increase, not change, increase
Increase, increase, not change, not change
Not change, increase, not change, decrease
Not change, decreases, not change, decrease
Increase, not change, not change, increase Solution: a) Not change, increase, not change, increase
In the long run, the effects of expansionary fiscal and expansionary monetary policy on
the price level and real GDP are similar—the price level increases, real GDP does not
change. Note, however, that the composition of real GDP changes under fiscal expansion,
while expansionary monetary policy is neutral. Page 19 of 26 ©Prep101 www.prep101.com/freestuff Use the figures below to answer question 41:
Price
level
150 SAS 140
130
AD1
120 AD2
AD0 110
800
Interest
rate (%) 900 1,000 1,100 1,200 MS1 Real GDP MS0 6
5
4
3
2
MD0 MD1
200 400 600 800 1000 Real money Q41. Which type of government policy does this figure illustrate? a)
b)
c)
d)
e) A contractionary fiscal policy.
An expansionary monetary policy.
An expansionary fiscal policy.
A contractionary monetary policy.
None of the above. Solution: c) An expansionary fiscal policy.
An expansionary fiscal policy increases aggregate demand from AD0 to AD1 Real
GDP and the price level increase
Increase in real GDP increases money demand, MD0 to MD1 interest rate rises I,C,
NX fall aggregate demand shifts back from AD1 to AD2
Price level increases higher prices reduce the real money supply; MS0 to MS1
interest rate rises and reduces expenditures further movement up the AD2 curve to the
intersection of SAS and AD2. Page 20 of 26 ©Prep101 www.prep101.com/freestuff 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 if the money supply and aggregate demand change as predicted? a)
b)
c)
d)
e) A decrease in the price level and an increase in real GDP.
No change in the price level and an increase in real GDP.
A decrease in the price level and no change in real GDP.
An increase in the price level and no change in real GDP.
No change in the price level and no change in real GDP. Solution: c) A decrease in the price level and no change in real GDP.
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.
If the money supply actually decreases by 20% and AD0 shifts to AD1 (as predicted), the
new equilibrium is at point B No change in GDP and lower prices. Page 21 of 26 ©Prep101 www.prep101.com/freestuff 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. The natural rate of unemployment is __ and the expected inflation rate is __ a)
b)
c)
d)
e) 1.5%, 4%
3.5 %, 2%
2%, 3%
2.5%, 2.5%
Cannot be determined without more information. Solution: b) 3.5 %, 2%
The short run Philips curve is drawn for a given level of expected inflation
On the long run Phillips curve, actual inflation equals expected inflation.
The two curves intersect where inflation =2% The expected inflation rate is 2%,
The long run Phillips curve is vertical at the natural rate of unemployment
the natural
rate of unemployment is 3.5% Q44. Assume over time real GDP increases to $1,200. The quantity of money increases
by 50% and velocity of circulation of money does not change. What will happen
to the price level?
a)
b)
c)
d)
e) The price level will increase by 10
The price level will increase by 20
The price level will increase by 37.5
The price level will increase by 50
The price level will decrease by 70 Page 22 of 26 ©Prep101 www.prep101.com/freestuff Solution: c) The price level will increase by 37.5
Initially the quantity of money =(P*Y) / V = 150*1000 / 10 = 15,000.
After the 50% increase, money =15,000*1.5=22,500.
P*Y = M*V P= M*V / Y = 22,500*10 / 1,200 = 187.5
The price level increases by 187.5 – 150 = 37.5 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 neoclassical 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 2 and then
to point 3
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 4
d) Productivity increases and the economy moves from point 1 to point 2
e) Productivity does not change, because population does not grow
Solution: b) Productivity increases and the economy moves from point 1 to point 4 and
then to point 3
Advances in technology increase productivity the productivity curve shifts
upwards economy moves from point 1 to point 4 at point 4, the rate of return exceeds
the target rate of return savings and investment increase capital stock per hour of
labour increases the economy moves from point 4 to point 3 Page 23 of 26 ©Prep101 www.prep101.com/freestuff Q46. If there were significant technological innovations last year and the capital stock
per hour of labour grew by 9 percent, growth of real GDP per hour of labour (assuming
the onethird rule holds) a)
b)
c)
d)
e) Would have been less than 3 percent
Would have been significantly greater than 3 percent.
Would have been about 2 percent
Would have been about 9 percent
Cannot be determined with given information Solution: b) Would have been significantly greater than 3 percent.
% change in real GDP per hour of labour (Y/L) = % change in technology (T) + 1/3 * %
change in capital per hour of labour (K/L) = % change in T + 3%
Since there were significant technological innovations, growth rate would be significantly
greater than 3%. Use the following table to answer question 47:
Real wage rate
6
7
8
9
10
Q47. Labour demand
110
100
90
80
70 Labour supply
20
40
60
80
100 What is the natural rate of unemployment if 20 workers are unemployed in longrun equilibrium?
a)
b)
c)
d)
e) 10%
15%
20%
25%
Cannot be determined with given information Solution: c) 20%
In long run equilibrium, labour demand = labour supply employment=80
Labour force= 80+20=100 unemployment rate=20/100=20% Page 24 of 26 ©Prep101 www.prep101.com/freestuff Use the following graph to answer question 48:
Price
level LAS
B 140 SAS1 130
C
D 120 SAS0 A
AD1 110
100 AD2
200 300 400 500 AD0
600 700 Real GDP Q48. Assume the economy is at point A. According to the Keynesian theory of the
business cycle, an increase in animal spirits (expected future sales and profits) a)
b)
c)
d)
e) Will move the economy from point A to point C
Will move the economy from point A to point D
Will move the economy from point A to point C and then to point B
Has no effect on the economy
None of the above Solution c) Will move the economy from point A to point C and then to point B
An increase in animal spirits demand for new capital increases investment increases
aggregate demand increases and the AD curve shifts right since money wages are
fixed, real GDP increases the economy moves to C real GDP exceeds potential
GDP money wages rise SAS shifts up real GDP falls and the price level
increases the economy moves to B. Q49. According to the new classical theory of the business cycle, economic fluctuations
are caused by ____. a)
b)
c)
d)
e) Unanticipated or anticipated changes in aggregate demand
Anticipated changes in aggregate demand
Unanticipated changes in aggregate demand
Fluctuations in productivity growth
None of the above Solution: c) Unanticipated changes in aggregate demand
Unanticipated fluctuations in AD (caused by slow growth rate of money, for example)
shift the AD curve money wage rate does not change real GDP and the price level
change
Anticipated fluctuations in AD money wage changes and shifts the SAS curve so that
when AD shifts, real GDP does not change Page 25 of 26 ©Prep101 www.prep101.com/freestuff Use the following figure to answer question 50:
LAS
Price level SAS A AD1
AD0
Real GDP Q50. Assume the economy experiences an unanticipated, permanent increase in
aggregate demand. The aggregate demand curve shifts from AD0 to AD1. Which
of the following describes best the outcome of the macroeconomic policy under a
fixed rule? 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 e) None of the above
Under the fixed rule policy, actions are pursued independent of the state of the economy
Neither fiscal nor monetary policies respond to this change money wage rate
increases and the SAS curve eventually shifts leftward. Page 26 of 26 ...
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 Winter '08
 Islam
 Macroeconomics

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