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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 interest-bearing 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 Working-age 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 part-time 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 part-time workers and 40 % of those working part-time wished to work full-time, what was the involuntary part-time 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 part-time= employed * 0.2 = 26 * 0.2 = 5.2 # of involuntary part-time workers = 5.2 * 0.4 = 2.08 Involuntary part-time rate = (# of involuntary part-time 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 part-time job last week and is searching for a full-time 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 working-age 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 labour-force 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. Labour-force participation rate = labour force / working-age population. Working-age population does not change, but labour force increases labour-force 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) Long-run 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 full-employment 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 feedback-rule, why do many economists prefer a fixed-rule policy over a feedback-rule 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) Feedback-rule policies are less predictable than fixed-rule policies c) Under feedback-rule 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 fixed-rule policies, the economy remains in recession for a long time. The feedback-rule seems to be superior, because it puts the economy right back into fullequilibrium. There are three problems with feedback-rule 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 fixed-rule 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 full-employment 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 Feedback-rule 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/ (1-slope of AE)} * change in Investment {1/ (1-slope 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*(Y-t*Y)= a+ b*(1-t)*Y If b increases 2 times, b*(1-t) 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*(1-t)-m]), where b is MPC, t is marginal tax rate, and m is marginal propensity to import. GEM = 1 / (1 – [0.5*(1-0.2)-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*(1-t)-m]), where b is MPC, t is marginal tax rate, and m is marginal propensity to import. ATM = -0.5 / (1 – [0.5*(1-0.2)-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 full-employment. In the long-run, 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 one-third 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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