Econ 202 Section H01 Midterm 2

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1 , Spring 2010 March 16, 2010 PLEDGE: I have neither given nor received unauthorized help on this exam. SIGNED: PRINT NAME: Econ 202 Section H01 Midterm 2 Multiple Choice. 2.5 points each. 1. What would happen to the equilibrium price and quantity of peanut butter if the price of bread (a complement) falls, and fewer firms decided to produce peanut butter? a. Price will fall and the effect on quantity is ambiguous. b. Quantity will fall and the effect on price is ambiguous. c. Quantity will rise and the effect on price is ambiguous. d. Price will rise and the effect on quantity is ambiguous. 2. A high demand for a company s stock is an indication that a. the company has recently sold a large quantity of bonds. b. people are optimistic about the company s future. c. the company is in need of funds. d. people are pessimistic about the company s future. 3. As the price level rises, the value of money a. falls, and people desire to hold more of it for transactions. b. rises, and people desire to hold more of it for transactions. c. rises, and people desire to hold less of it for transactions. d. falls, and people desire to hold less of it for transactions. 4. If you deposit $100 in a savings account an annual interest rate of 14 percent and leave the interest compounding in the account, about how many years will it take before you have $200? a. 4 b. 7 c. 5 d If the reserve ratio for all banks is 20 percent, then $100 of new reserves can generate up to a. $500 of new money in the economy. b. $60 of new money in the economy. c. $2,000 of new money in the economy. d. $250 of new money in the economy. 6. Credit cards a. are included in M1 and M2. b. are included in M2 but not M1 c. are not included in any measure of the money supply. d. are included in M1 but not M2. 7. To decrease the money supply, the Fed can a. sell government bonds or decrease the discount rate. b. buy government bonds or decrease the discount rate. c. buy government bonds or increase the discount rate. d. sell government bonds or increase the discount rate. 8. At any given time, the voting members of the Federal Open Market Committee include a. all members of the Board of Governors. b. five of the 12 presidents of the regional Federal Reserve banks. c. the president of the Federal Reserve Bank of New York. d. All of the above are correct. 2

2 9. We associate the term debt finance with a. financial intermediaries, and we associate the term equity finance with financial markets. b. financial markets, and we associate the term equity finance with financial intermediaries. c. the bond market, and we associate the term equity finance with the stock market. d. the stock market, and we associate the term equity finance with the bond market. 10. The federal funds rate is the interest rate that a. banks charge the Fed for loans. b. the Fed charges Congress for loans. c. the Fed charges banks for loans. d. banks charge one another for loans. 11. According to the Arnold Kling blog post we read in class, the financial crisis of 2008 was primarily due to a. poor risk modeling, mortgage loans to poor people, and too little use of the secondary mortgage market. b. the secondary mortgage market, low down payment mortgages, and clueless financial managers. c. the Community Reinvestment Act, the Chinese, and Fannie Mae. d. insufficient regulation, greedy bankers, and the Federal Reserve. 12. Suppose a closed economy had public saving of $3 trillion and private saving of $2 trillion. What are national saving and investment for this country? a. $1 trillion, $2 trillion b. $1 trillion, $5 trillion c. $5 trillion, $5 trillion d. $5 trillion, $2 trillion 13. In which of the following instances is the present value of the future payment the largest? a. You will receive $2,000 in 10 years and the annual interest rate is 10 percent. b. You will receive $2,000 in 10 years and the annual interest rate is 8 percent. c. You will receive $1,000 in 5 years and the annual interest rate is 5 percent. d. You will receive $1,000 in 5 years and the annual interest rate is 3 percent. Figure Refer to Figure 4-9. If there is currently a surplus of 20 units of the good, then a. supply and demand will interact to make the price fall by $2 to eliminate the surplus. b. supply and demand will interact to make the price fall by $4 to eliminate the surplus. c. supply and demand will interact to make the price rise by $4 to eliminate the surplus. d. supply and demand will interact to make the price rise by $2 to eliminate the surplus. 2

3 15. The Fed can increase the price level by conducting open-market a. sales and raising the discount rate. b. sales and lowering the discount rate. c. purchases and lowering the discount rate. d. purchases and raising the discount rate. 16. In the United States in a typical year, purchases by households of durable goods, non-durable goods, and services compose about a. 5 percent of GDP. b. 15 percent of GDP. c. 19 percent of GDP. d. 70 percent of GDP. 17. When the money market is drawn with the value of money on the vertical axis, if the Federal Reserve buys bonds, then the money supply curve a. shifts rightward, causing the price level to rise. b. shifts rightward, causing the price level to fall. c. shifts leftward, causing the price level to fall. d. shifts leftward, causing the price level to rise. Figure MS is money supply and MD is money demand. 18. Refer to Figure If the current money-supply curve is the one labeled MS 1, then the equilibrium price level is a. 0.5 and the equilibrium value of money is 2. b. 2 and the equilibrium value of money is 0.5. c. 2 and the equilibrium value of money cannot be determined from the graph. d. 0.5 and the equilibrium value of money cannot be determined from the graph. 19. According to the blog post by James Hamilton discussed in class, since September 2008 the Fed has provided a tremendous amount of liquidity to mortgage markets, which it has financed primarily by a. issuing long-term government bonds. b. raising taxes. c. crediting banks excess reserve accounts at the Fed. d. more than doubling the money supply. 3

4 20. Suppose that you borrowed $60,000 in 2008 at 10% annual interest and combined it with $40,000 of your own money to buy $100,000 worth of Microsoft stock. The stock s price rose, and you sold one year later for $150,000. Your return on your own capital was a. 44% b. 110% c. 125% d. 50% 21. The efficient markets hypothesis implies that a. managed mutual funds should generally outperform indexed mutual funds. b. building a portfolio based on a published list of the most respected companies is likely to produce a better-than-average return. c. if a stock rose in price last year, it is likely to rise in price this year. d. None of the above are correct. 22. Short-term bonds are generally a. more risky than long-term bonds and so they feature higher interest rates. b. more risky than long-term bonds and so they feature lower interest rates. c. less risky than long-term bonds and so they feature lower interest rates. d. less risky than long-term bonds and so they feature higher interest rates. 23. Which of the following combinations implies a nominal interest rate of 7%? a. a real interest rate of 6 percent and an inflation rate of 1 percent b. a real interest rate of 2.5 percent and an inflation rate of 2 percent c. a real interest rate of 5.5 percent and an inflation rate of 3 percent d. a real interest rate of 4 percent and an inflation rate of 11 percent 24. Diversification of a portfolio a. can eliminate market risk, but it cannot eliminate firm-specific risk. b. increases the portfolio s standard deviation. c. can eliminate firm-specific risk, but it cannot eliminate market risk. d. is not necessary for a person who is risk averse. 25. According to the James Hamilton blogpost on Bernanke s recent testimony, when the Fed raises interest rates paid to banks on reserves held at the Fed, it is primarily trying to a. drive other interest rates in the economy (such as the Fed Funds Rate) higher. b. provide a subsidy to the banking system so that it can afford to pay bonuses to managers. c. stimulate the economy to reduce unemployment. d. persuade banks not to lend out their excess reserves. 26. Which of the following sets of events would almost certainly cause an increase in the equilibrium quantity sold of new cars? a. higher steel prices, and decreases in population b. improved technology for producing cars, and higher interest rates for car loans c. higher wages for auto workers, and increases in consumer incomes d. lower steel prices, and increases in consumer incomes 27. The principle of monetary neutrality implies that an increase in the money supply will a. increase neither the price level nor real GDP. b. increase real GDP, but not the price level. c. increase the price level, but not real GDP. d. increase real GDP and the price level. 28. On a T-account for a bank, a. deposits are assets and reserves are liabilities. b. reserves and deposits are both liabilities. c. reserves are assets and deposits are liabilities. d. reserves and deposits are both assets. 4

5 29. Fundamental analysis shows that the present value of the income expected from holding a share of stock in Wallace Electronics Corporation is less than its price. a. This stock is high-priced; you should consider adding it to your portfolio. b. This stock is low-priced; you should consider adding it to your portfolio. c. This stock is low-priced; you shouldn't consider adding it to your portfolio. d. This stock is high-priced; you shouldn't consider adding it to your portfolio. 30. Based on the quantity equation, if M = 150, V = 4, and Y = 200, then P = a. 1/3. b. 3. c. 2. d. 1/2. 5

6 25 points total. Answer in the space provided. Name 31. a. Suppose that the federal government s tax revenues fall at the same time that it increases its expenditures. According to the model of the financial system that we discussed in class, this change in policy should cause equilibrium interest rates to (circle one: RISE, FALL) and the amount of private investment to (RISE, FALL). Use a graph below to illustrate this change, being sure to label all curves, axes, and equilibria: b. At the same time as the change in policy discussed above, suppose that a recession occurs due to a fall in investor optimism. The decline in investor optimism will reverse the effect of the government policy change on (INTEREST RATES, INVESTMENT), but it will accentuate its effect on (INTEREST RATES, INVESTMENT), c. Explain your answer in part b, using a graph. Label all curves and axes. Turn over for Extra Credit Questions 6

7 EXTRA CREDIT (UP TO 8 POINTS) ANSWER BELOW. XCa Recently, the Fed has injected a tremendous amount of liquidity into the banking system, as explained in Hamilton s blogpost. Using a graph, show the effect of the Fed s liquidity injections on equilibrium interest rates and investment. Be careful to justify the curve shift(s) that you portray, using a sentence or two of discussion. XCb. Suppose the Chinese, Japanese, Saudis, and other foreigners buy large amounts of U.S. Treasury bonds. Using a new graph, show the effect on equilibrium interest rates and investment. Be careful to justify the curve shift(s) that you portray, using a sentence or two of discussion. 7

8 ID: A Econ 202 Section H01 Midterm 2 Answer Section MULTIPLE CHOICE 1. D 2. B 3. A 4. C 5. A 6. C 7. D 8. D 9. C 10. D 11. B 12. C 13. B 14. A 15. C 16. D 17. A 18. B 19. C 20. B 21. D 22. C 23. A 24. C 25. D 26. D 27. C 28. C 29. D 30. B 1

9 ID: A SHORT ANSWER 31. a. RISE, FALL, Graph should show a decrease in the supply of loanable funds. b. Interest Rates, Investment. c. Graph should show a demand decrease. XCa. The inflow of liquidity will not affect savings, but it might affect optimism and faith in the financial system. Therefore, a rightward shift in the Demand for loanable funds curve will tend to drive interest rates and investment up. XCb. Foreigners savings will move into the system, increasing the supply of loanable funds and increasing investment and driving down interest rates. Alternatively, you can think of it as a decrease in the net domestic demand for loanable funds, as the foreigners investment in the US crowds out domestic investment spending. 2

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