Economics 345 Practice Examination. This exam has two parts. Part I is worth 30 points, Part II is worth 20 points.

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1 Spring 2004 Mr. Easton Economics 345 Practice Examination This exam has two parts. Part I is worth 30 points, Part II is worth 20 points. Part I. Answer the following questions by writing the question number in your exam booklet and the letter of the correct answer. There is one correct answer per question. 1. Which one of the following statements is the most accurate? A. A depreciation of a country s currency makes its goods cheaper for foreigners. B. A depreciation of a country s currency makes its goods more expensive for foreigners. C. A depreciation of a country s currency makes its goods cheaper for its own residents. D. A depreciation of a country s currency makes its goods cheaper. 2. A foreign exchange swap A. is a spot sale of a currency. B. is a forward repurchase of the currency. C. is a spot sale of a currency combined with a forward repurchase of the currency. D. is a spot sale of a currency combined with a forward sale of the currency. 3. Which one of the following statements is the most accurate? Countries in the euro zone include A. Austria, Belgium, Finland, France, and Germany. B. Austria, Belgium, Finland, France, Germany, and Greece. C. Austria, Belgium, Finland, France, Germany, and Ireland. D. Austria, Belgium, Finland, France, Germany, and Italy. E. All of the above statements are correct. 4. If the dollar interest rate is 10 percent and the euro interest rate is 6 percent, then A. an investor should invest only in dollars. B. an investor should invest only in euros. C. an investor should be indifferent between dollars and euros. D. it is impossible to tell given the information. E. All of the above. 5. Individuals base their demand for an asset on A. the expected return the asset offers compared with the returns offered by other assets. 1

2 B. the riskiness of the asset s expected return. C. the asset s liquidity. D. All of the above. E. Only A and B. 6. The aggregate money demand depends on A. the interest rate. B. the price level. C. real national income. D. All of the above. E. Only A and C. 7. After a permanent one time increase in the money supply, A. the exchange rate overshoots in the short run. B. the exchange rate overshoots in the long run. C. the exchange rate smoothly depreciates in the short run. D. the exchange rate smoothly appreciates in the short run. 8. An increase in a country s money supply causes A. its currency to appreciate in the foreign exchange market, while a reduction in the money supply causes its currency to depreciate. B. its currency to depreciate in the foreign exchange market, while a reduction in the money supply causes its currency to appreciate. C. no effect on the values of its currency in international markets. D. its currency to depreciate in the foreign exchange market, while a reduction in the money supply causes its currency to further depreciate. 9. Under Purchasing Power Parity, A. E $/E = P US / P E. B. E $/E = P E / P ES. C. E $/E = P US + P E. D. E $/E = P US - P E. 10. Under the monetary approach to the exchange rate theory, money supply growth at a constant rate A. eventually results in ongoing price level deflation at the same rate, but changes in this long-run deflation rate do not affect the full-employment output level or the long-run relative prices of goods and services. B. eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do affect the full-employment output level and the long-run relative prices of goods and services. 2

3 C. eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level or the long-run relative prices of goods and services. D. eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level, only the long-run relative prices of goods and services. 11. In the short run, A. the interest rate can rise when the domestic money supply falls. B. the interest rate can decrease when the domestic money supply falls. C. the interest rate stays constant when the domestic money supply falls. D. the interest rate rises in the same proportion as the domestic money supply falls. 12. If people expect relative PPP to hold, A. the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected, in the United States and Europe, over the relevant horizon. B. the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected in Europe and the United States. C. the difference between the interest rates offered by dollar and euro deposits will equal the difference between the inflation rates expected, over the relevant horizon, in the United States and Europe, in the short run. D. the difference between the interest rates offered by dollar and euro deposits will be above the difference between the inflation rates expected, over the relevant horizon, in the United States and Europe. 13. The real exchange rate, q, is defined as A. the price of the foreign basket in terms of the domestic one. B. the price of the domestic basket in terms of the foreign one. C. the price of the foreign basket. D. the price of the domestic basket. 14. When the real exchange rate rises, A. Imports measured in terms of domestic output will rise. B. Imports measured in terms of domestic output will fall. C. Imports measured in terms of domestic output will not be affected. D. Imports measured in terms of domestic output will rise or fall. 3

4 15. Using the DD AA framework, which one of the following statements is the most accurate? A. Only monetary policy can bring the economy to full employment. B. Only fiscal policy can bring the economy to full employment. C. Only both monetary and fiscal policies can bring the economy to full employment. D. Neither policy is capable of bringing the economy to full employment. E. Monetary policy by itself or fiscal policy by itself can bring the economy to full employment. Suggested answers to the short answer questions 1.A 2.C 3.E 4.D 5.D 6.D 7.A 8.B 9.A 10.C 11.A 12.A 13.A 14.B 15.E 4

5 Illustrative Practice Questions Part II Midterm Examination 1. Explain why one can write the price level in the demand for money as follows: M d = P L (R, Y). Answer: The aggregate money demand is proportional to the price level. Imagine that all prices in an economy doubled, but the interest rate and everyone s real incomes remained unchanged. Then, the money value of each individual s average daily transactions would then simply double, as would the amount of money each wishes to hold. 2. Does the existence of non-tradable goods allow for deviations from Purchasing Power Parity? Answer: Yes, the existence of non-tradable goods allows deviations from PPP. This is because the price of a non-tradable good is determined entirely by its domestic supply and demand curves, and in turn fluctuations in demand and supply for these goods will affect the price level. Examples include housing, haircuts, services, etc. 3. How can long-run values in the real exchange rate change? Answer: An increase in world relative demand for Canadian output causes a long-run real appreciation of the dollar against the euro (a fall in the real dollar/euro exchange rate). A relative expansion of Canadian output causes a long-run real depreciation of the dollar against the euro (a rise in the real dollar/euro exchange rate). Practice long-answer questions for which no answer is given. Each questions should take about 10 minutes. 1. How does the impact of fiscal policy on the exchange rate differ if it is temporary or permanent? 2. An increase in the money stock will depreciate the exchange rate especially if expectations of future exchange rates change. Discuss. 3. A once-and-for-all or a continuous rate of increase in the money supply both give rise to changing prices and consequently have the same outcome. Discuss this statement. 5

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