Econ 202 Honors Midterm 2

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1 , Spring 2009 April 7, 2009 PLEDGE: I have neither given nor received unauthorized help on this exam. SIGNED: PRINT NAME: Econ 202 Honors Midterm 2 1. The price level falls if either a. money demand shifts rightward or money supply shifts leftward. b. money demand shifts leftward or money supply shifts rightward. c. money demand or money supply shifts leftward. d. money demand or money supply shifts rightward. 2. If the demand for loanable funds shifts to the right, then the equilibrium interest rate a. and equilibrium investment both fall. b. falls and equilibrium investment rises. c. and equilibrium investment both rise. d. rises and equilibrium investment falls. 3. If both the principle of monetary neutrality and MV = PY are true, an increase in the money supply will a. increase real GDP, but not the price level. b. increase neither the price level nor real GDP. c. increase the price level, but not real GDP. d. increase real GDP and the price level. 4. You put money into an account that earns a 5 percent nominal interest rate. The inflation rate is 3 percent, and your marginal tax rate is 20 percent. What is your after-tax real rate of interest? a. 1.0 percent b. 1.6 percent c. 3.4 percent d. None of the above is correct. 5. If a country exports more than it imports, then it has a. positive net exports and negative net capital outflows. b. positive net exports and there is not enough information to say anything definite about its net capital outflows. c. positive net exports and positive net capital outflows. d. negative net exports and negative net capital outflows. 6. If a country experienced deflation, then a. the nominal interest rate would be greater than the real interest rate. b. the real interest rate would be greater than the nominal interest rate. c. the real interest rate would equal the nominal interest rate. d. None of the above is necessarily correct. 7. Which of the following is not included in M1? a. a $5 bill in your wallet

2 Table First Tarheel Bank Assets Liabilities Reserves $25,000 Deposits $150,000 Loans 125, Refer to Table If the bank faces a reserve requirement of 10 percent, then the bank a. has excess reserves of $12,500. b. has fewer reserves than are required. c. is in a position to make a new loan of up to $10,000. d. None of the above is correct. 9. If the price level were lower, then the value of money would be a. higher, so people would want to hold more of it for transactions. b. higher, so people would want to hold less of it for transactions. c. lower, so people would want to hold more of it for transactions. d. lower, so people would want to hold less of it for transactions. 10. High and unexpected inflation causes a. a gain for those who lend and a loss for those who borrow. b. a gain for those who hold their wealth as money and a loss to the government. c. a gain for those who borrow and a loss for those who lend. d. a gain for those who hold only moderate amounts of money and a loss for those who hold a lot of money. 11. Suppose that foreigners acquire more Irish assets than the Irish aqcuire of foreign assets. Ireland has a. negative net capital outflow and a trade surplus. b. positive net capital outflow and a trade surplus. c. negative net capital outflow and a trade deficit. d. positive net capital outflow and a trade deficit. 12. Before he became the chairman of the Federal Reserve Board of Governors, Ben Bernanke was a. a Washington, D.C. lawyer for the banking industry. b. an Economics professor with special expertise in the Great Depression. c. a congressman from South Carolina. d. a Wall Street investment banker. 13. Suppose a country has only a sales tax. Now suppose it replaces the sales tax with an income tax that includes a tax on interest income. This would make equilibrium a. interest rates and the equilibrium quantity of investment rise. b. interest rates and the equilibrium quantity of investment fall. c. interest rates fall and the equilibrium quantity of investment rise. d. interest rates rise and the equilibrium quantity of investment fall.

3 Figure Refer to Figure 4-8. At a price of $20, a. there would be a surplus of 100 units. b. there would be a surplus of 200 units. c. there would be a shortage of 200 units. d. there would be a shortage of 100 units. 15. Credit cards a. are included in M1 and M2. b. are not included in any measure of the money supply. c. are included in M1 but not M2. d. are included in M2 but not M1 16. When the rate of inflation rises, people will desire to hold a. less money and will go to the bank less frequently. b. more money and will go to the bank less frequently. c. less money and will go to the bank more frequently. d. more money and will go to the bank more frequently. 17. Consider the market for Labrador Retriever puppies. If the price of Golden Retriever puppies falls at the same time that the price of dog food and kennel boarding services rise, then the equilibrium price of Labrador Retriever puppies would a. rise and the equilibrium quantity would rise.. b. fall and the equilibrium quantity would rise. c. fall and the equilibrium quantity would fall. d. maybe rise and maybe fall; we can t tell. 18. You know that a candy bar cost five cents in You also know the CPI for 1962 and the CPI for today. Which of the following would you use to compute the price of the 1962 candy bar in today's dollars? a. five cents today's CPI - five cents 1962 CPI. b. five cents ((today's CPI CPI)/1962 CPI) five cents (1962 CPI / today's CPI)

4 20. Suppose the economy is closed with national saving of $2 trillion, consumption of $7 trillion, taxes of $1 trillion and government purchases of $1 trillion. What is GDP? a. $11 trillion b. $9 trillion c. $10 trillion d. $8 trillion 21. If the Fed wanted to increase the money supply, it would make open market a. purchases or lower the discount rate. b. sales or raise the discount rate. c. sales or lower the discount rate. d. purchases or raise the discount rate. 22. All else equal, when people become more optimistic about a company's future, the a. supply of the stock and the price will both rise. b. demand for the stock and the price will both fall. c. demand for the stock and the price will both rise. d. supply of the stock and the price will both fall. 23. The federal funds rate is the interest rate that a. banks charge the Fed for loans. b. banks charge one another for loans. c. the Fed charges Congress for loans. d. the Fed charges banks for loans. 24. The reserve ratio is 10 percent, banks do not hold excess reserves, and people deposit all currency back into the banking system. If the Fed sells $10 million dollars of bonds to the public, bank reserves a. increase by $1 million and the money supply eventually increases by $10 million. b. increase by $10 million and the money supply eventually increases by $100 million. c. decrease by $1 million and the money supply eventually increases by $10 million. d. decrease by $10 million and the money supply eventually decreases by $100 million. 25. According to James Hamilton, the FOMC s recent statement indicates that the Fed s new policy of quantitative easing a. will prevent deflation by purchasing longer-term bonds and mortgage-backed securities. b. will fight inflation by easing away from the policy of purchasing massive amounts of bonds. c. represents a government takeover of the banking system. d. is simply a continuation of traditional Fed policies in disguise.

5 Figure Refer to Figure When the money supply curve shifts from MS 1 to MS 2, a. the demand for goods and services decreases. b. the economy's ability to produce goods and services increases. c. the equilibrium price level increases. d. the equilibrium value of money increases. 27. Ben Bernanke is sometimes called Helicopter Ben because a. he spends so much of his time frenetically traveling from one economic trouble spot to another. b. he likes to wear a beanie hat with a little toy propellor on it. c. he swoops down on badly managed banks like an attack helicopter. d. he advocates fighting depression by buying large amounts of treasury bonds to finance stimulus spending by the federal government. 28. On a T-account for a bank, a. reserves and deposits are both assets. b. deposits are assets and reserves are liabilities. c. reserves are assets and deposits are liabilities. d. reserves and deposits are both liabilities. 29. If the price level rises, but the number of dollars you are paid per hour stays the same, then your a. real wage is higher. b. nominal wage is lower. c. nominal wage is higher. d. real wage is lower. 30. For the purpose of calculating GDP, investment is spending on a. real estate and financial assets such as stocks and bonds. b. capital equipment, inventories, and structures, excluding purchases of new housing. c. stocks, bonds, and other financial assets. d. capital equipment, inventories, and structures, including purchases of new housing.

6 NAME Short Answer Questions. 25 Points. Answer in the space provided. Fill in blanks as appropriate. 31. Suppose one Euro ( 1) is worth $1.50, and a pair of Nike Air Max shoes cost $100 in New York and 50 in Paris. a) What is the nominal U.S. exchange rate (i.e, the exchange rate of the dollar)? b) Judging by the price of Nike Air Max shoes, what is the European real exchange rate? c) Suppose that you use $750 to purchase Nike Air Max running shoes on one side of the Atlantic and sell them on the other. Briefly describe the sequence of transactions you would perform in order to complete a single profitable purchase and sale of shoes. Please specify whether you would buy the shoes in Paris or New York, and also describe any currency exchange transactions required. d) How much profit would you make from buying and selling your first batch of shoes? $ e) Arbitrage opportunities are created by an imbalance of domestic prices (P), foreign prices (P*), and exchange rates (e). Describe, using a supply and demand diagram, the effect of your shoe arbitrage business on ONE of these three variables. Be sure to label the axes, equilibrium point(s), and curves that you draw. f) The opportunity for arbitrage will disappear when the REAL exchange rate E =. If the prices of shoes in New York and Paris stay constant at $100 and 50 respectively, the Nike shoe arbitrage opportunity will disappear if the NOMINAL exchange rate of the dollar is

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

8 ID: A SHORT ANSWER 31. ANS: a).667 (= 2/3) Euros per dollar. b) E = e x (P/P*) = 1.25x(50/100) =.625 USNikes/EuroNike. c) Buy (2/3)*$750 = 500, and use it to purchase 10 pairs of shoes in Paris. Sell them in New York for $1000. d) Profit = $ $750 = $250. e) Increases Supply of shoes in New York. Increase Demand for shoes in Paris. Increase Supply of dollars, or increase Demand for Euros, which will cause the dollar to depreciate against the Euro. f) E = 1 is the arbitrage-extinguishing (PPP) real exchange rate. To find the nominal exchange rate, set E = e x (P/P*) = 1 and solve for e x (100/50) = 1. That gives you 2e = 1, so the PPP-equivalent e =.5 Euros per dollar. (In other words, at an exchange rate of.67 the dollar is overvalued.) Extra Credit: A currency s nominal exchange rate e is its price in another currency. Overvalued means expensive, which means high-priced. A high value of the nominal exchange rate e a high value of the real exchange rate E = e(p/p*). The domestic currency can be said to be overly expensive if it is so expensive that it makes domestic goods and services artifically expensive to foreigners - i.e., the currency is overvalued if e is so high that it drives E above 1.

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