MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

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1 Econ 111 Summer 2007 Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The classical dichotomy allows us to explore economic growth A) by ignoring real GDP per person. B) by focusing on the forces that determine the price level and the inflation rate. C) and ignore what determines the price level. D) by looking only at government policies. 1) 2) In the above figure, for a movement from point c to point d, the marginal product of labor equals A) $150 per hour. B) $45 per hour. C) $100 per hour. D) $200 per hour. 2) 3) If new capital increases labor productivity, the supply of labor and the demand for labor. 3) A) increases; decreases B) decreases; stays the same C) stays the same; increases D) increases; increases 1

2 4) If the real wage rate is such that the quantity of labor supplied by workers is less than the quantity of labor demanded by firms, 4) A) real GDP equals potential GDP since firms make the decision on how many workers to hire. B) the economy is at full employment. C) the real wage rate will decrease. D) the unemployment is less than the natural unemployment rate. 5) Classical growth theory assumes that A) there are no diminishing returns to capital. B) when interest rates increase, savings and investment both increase. C) there are increasing returns to capital. D) population increases when wage rates are above subsistence levels. 5) 6) A problem with the neoclassical growth theory is its A) comparison of the economy to a perpetual motion machine. B) prediction that population growth raises the real wage rate. C) prediction that population growth lowers the real wage rate. D) inability to explain persistent differences between countries' GDP growth rates. 6) 7) Money. A) is any commodity that is generally acceptable as a means of payment B) requires a double coincidence of wants C) is always composed of coins and paper D) loses its value as it becomes older 7) 8) Which of the following is a tool that is used by the Fed to control the quantity of money? A) excess reserves B) government expenditure multiplier C) open market operations D) real interest rate 8) 9) Which of the following is NOT a monetary policy tool? A) required reserve ratio B) federal funds rate C) open market operations D) discount rate 9) 10) The monetary expansion process from an open market operation continues until A) the discount rate is lower than market interest rates. B) excess bank reserves are eliminated. C) required reserves are eliminated. D) the Federal Reserve takes actions to stop the process. 10) 2

3 11) If a customer deposits $10,000 in currency into a checking account, the bank's total reserves. 11) A) do not change B) are greater than 100 percent C) decrease D) increase 12) The quantity theory of money predicts that A) in the long run, a 10 percent increase in the quantity of money leads to a 10 percent increase in real GDP. B) in the long run a 10 percent increase in the quantity of money leads to a 10 percent increase in the price level. C) in the long run, a 10 percent increase in the quantity of money leads to a 10 percent increase in velocity. D) in the short run, a 10 percent increase in the quantity of money leads to a 10 percent increase in velocity. 12) 13) Which of the following counts as part of money? A) $10,000 of government bonds B) $10,000 in a checking account C) $10,000 of gold bars D) $10,000 of corporate bonds 13) 14) Which of the following is an asset of the Federal Reserve? A) Federal Reserve notes B) commercial bank deposits C) loans to commercial bank D) the monetary base 14) 15) If a bank kept all its deposits as reserves A) it would be able to make the most profit. B) it would make only minimal profits. C) We cannot determine how much profit it would make without more information regarding its balance sheet. D) it would not make any profits. 15) 16) If the real interest rate falls, the consumption function A) is unaffected. B) shifts downward. C) has a flatter slope. D) shifts upward. 16) 17) Which of the following events will make the consumption function steeper? A) an increase in the marginal propensity to consume B) an increase in real GDP C) an increase in disposable income D) an increase in unplanned inventory investment 17) 3

4 18) An increase in shifts the AE curve and an increase in shifts the aggregate demand curve. 18) A) autonomous expenditure; upward; the price level; rightward B) autonomous expenditure; upward; the price level; leftward C) the price level; upward; autonomous expenditure; leftward D) the price level; downward; autonomous expenditure; rightward 19) The long-run Phillips curve shows the relationship between the inflation rate and the unemployment rate when the 19) A) real interest rate equals the nominal interest rate. B) real interest rate is zero. C) inflation rate is zero. D) actual inflation rate equals the expected inflation rate. 20) According to the business cycle is the result of shifts in the economy's AD curve. A) the Keynesian, monetarist, and real business cycle theories B) only the Keynesian and monetarist cycle theories C) the Keynesian, monetarist, and new classical cycle theories D) the Keynesian cycle theory only 20) 21) Which of the following is the factor the creates business cycles in the real business cycle theory? A) a change by the Fed in the growth rate of the quantity of money B) an unexpected change in aggregate demand C) a change in expectations about future sales and profits D) a change in the growth rate of productivity 21) 22) The supply side effects of a cut in tax rates include in the supply of labor and in the supply of capital. 22) A) an increase; a decrease B) an increase; an increase C) a decrease; a decrease D) a decrease; an increase 23) According to the Ricardo-Barro effect, A) financing government spending with taxes has a less severe effect on private investment than financing through government borrowing. B) the government budget has no effect on the real interest rate. C) a government budget deficit crowds out private investment. D) None of the above answers are correct. 23) 4

5 24) Which of the following is one of the Fed's policy goals? A) exchange rate B) price level stability C) help the President win reelection D) monetary base 24) 25) If the Fed follows the Taylor rule and the economy goes into a recession, the Fed would A) lower the federal funds rate. B) increase government expenditures. C) reduce tax rates. D) None of the above answers are correct. 25) 26) If the Fed carries out an open market operation and buys U.S. government securities, the federal funds rate and the quantity of reserves. 26) A) rises; decreases B) rises; increases C) falls; increases D) falls; decreases 27) In the above figure, if the economy is initially at point d, the short-run effect of a hike in the federal funds rate is given by movement from point 27) A) d to point a, increasing output and decreasing the unemployment rate. B) d to point b, keeping output and the unemployment rate constant. C) d to point b, increasing output and decreasing the unemployment rate. D) d to point c, increasing output and decreasing the unemployment rate. 5

6 28) The figure above shows the PPFs for Utopia and Apogee. The opportunity cost of a truck is A) 5/4 of a car in Utopia. B) 4/5 of a car in Apogee. C) 5 cars in Utopia. D) 2/7 of a car in Apogee. 28) 29) Increasing a tariff will the domestic quantity consumed of the good, while the domestic production of the good. 29) A) decrease; decreasing B) increase; increasing C) increase; decreasing D) decrease; increasing 30) The above figure shows the international market for some good "x". Suppose a tariff is imposed by the governments of importers of x. The tariff is shown as the amount given by the distance 30) A) P0P1. B) ac. C) P1P4. D) dc. 6

7 SHORT ANSWER. Write your answer in the space provided or on a separate sheet of paper. 31) Compare the policy prescriptions of Keynesian, Classical, and Monetarist economists. 32) In the figure above, illustrate the effect of an increase in the U.S. interest rate. What is the effect on the exchange rate? 33) In the economy of Jokey Island, autonomous consumption expenditure is $60 million, and the marginal propensity to consume is 0.6. Investment is $110 million, government expenditure is $70 million, and there are no income taxes. Investment and government expenditure are constant they do not vary with income. The island does not trade with the rest of the world. a) Draw the aggregate expenditure curve. b) What is the island's autonomous aggregate expenditure? c) What is the size of the multiplier in Jokey Island's economy? d) What is the island's aggregate planned expenditure and what is happening to inventories when real GDP is $800 million? e) What is the economy's equilibrium aggregate expenditure? 7

8 Leisure (hours) Real GDP (2000 dollars) 0 2, , , , ) The people of Palm Island are willing to work 80 hours a day for a real wage rate of $4 an hour. Then each dollar increase in the real wage, they are willing to work 10 additional hours a day. Palm Island's production possibilities are in the table above. a) Draw Palm Island's demand for labor curve. b) Draw Palm Island's supply of labor curve. c) What are the full-employment equilibrium real wage rate and quantity of labor in Palm Island's economy? d) What is Palm Island's potential GDP? 35) Friedmania is a country in which the quantity theory of money operates. The country has a constant population, capital stock, and technology so real GDP does not change. In 2006, real GDP was $500 million, the price level, measured by the GDP deflator, was 150 and the velocity of circulation of money was 10. (Because the price level is measured by the GDP deflator, it must be divided by 100 before it is used in the equation of exchange.) In 2007, the quantity of money increased by 20 percent. a) What was the quantity of money in 2006? b) What was the velocity of circulation in 2007? c) What was the price level in 2007? 8

9 Answer Key Testname: FINAL 1) C 2) C 3) C 4) D 5) D 6) D 7) A 8) C 9) B 10) B 11) D 12) B 13) B 14) C 15) D 16) D 17) A 18) D 19) D 20) C 21) D 22) B 23) B 24) B 25) A 26) C 27) D 28) A 29) D 30) D 31) Keynesians believe that without assistance the economy would almost never be at full employment. They prescribe activist fiscal and monetary policy to drive the economy to full employment. Classical economists believe the economy is self-regulating and will always tend towards full employment. Their main policy initiatives center on removing tax created disincentives for growth. Monetarists call for low taxes and consistent money growth because Monetarists believe that recessions are the result of fluctuations in the quantity of money. 9

10 Answer Key Testname: FINAL 32) The figure above shows the effect of the increase in the U.S. interest rate. The demand for dollars increases and the demand curve shifts rightward. The supply of dollars decreases and the supply curve shifts leftward. The equilibrium exchange rate rises, to 100 yen per dollar in the figure. 10

11 Answer Key Testname: FINAL 33) a) See the figure above. Because the island does not trade with the rest of the world, net exports are zero. When net exports are zero, aggregate expenditure, or AE, is given by AE = C + I + G. Consumption equals $60 million plus 0.6 of income, so the consumption function is C = $60 million + 0.6Y, where $60 million is autonomous consumption, 0.60 is the marginal propensity to consume, and Y is real GDP which equals real income. Using the formula in the equation for aggregate expenditure gives AE = $60 million + 0.6Y + $110 million + $70 million, so the formula for aggregate expenditure is AE = $240 million + 0.6Y. b) Autonomous expenditure is expenditure that does not vary with real GDP; it is the level of aggregate expenditure if real GDP were equal to zero. In the economy of Jokey Island, if Y = 0, AE = $ , so autonomous expenditure is $240 million, shown by point A in the figure above. c) The multiplier is the amount by which a change in autonomous expenditure is multiplied to determine the change in equilibrium expenditure and real GDP. The multiplier equals 1/(1 - MPC). So in the economy of Jokey Island, the multiplier is 1/(1-0.6) = 2.5. d) When real GDP is $800 million, aggregate planned expenditure, AE, equals $ $800 million, which is $720 million. This level of aggregate planned expenditure is point B in the figure above. Because this level of aggregate planned expenditures is less than real GDP, point C in the figure, inventories increase. e) Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure, AE, equals real GDP. In the economy of Jokey Island equilibrium is at point E in the figure, when real GDP and aggregate expenditure equal $600 million. Equilibrium expenditure also can be calculated by solving the equation Y = $240 million + 0.6Y for Y. Start by subtracting 0.6Y from both sides to give 0.4Y = $240 million. Then divide both sides by 0.4 to obtain Y = $240 million/0.4, so that Y, which is real GDP, equals $600 million. 11

12 Answer Key Testname: FINAL 34) a) See the figure above. Palm Island's demand for labor curve is the marginal product of labor curve. The marginal product of labor for each quantity of labor employed is the change in real GDP divided by the change in quantity of labor employed. For example, 100 hours of labor employed is the midpoint between 80 and 120 hours on the production function. The 40 hors of additional labor between 80 and 100 hours produce $1,680 - $1,280 = $400 of additional real GDP. So for these 40 hours of labor, one hour will produce additional real GDP of $400/40 = $10 per hour. So the marginal product of labor is $10 per hour when 100 hours of labor are employed. The rest of the marginal products are calculated similarly and are in the figure above. b) The figure above shows the labor supply curve. c) The full-employment equilibrium real wage rate is the one at which the quantity of labor demanded equals the quantity of labor supplied so that real GDP is at its full-employment level. In the economy of Palm Island, the figure above shows that the full-employment equilibrium real wage rate is $8 per hour and the full-employment quantity of labor is 120 hours per day. d) Potential GDP is the level of real GDP at full employment. As the figure above shows, Palm Island's full employment is 120 hours per day. And the production function shows that 120 hours of labor can produce a real GDP of $1,280. So Palm Island's potential GDP is $1,280 per day. 35) a) The equation of exchange states that the quantity of money, M, multiplied by the velocity of circulation, V, equals real GDP, Y, multiplied by the price level, P. In terms of a formula, the equation of exchange is that M V = P Y. Using this formula, M = PY/V, [(150/100) $500 billion]/10 gives the quantity of money as $75 billion. b) The quantity theory of money asserts that the velocity of circulation is not influenced by the quantity of money. So the velocity of circulation remains constant at 10. c) From the equation of exchange, the price level is P = MV/Y. Because the quantity of money increased by 20 percent, the quantity of money in 2007 is $75 billion 1.2 = $90 billion. So P = [($90 billion 10)/$500 million] 100 = 180. Another way to calculate the price level in 2007 is to notice that according to the quantity theory, a change in the quantity of money has no effect on velocity and real GDP. So if the quantity of money increases by 20 percent, to balance the equation of exchange, the price level must also increase by 20 percent. So from this approach, the price level in Friedmania is , which is also equal to