ECON 1010 Principles of Macroeconomics Final Exam

ECON 1010 Principles of Macroeconomics Final Exam 1. Expansionary monetary policy: Section A: Multiple Choice Questions. (120 points; 3 pts each) a. increases the money supply, interest rates, consumption, and investment. b. decreases the money supply, interest rates, consumption, and investment. c. d. increases the money supply, decreases interest rates, and increases consumption and investment. decreases the money supply, increases interest rates, and decreases consumption and investment. 2. An increase in the money supply causes in output in the short run and in output in the long run. a. an increase; no change b. an increase; an increase c. no change; an increase d. no change; no change 3. Scarcity exists when: a. making choices among two or more alternatives is not necessary. b. individuals can have more of any good without giving up anything. c. individuals can have more of one good but only by giving up something else. d. resources are unlimited. 4. If an economy has to sacrifice increasing amounts of good X for each unit of good Y produced, then its production possibility frontier is: a. bowed out from the origin. b. bowed in toward the origin. c. a straight line. d. a vertical line. 1

5. The fact that a society's production possibility frontier is bowed out or concave to the origin of a graph demonstrates the law of: a. increasing opportunity cost. b. decreasing opportunity cost. c. constant opportunity cost. d. concave opportunity cost. 6. Sweden has a comparative advantage in producing: a. cell phones only. b. herring only. c. both cell phones and herring. d. neither cell phones nor herring. 7. Bill and Mickey make bongos and Frisbees. Who should specialize in the production of bongos? a. Bill b. Mickey c. both d. neither 2

8. Which influence does NOT shift the supply curve? a. people deciding that they want to buy more of the product b. a decrease in the price firms expect to receive in the future c. a rise in the wages paid to workers d. the development of a new production technology 9. Suppose the demand curve for good Z is downward sloping. If the price of good Z decreases because of a shift in the supply of good Z, this will cause: a. fewer people to purchase good Z. b. no effect on the quantity demanded of good Z. c. a movement along the demand curve of good Z. d. an increase in the demand for good Z. 10. Rent controls usually set a price ceiling below the equilibrium price and therefore: a. quantity supplied exceeds the quantity demanded. b. quantity demanded exceeds the quantity supplied. c. a surplus of rental units will result. d. all low-income recipients will clearly be helped. 11. If the government imposes a price ceiling of $0.90 per pound of butter, the quantity of butter actually purchased will be: a. 10.5 million pounds. b. 9.0 million pounds. c. 1.5 million pounds. d. 10.0 million pounds. 3

12. The relation between a country's level of saving and investment: a. affects its trade balances. b. does not affect an open economy. c. has often been used to correct a trade deficit but not a trade surplus. d. pertains to trade surpluses only. 13. Goods and services sold to people in other countries are known as: a. imports. b. investments. c. exports. d. transfer payments. 14. GDP can be calculated as: a. the total value of all final goods and services produced in a given year. b. c. the sum of all spending by firms on inputs used to produce final goods and services in a given year. the value of all of the intermediate goods used to produce final goods and services in a given year. d. the amount of tax paid on all intermediate and final goods and services in a given year. 15. Nominal GDP in 2010 was: a. $200. b. $400. c. $450. d. $525. 16. A person who is out of work, would like to work, but has given up looking for work is called: a. unemployed. b. employed. c. a discouraged worker. d. a lazy nonworker. 4

17. The labor demand curve is negatively sloped because: a. more people are willing to work at lower wages than at higher wages. b. more people are willing to work at higher wages than at lower wages. c. employers are willing to hire more people at lower wages. d. employers are willing to hire more people at higher wages. 18. Figure: The Effect of a Minimum Wage Suppose the labor market is in equilibrium at E when the government imposes a minimum wage of W F. Structural unemployment will equal: a. Q S Q D. b. Q E Q D. c. Q S Q E. d. 0. 19. What is the value of the price index in 2011? a. 100 b. 90 c. 111 d. 132 5

20. The convergence hypothesis states that international differences in real GDP per capita: a. tend to diverge over time. b. tend to fluctuate over time. c. remain constant over time. d. tend to narrow over time. 21. Which is considered investment spending in macroeconomics? a. GM builds a new plant to manufacture automobiles. b. Ryan Jones buys some GM stock. c. Ryan Jones buys some GM bonds. d. Ryan Jones buys some GM stock and bonds. 22. Scenario: A Small Economy Suppose there is no trade and no government in a small economy. The GDP is equal to $25 trillion, and consumption spending is equal to $18 trillion this year. Then there is a new government and it imposes taxes on its citizens in order to spend on infrastructure. Taxes are equal to $2 trillion and government spending is equal to taxes. What is the level of investment spending now? a. $7 trillion b. $5 trillion c. $18 trillion d. $4 trillion 23. The price in the loanable funds market is the: a. consumer price index. b. interest rate. c. price level. d. rate of return of a project. 24. When there is a widely held belief that there is an increase of promising business opportunities, the: a. supply of loanable funds will increase. b. demand for loanable funds will decrease. c. demand for loanable funds will increase. d. supply of loanable funds will decrease. 6

25. A downward shift in the consumption function can be caused by: a. expectations of higher future incomes. b. an increase in the MPC. c. a decline in consumer wealth. d. an increase in the wealth of households. 26. Inventory investment is: a. a part of planned investment spending and is always positive. b. a part of unplanned investment spending and may either be positive or negative. c. not a part of investment spending by firms, as it can't be properly planned ahead of time. d. a part of the consumption spending, as these are unsold goods. 27. Figure: Income Expenditure Equilibrium If planned investment spending increases by $100, income expenditure equilibrium occurs at GDP of: a. $8100. b. $3600 c. $2250. d. $4000. 7

28. Figure: Aggregate Expenditures Curve III Suppose that the consumption function in this figure rises by $100. The result would be a shift in the aggregate expenditures curve upward by: a. $100. b. $400. c. $100 times the multiplier. d. $200 times the multiplier. 29. The recession in 2008 was caused by a reduction in a. tax rates on capital gains. b. consumer spending on durable goods, especially automobiles. c. consumer spending on nondurables, especially gasoline and clothing. d. housing prices. 30. In the long run, nominal wages are: a. sticky in both an upward and downward direction. b. flexible because contracts and informal agreements are renegotiated in the long run. c. sticky downward but flexible in an upward direction. d. sticky upward but flexible in a downward direction. 8

31. Figure: Fiscal Policy II Suppose that this economy is in equilibrium at E 1. If there is a decrease in government transfers, then: a. AD 2 will shift to the left, causing an increase in the price level and a decrease in real GDP. b. AD 2 will shift to the left, causing a decrease in the price level and a decrease in the real GDP. c. AD 1 will shift to the right, causing an increase in the price level and an increase in real GDP. d. AD 1 will shift to the left, causing a decrease in the price level and a decrease in real GDP. 32. Figure: Fiscal Policy Choices Contractionary fiscal policy would most likely be used to shift aggregate demand in panel from. a. (b); AD 1 to AD 2 b. (a); AD 2 to AD 1 c. (a); AD 1 to AD 2 d. (b); AD 2 to AD 1 9

33. Holding everything else constant, the multiplier effect for: a. taxes is the same as that for changes in autonomous aggregate spending. b. aggregate autonomous spending is bigger than that for taxes. c. taxes is bigger than that for aggregate autonomous spending. d. taxes and aggregate autonomous spending is always equal to 0. 34. Suppose that the budget deficit of a country remains level for five years. Which is true concerning the fiscal stance of this government? a. The federal debt will remain constant. b. The federal debt will fall. c. The federal debt will rise. d. The federal debt will either remain constant or fall. 35. Money that the government has ordered to be accepted as money is: a. fiat money. b. currency. c. convertible paper money. d. commodity money. 36. M1 consists of: a. currency only. b. currency and checkable deposits only. c. currency in circulation and checkable deposits only. d. currency in circulation, checkable deposits, and travelers checks only. 37. When an individual decides to hold money instead of other assets, that individual: a. is giving up the interest that could have been earned by holding other types of assets. b. becomes more likely to suffer from money illusion. c. is not affected by unanticipated inflation. d. is able to maintain a higher standard of living. 10

38. The higher the short-term interest rate, the: a. lower the opportunity cost of holding money. b. higher the opportunity cost of holding money. c. more quantity demanded of money the public will be willing to hold. d. higher the long-term interest rate. 39. Contractionary monetary policy causes a(n) in interest rates in the short run and in interest rates in the long run. a. increase; an increase b. increase; no change c. decrease; no change d. decrease; a decrease 40. Figure: Monetary Policy I If the money market is initially at E 1 and the central bank chooses to buy bonds: a. AD 1 may shift to AD 2, closing an existing recessionary gap. b. AD 1 will shift to the left, increasing an existing recessionary gap. c. SRAS 1 will shift immediately to the left, closing an existing inflationary gap. d. SRAS 2 will shift immediately to the right, increasing an existing inflationary gap. 11

Section B: Short Answer Questions. (80 points) 1. (20 pts) The table below shows production and prices for a stylized economy. Assume the base year is 2012. The market basket for CPI is given by production in 2012. Year Production of X Price of X ($) Production of Y Price of Y ($) Production of Z Price of Z ($) 2012 10 units 3 15 units 10 5 units 4 2013 12 units 5 20 units 10 10 units 4 2014 15 units 8 20 units 5 15 units 2 a) (15 pts) Calculate nominal GDP, real GDP, the GDP deflator, and the CPI for 2012, 2013, and 2014. Nominal GDP for year 2012, 2013 and 2014 are GGGGPP 22 = (1111 $33) + (1111 $1111) + (55 $44) = $ GGGGPP 22 = (1111 $55) + (2222 $1111) + (1111 $44) = $333333 GGGGPP 22 = (1111 $88) + (2222 $55) + (1111 $22) = $ Real GDP for year 2012, 2013 and 2014 are RRRRRRRR GGGGPP 22 = (1111 $33) + (1111 $1111) + (55 $44) = $ RRRRRRRR GGGGPP 22 = (1111 $33) + (2222 $1111) + (1111 $44) = $ RRRRRRRR GGGGPP 22 = (1111 $33) + (2222 $1111) + (1111 $44) = $333333 The GDP deflator for year 2012, 2013 and 2014 are 111111 = 111111 333333 111111 = 111111 111111 = 8888 333333 The CPI for year 2012, 2013 and 2014 are CCCCII 22 = 111111 = 111111 CCCCII 22 = 111111 = 111111 CCCCII 22 = 111111 111111 = 8888. 55 b) (5 pts) What is the 2014 CPI inflation rate? Which year is the economy growing faster, 2013 or 2014? The 2014 CPI inflation rate is 8888. 55 111111 111111 = 2222% 111111 12

The growth rate during 2013 is The growth rate during 2014 is 111111 = 3333 333333 111111 = 1111. 55 Therefore the economy is growing faster during year 2013. 2. (20 pts) Countries A and B each produce pens and pencils. Currently the two economies do not trade with one another. The table below provides information about the maximum amount of each good they can produce. Maximum Number of Pencils Produced Maximum Number of Pens Produced Country A 1000 500 Country B 500 200 a) (5 pts) Use the information from the table to draw the (linear) PPFs for these two economies. In each graph, measure pencils on the horizontal axis and pens on the vertical axis. b) (5 pts) What is the slope of each PPF and how does it relate to the opportunity cost of production? Slope of country A s PPF is 555555 11111111 = 11 22 This implies that for country A, the opportunity cost for 1 pencil is equal to 11 of a pen. 22 Slope of country B s PPF is 13

555555 = 22 55 Aadland Spring 2015 This implies that for country B, the opportunity cost for 1 pencil is equal to 22 of a pen. 55 c) (5 pts) Does either country have an absolute advantage in pens and pencils? Who has a comparative advantage in producing pencils? Explain. Country A has an absolute advantage in producing both pens and pencils. Country B has a comparative advantage in producing pencils. The opportunity cost for 1 pencil is equal to 22 of a pen in country B, while the opportunity cost for 1 pencil is equal to 55 11 of a pen in country A. Therefore country B has a smaller opportunity cost of producing 22 pencil compared to country A. d) (5 pts) Suppose Country A produces 500 pencils and 250 pens. Suppose Country B produces 250 pencils and 100 pens. Redraw the PPFs and label the points C and D. Are both countries efficient in production? Show how each country can specialize completely in one good, trade, and operate on a point outside the PPF. Both point C and D are on the PPFs of each country respectively, therefore both countries are efficient in production. Each country should specialize in producing the product that it has a comparative advantage in. Country A should use all its resources to produce 500 pens. Country B should use all its resources to produce 500 pencils. Country B can then trade 250 pencils for 110 pens with country A. Country B s consumption with trade is 110 pens and 250 pencils, this point is above point D and is outside the PPF. Without trade, when producing 250 pencils, country B can only produce a maximum of 100 pens. Country A s consumption with trade is 390 pens and 250 pencils, this point is outside its PPF as well. Without trade, when producing 250 pencils, country A can only produce a maximum of 375 pens. 14

3. (20 pts) Assume that planned investment is 250, government spending is 50, autonomous consumption is 100, and the MPC is 0.5. Taxes are zero and the economy is closed. Aadland Spring 2015 a) (10 pts) Find the equilibrium level of real GDP and show the equilibrium using the graphical version of the income-expenditure (Keynesian cross) model. The equilibrium level of real GDP is equal to the planned aggregated spending. GGGGGG = AAEE PPPPPPPPPPPPPP = CC + II PPPPPPPPPPPPPP + GG where CC = 111111 + 00. 55 DDDD DDDD = GGGGGG Substitute and solve for GDP GGGGGG = 111111 + 00. 55 GGGGGG + + 5555 GGGGGG = 888888 b) (10 pts) Assume new housing construction increases by 50. What expenditure category is impacted? Find the new equilibrium and show this graphically. What is the multiplier effect of this new construction? The increase in new housing construction increases the planned investment. The new equilibrium is GGGGGG = 111111 + 00. 55 GGGGGG + ( + 5555) + 5555 GGGGGG = 999999 11 In this case, the multiplier is = 22. An increase of 50 in planned investment increases 11 MMMMMM real GDP by 100. 15

4. (20 pts) Assume OPEC decides to restrict output to raise crude oil prices. Use the AD-SRAS-LRAS model to show graphically how this will impact the U.S. macroeconomy in the short and long run. Label your initial equilibrium A, short-run equilibrium B, and the long-run equilibrium C. Write a corresponding paragraph explaining the transition of the economy and how the Fed could use monetary policy in reaction to the shock. 16

An increase in oil price will raise production cost across the economy and reduce the quantity of aggregate output supplied, causing a leftward shift of the short-run aggregate supply curve. Graphically, the initial short-run aggregate supply curve, SRAS 1, shifts leftward and becomes SRAS 2. The new intersect between AD and SRAS 2 is the short-run macroeconomic equilibrium, shown as point B. This results in a higher equilibrium aggregate price level at P 2 and a lower equilibrium aggregate output level at Y 2. The economy faces a recessionary gap and stagflation. In the long-run, nominal wages will fall and cause the SRAS 2 to return to SRAS 1. However, because of wage stickiness the return to the long-run equilibrium may be very slow. In the case of a negative supply shock, it is not easy to use monetary or fiscal policy to stabilize the economy. The Fed could use expansionary monetary policy to increase aggregate demand. This limits the rise in unemployment but causes even more inflation. 17