PART I: Multiple Choice. 10 points (each question worth ½ point)

 

 

1.      Which of the following statements about gross domestic product (GDP) is correct?  

 

a)      GDP measures the market value of final goods and services produced within a country.

b)      GDP measures the market value of goods and services produced by U.S. owned companies.

c)      GDP measures physical quantity of goods produced in the United States. Because there is no common unit for measuring services, they are excluded from GDP.

d)      GDP measures the market value of both intermediate and final goods and services produced within a country.

 

Ans: a

 

2.      Which of the following is considered part of consumption spending in the calculation of GDP for 2001?

      

a)      The construction of a new house in Dallas, Texas in 2001

b)      The purchase of bootleg CD’s of your favorite rock band on June 2001.

c)      The payment for a haircut on May 21st 2001

d)      The purchase of a baseball that was signed by legendary player Babe Ruth in 1920.

 

Ans: c

 

3.      Nominal GDP is higher this year than last. We can conclude that:

 

a)      Production levels are higher this year.

b)      Price levels are higher this year.

c)      There is less unemployment this year.

d)      We need more information before commenting.

 

Ans: d

 

4.      Which of the following measures is the best indicator of changes in the well-being of individuals in a country?

          

a)      An increase in nominal GDP

b)      An increase in real per-capita GDP

c)      An increase in real GDP

d)      An increase in the money supply

 

Ans: b

 

5.      Every payment from one individual to another:

 

a)      increases GDP

b)      decreases GDP

c)      increases national income

d)      none of the above

 

Ans: d

 

6.      The natural rate of unemployment is equal to:

 

a)      The minimum unemployment rate consistent with price stability

b)      The long-run average unemployment rate around which the short-run unemployment rate fluctuates

c)      The deviation of the unemployment rate from its long-run average

d)      The cyclical unemployment rate

 

Ans: a or b

 

7.      Which type of unemployment is most likely to be affected by more information about available jobs?

       

a)      Frictional

b)      Structural

c)      Cyclical  

d)      Seasonal

 

Ans: a

 

8.      If CPI =132 for this quarter (Q1 2004), by how much have prices risen over the last decade. The base year is Q1 1994.

 

a)      By 132%

b)      By 1.32%

c)      By 32%

d)      We cannot tell, we need the CPI for Q1 1994.

 

Ans: c


 

9.      Consider a closed, private economy, where GDP is composed of consumer spending and investment spending that is independent of the level of output.  If investment spending increases by 10 million dollars and as a result aggregate output increases by 10 million dollars, then the slope of the planned aggregate expenditure curve is:

 

a)      vertical

b)      horizontal

c)      upward sloping

d)      Not enough information

 

Ans: b

 

10.  When aggregate output equals planned aggregate expenditures, unplanned changes in inventories in the economy should be:

 

a)      positive

b)      zero

c)      negative

d)      It depends.

 

Ans: b

 

11.  If inventories fall unexpectedly, a firm will most likely

 

a)      reduce output

b)      increase output

c)      keep producing the same amount

d)      none of the above

 

Ans: b

 

12.  The government cuts taxes by $300 billion, but does not change spending.  The MPS in the economy is .2.  The effect on GDP will be:

 

a)      an increase of $300 billion

b)      a decrease of $300 billion

c)      an increase of more than $300 billion

d)      a decrease of less than $300 billion

 

Ans: c

 

13.  Which of the following actions would successfully eliminate an inflationary tendency in the economy?

 

(I) Raise taxes

(II) Lower taxes

(III) Increase government purchases

(IV) Decrease government purchases

(V) Raise transfer payments

(VI) Lower transfer payments

          

a)      (I), (III), and (V)

b)      (II), (IV), and (VI)

c)      (I), (IV), and (VI)

d)      (II), (V), and (VI)

 

Ans: c

 

14.  If government spending is increased by $500 and taxes are increased by $500, the equilibrium level of income will

 

a)      decrease by $500

b)      increase by $500

c)      not change

d)      it depends on the MPC

 

Ans: b

 

15.  Assuming there is no foreign trade in the economy the leakages/injections approach to equilibrium can be written as

 

a)      S + T + I = G

b)      S – T = I + G

c)      S + I = T + G

d)      S + T= I +G

 

Ans: d

 

16.  The deposit of $500 of currency when the required reserve ratio is 0.20 has which of the following IMMEDIATE effects?

       

a)      Increases the money supply by $500

b)      Increases the bank's required reserves by $400

c)      Increases the bank's excess reserves by $400

d)      Increases the transactions accounts in the bank by $400

Ans: c

 

17.  The money multiplier process would come to a halt if:

       

a)      No one borrowed from a bank

b)      The banks' reserves were entirely cash in their vaults

c)      Individuals held no currency and made all their transactions with checks

d)      The assets of banks equaled their liabilities

 

Ans: a

 

18.  Fill the blank

As the Fed engages in open market purchases of bonds we expect interest rates to ( fall        )

 

19.  Fill the blank

Suppose the reserve requirement is 5% and that all banks hold minimum reserves. Assume that there is a new deposit of $1,000 in a bank.

How much (new) money will the entire banking system be able to create?

  $ 20,000

 

20.  As the interest rate increases

 

a)      planned investment decreases, but aggregate expenditure remains constant

b)      planned investment increases, but aggregate expenditure remains constant

c)      planned investment decreases and aggregate expenditure decreases

d)      planned investment increases and aggregate expenditure increases

 

Ans: c


PART II: Short Answer Questions. 10 points (each question worth 2 points)

 

Answer each question fully and SHOW YOUR WORK!!! You will lose credit for correct answers which seemingly came out of nowhere.

 

1.      “Being concerned about the recent recession, I decided to go out and spend money to help the recovery of the economy. This time I bought a second-hand Chevy 95. If everybody acted like me our economy would be out of the slump!” Comment.

 

No. Buying used goods do not help raise today’s GDP, since GDP accounts only for goods produced this year using factors of production located in America.

 

 

2.      Mention one group that has been negatively affected by inflation in terms of their income loss.

 

One example is fixed income earners. For instance, the elderly who receive a fixed pension every month and hence inflation erodes their real income. Another example is given by the poor, since welfare benefits have not raised as much as inflation over the last decades.

 

 

3.      If the government can expand output by the cutting taxes and expanding expenditures then why doesn’t it do it continuously to generate growth?

 

The expansionary tools of the government have limits. Not only output will not grow forever due to productive limitations, but also budget deficit will grow, and hence future generations will have to pay this debt by sacrificing their consumption.

 

 

4.      “If the Fed engages in open market purchases of bonds for 50 million dollars, the money supply will increase by 50 million dollars” Comment

 

No. An initial increase in money supply of 50 million dollars will have a larger effect on the total final supply of money due to the money multiplier effect. (Recall money multiplier equals 1/Required Reserve Ratio)

 

 

5.      “Commercial banks can only lend money to other private citizens or companies the dollars deposited with them. Therefore banks cannot create money. They can only transfer money from bank depositors to people who borrow from banks.” Qualify this statement.

 

False. Banks actually create money by making loans out of its excess reserves. These loans are the reason why an increase of the money supply by $1 will have an effect larger than $1.
PART III: Essay – 10 points (each question worth 5 points)

Essay # 1

LISBON- Portugal has declared victory in a battle to keep its budget deficit below the limit set by the European Union, after imposing tough austerity measures and suffering a sharp economic recession. Its determination to comply with the EU's growth and stability pact despite enduring the worst recession in Europe contrasts with Germany and France, which are running deficits above the permitted maximum.

February 22, 2004 (Financial Times)

  1. Define the budget deficit.

Budget Deficit = Government Expenditures - Taxes

 

  1. Why can keeping a low budget deficit cause a recession in the economy?

Keeping the budget deficit low will imply cutting on government expenditures and/or raising taxes. Both actions reduce aggregate expenditure and hence can lead to a fall in output in the economy.

 

  1. Suppose the government decides to ignore the deficit limits and increase spending next year. Illustrate graphically the effects on the money market, investment, and equilibrium output.

 


Essay # 2

 

“There have been so many aborted take-offs that Japan’s latest economic recovery is bound to be greeted with some skepticism…Figures for real GDP in the fourth quarter of 2003 could well show an annualized growth rate of as much as 4%....How can this miracle have happened?  Part of the reason is a benign mixture of cycle and happenstance:  economic activity tends to revive naturally after a few years of stagnation, once companies invest more and rebuild their stocks; and China’s economic boom has helped by sucking in huge quantities of Japanese-made steel, manufactures and capital goods.  Another big explanation, though, lies in corporate restructuring,….They have cut costs and repaid trillions of yen worth of debt….The final reason is that the Bank of Japan’s monetary policy has now become steadily and credibly expansionary.” 

 

                                                                                                            -The Economist

                                                                                                            Feb. 14, 2004

 

  1. According to the article, what components of Japan’s real GDP have changed to cause economic growth?  How does current monetary policy affect firms’ debt? 

 

  GDP= C+I+G+(EX-IM)

            -Exports to China have increased

-Investment has increased due to business cycles

 

Inflationary monetary policies that favor borrowers (Japanese firms) has also freed up investment since firms have to pay back less money in real terms than they borrowed. Another accepted answer is that now Japanese firms can restructure their debt, by borrowing at low interest rates to pay their old debts (that were charging higher interests).

 

  1. Illustrate graphically the effects of a decision by the Bank of Japan to loosen monetary policy. What are the effects on money markets, equilibrium output and investment?

 

 


 

Of course second-round effects could be included here too.