Final Exam Fall 2004 Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A newly created bank just opened and its first customer made a deposit of $50,000 cash in a checkable deposit. At this point, if the required reserve ratio is 20 percent, the bank has A) $50,000 in actual reserves.

B) $50,000 in required reserves.

C) $50,000 in excess reserves.

D) None of the above answers is correct.

2) If a single bank has $25,000 in excess reserves and the required reserve ratio is 20 percent, how much can this bank loan? A) $25,000.

B) $20,000.

C) $125,000.

B) 0.10.

C) 1.0.

B) increase; increase

C) increase; decrease

D) decrease; increase

5) In the long run, an increase in the quantity of money ____ the nominal interest rate and ____ the real interest rate. A) raises; raises

B) lowers; lowers

C) raises; does not change

D) lowers; does not change

6) If nominal GDP is $6.0 trillion and the quantity of money is $1.5 trillion, then the A) velocity of circulation is 4.

B) price level is 120.

C) price level is 110.

D) velocity of circulation is 10.

7) Suppose that potential GDP grows by 3 percent a year, the quantity of money grows 6 percent a year, and velocity does not change. In the long run, the inflation rate equals A) 3 percent.

B) 12 percent.

C) 9 percent.

B) 8; 4

C) 8; 2

1

4)

5)

6)

7)

D) 5 percent.

8) Assume an economy begins with zero inflation, a 25 percent income tax rate, and a real interest rate of 4 percent. If inflation rises to 4 percent, the nominal interest rate becomes ____ percent and the after-tax real interest becomes ____ percent. A) 0; 1

3)

D) 100.0.

4) In the money market, if the quantity of money supplied exceeds the quantity of money demanded, there will be a(n) ____ in the interest rate and a(n) ____ in the prices of assets. A) decrease; decrease

2)

D) $5,000.

3) The Fed purchases $1 million of U.S. government securities from First Bank. The required reserve ratio is 10 percent, the currency drain is zero, and banks loan all excess reserves. The money multiplier is equal to A) 10.0.

1)

D) 6; 2

8)

9) The change reflected in the above figure might be a result of A) a decrease in the money wage rate.

B) a decrease in the real wage rate.

C) an increase in the real wage rate.

D) an increase in the money wage rate.

10) A tax increase

9)

10)

A) decreases aggregate demand and the AD curve shifts leftward. B) increases the quantity of real GDP demanded and there is a movement down along the AD curve. C) decreases the quantity of real GDP demanded and there is a movement up along the AD curve. D) increases aggregate demand and the AD curve shifts rightward. 11)

11) If the Fed increases the quantity of money, then A) aggregate demand increases and the AD curve shifts rightward. B) aggregate demand decreases and the AD curve shifts leftward. C) the quantity of real GDP demanded increases and there is a movement down along the AD curve. D) the quantity of real GDP demanded decreases and there is a movement up along the AD curve.

2

12) In the figure above, the shift in the aggregate demand curve from AD1 to AD3 could be the result of

12)

A) a decrease in the buying power of money. B) a decrease in the real interest rate. C) an increased expectation of a recession that lowers the expected profit from investment. D) a decrease in the foreign exchange rate. 13) Real GDP definitely increases if

13)

A) both the AD curve and the AS curve shift rightward. B) the AD curve shifts leftward and the AS curve shifts rightward. C) both the AD curve and AS curve shift leftward. D) the AS curve shifts leftward and the AD curve does not shift. Disposable income (trillions of 1996 dollars) 0.0 1.0 2.0 3.0 4.0

Consumption expenditure (trillions of 1996 dollars) 1.8 2.6 3.2 4.0 5.8

14) The above table has data from the nation of Atlantica. Based on these data, autonomous consumption is A) $2.6 trillion.

B) $3.2 trillion.

C) $4.0 trillion.

D) $1.8 trillion.

15) What is the value of the MPC if $66 out of every $100 increase in disposable income is consumed? A) 0.66

B) $34

C) $166

3

14)

D) 0.34

15)

16) If the multiplier is 5, the slope of the aggregate expenditure (AE) curve is A) 0.5.

B) 0.7.

C) 0.6.

16) D) 0.8.

17) If the economy is in an equilibrium with real GDP less than potential GDP, discretionary fiscal policy could move the economy toward potential GDP by simultaneously ____ taxes and ____ government purchases of goods and services. A) raising; increasing

B) raising; decreasing

C) cutting; decreasing

D) cutting; increasing

17)

18)

18) When the Fed raises the nominal interest rate, A) the real interest rate temporarily falls, thereby increasing investment and consumption expenditure. B) investment and consumption expenditure increase, thereby raising the real interest rate temporarily. C) the real interest rate is unchanged so investment and consumption expenditure are not changed. D) the real interest rate temporarily increases, thereby decreasing investment and consumption expenditure.

19) The economy is at the equilibrium shown at point a in the above figure. If the Fed A) buys government securities, the economy moves to an equilibrium at point b. B) buys government securities, the economy moves to an equilibrium at point c. C) sells government securities, the economy moves to an equilibrium at point c. D) sells government securities, the economy moves to an equilibrium at point b.

4

19)

20) Do automatic fiscal stabilizers eliminate business cycles?

20)

A) No, but they do moderate business cycles. B) No, because they have no effect if the business cycle is the result of some unanticipated change. C) Yes. D) None of the above answers is correct. 21) The tradeoff exhibited by the short-run Phillips curve is

21)

A) lower inflation with lower unemployment. B) changing inflation with constant unemployment. C) higher unemployment with lower inflation. D) higher inflation with higher unemployment. 22) The long-run Phillips curve indicates that

22)

A) there is no way to control the inflation rate in the long run. B) there is a tradeoff between the inflation rate and the unemployment rate in the long-run. C) any inflation rate is possible at the natural unemployment rate. D) potential GDP can never be achieved. 23) If the expected inflation rate changes,

23)

A) the short-run Phillips curve shifts and the long-run Phillips curve does not shift. B) the long-run Phillips curve shifts and the short-run Phillips curve does not shift. C) both the short-run and long-run Phillips curves shift. D) neither the short run nor the long run Phillips curve shift. 24) According to the natural rate hypothesis, if the economy begins at full employment with an unemployment rate of 5 percent and then the inflation rate increases from 2 percent to 4 percent, then the economy will

24)

A) not see any lower unemployment, even temporarily, just higher prices. B) have lower unemployment but then return to its natural rate with an inflation rate of 4 percent. C) stay at the 4 percent inflation rate and the natural unemployment rate will fall. D) return to its natural rate of 2 percent inflation and a new lower unemployment rate. 25) The factors that determine the power of monetary and fiscal policy are

25)

A) investment demand and the demand for money. B) the demand for and supply of money. C) unemployment and inflation. D) aggregate demand and aggregate supply. 26) Fiscal policy is most powerful when there is a

26)

A) small effect on interest rates from changes in money demand. B) large effect on interest rates from changes in the demand for money. C) large effect on investment from a change in interest rates. D) lot of crowding out. 5

27)

27) The three main goals of fiscal policy are A) price stability, income redistribution, and aggregate demand stabilization. B) provision of public goods and services, income redistribution, and aggregate demand stabilization. C) provision of all types of goods and services, price stability, and income redistribution. D) income redistribution, price stability, and full employment. 28) Which of the following is NOT a monetary policy goal? A) stability of the financial system

B) price level stability

C) stability of individual family income

D) real GDP stability

28)

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. Consumption Real GDP, Y expenditure, C (billions of 1996 (billions of 1996 dollars) dollars) 100 150 200 200 300 250 400 300 500 350 600 400 700 450 800 500 900 550

Government purchases, G Investment, I (billions of 1996 (billions of 1996 dollars) dollars) 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150

29) The above table gives information for the nation of North Hampton. There are no imports to or exports from North Hampton. a. Find aggregate planned expenditure for each level of real GDP. b. What is the equilibrium level of real GDP?

6

29)

30) Suppose the currency drain is 20 percent and the required reserve ratio is 10 percent. a. What does the money multiplier equal? b. If the Fed purchases $10 million of U.S. government securities, by how much will the quantity of money increase or decrease?

30)

31) Suppose there is a $200 billion deflationary gap. If there are no taxes or imports, to restore the economy back to potential GDP, how much should government spending be changed if the marginal propensity to consume is 0.75? Does government spending need to be increased or decreased?

31)

7

32) Assume consumption function is: C = 10 + 0.6Y. Government expenditureis: G = 300 Imports are: I = 5 + 0.1Y Exports are: Ex = 0 Investment: I = 195

32)

a) What is MPC in this case? b) How much equilibrium output will change if I (investment) changes by 10? c) What is the equilibrium output in this economy? d) Let's say that the potential GDP is 900 what kind of *monetary* policy is appropriate in this case?

8

Answer Key Testname: FINAL

1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17) 18) 19) 20) 21) 22) 23) 24) 25) 26) 27) 28) 29)

A A A D C A A C A A B C A D A D D D A A C C A B A A B C Real GDP, Y Aggregate planned (billions of expenditure 1996 dollars) (billions of 1996 dollars) 100 450 200 500 300 550 400 600 500 650 600 700 700 750 800 800 900 850

a. To calculate aggregate expenditure, for each level of real GDP sum consumption expenditure plus investment plus government purchases. The above table has the answers for each level of real GDP. b. Equilibrium real GDP is $800 billion because that is the level of real GDP that equals aggregate planned expenditure. 30) a. The money multiplier is 3.57. The money multiplier equals 1/(1 - L), with L = (0.80) ˛ (0.90) = 0.72. Therefore the money multiplier equals 1/(1 - 0.72) = 1/(0.28) = 3.57. b. If the Fed purchases $10 million of U.S. government securities, the quantity of money increases by ($10 million) ˛ (3.57) = $35.7 million. 9

Answer Key Testname: FINAL

31) The multiplier is equal to 1/(1 - MPC). So, with a marginal propensity to consume of 0.75, the expenditure multiplier is 1/(1 - 0.75) = 1/0.25, which is 4. Dividing the size of the deflationary gap, $200 billion, by 4 shows that government spending needs to be changed by $50 billion to restore the economy back to potential GDP. Because a deflationary gap occurs when real GDP is less than potential GDP, real GDP needs to increase in order for it to equal potential GDP. So, because real GDP needs to be increased, government spending needs to increased.

10