ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING Prof. Bill Even FORM 3. Directions

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1 1 ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING 2013 Prof. Bill Even FORM 3 Directions 1. Fill in your scantron with your unique id and form number. Doing this properly is worth the equivalent of 1 question. 2. There are 38 multiple choice questions. Record your answer on both your scantron and your exam. Your scantron will not be returned, so your exam will serve as the record of your answers. 3. Your grade is determined entirely upon the answers listed on your scantron. Your scantron will not be returned so be sure to record your answers on your exam so that you will be able to check your answers once the key is posted. 5. You may use a calculator. The use of a cell phone is strictly prohibited and considered academic dishonesty. 6. You have until the end of the period to finish the exam. Additional time may be purchased at a price of 5 percentage points per minute. 7. You may not leave the room during the examination period. 8. Academic dishonesty is a serious offense. In the event I find someone behaving in a dishonest manner, I will ask that the maximum penalty allowed by the university be imposed. 9. When you finish, turn in your scantron and exam.

2 2 To answer the next 4 questions, assume that the banking system starts with the following "base case" balance sheet and that (i) the public initially holds $3000 of nonbank cash; (ii) the reserve ratio is 5%; (iii) banks always loan out the maximum amount allowed. BALANCE SHEET Reserves $2,000 Demand Deposits $40,000 Loans $20,000 Govt. bonds $23,000 Owner's Equity $5,000 $45,000 $45, Starting with the base case balance sheet and the 5% reserve ratio, if the public chooses to withdraw $100 from its demand deposits and hold it as cash, after the bank system completely adjusts to this change, a. the monetary base will rise by $100 b. M1 will rise by $2,000 c. M1 will fall by $2,000 d. loans will fall by $1, Start with the base case balance sheet. If the Fed buys $100 of government bonds to the banking system and the banking system completely adjusts to this change in their balance sheet, the demand deposits will and the monetary base will. a. increase $2000; increase $100 b. decrease $2000; decrease $100 c. decrease $2000; decrease $2000; d. none of the above 3. Start with the base case balance sheet. If the Fed decreases the reserve ratio from 5% to 4% and the bank system completely adjusts to this change, M1 will and the loans will. a. drop $400; not change b. drop $1,000; drop $1,000 c. increase $10,000; not change. d. increase $10,000; increase $10, Suppose that there are 10 grams of gold in a $1 gold coin and 30 grams of silver in a $1 silver coin. If gold coins circulate and silver coins do not, Gresham s law would predict that a gram of gold is worth: a. more than 3 times as much as a gram of silver b. less than 3 times as much as a gram of silver c. less than 1/3 as much as a gram of silver d. none of the above.

3 3 5. Which of the following statements is true? a. there are 7 members on the Federal Reserve Board of Governors. b. the Federal Reserve was established in c. Ben Bernanke is the chair of the Federal Reserve d. All of the above 6. Which of the following is INCORRECT? a. the three functions of money are unit of account, medium of exchange, and store of value. b. without money, an economy would have to function on a barter system. c. inflation makes money a poor store of value. d. fiat money is backed by gold or some other precious metal. 7. Other things being the same, as the price of a bond falls, the yield on the bond: a. could rise or fall b. rises c. falls d. does not change 8. If the Federal Reserve sells government bonds and banks always lend the maximum amount possible, we should expect the money supply to and interest rates to. a. rise; rise b. rise; fall c. fall; fall d. fall; rise. 9. Consider a one year bond with a 6% coupon rate and a maturity value of $1000 that sells for $950 today. The yield to maturity on this bond is: a. 5.8% b. 9.3% c.11.6% d. 12.7% 10. The yield on a bond will be greater than the coupon rate if: a. the price paid is above the maturity value b. the price paid is below the maturity value c. the price paid is above par d. both a and c.

4 4 11. Suppose stock prices reflect their fundamental value. Which of the following would lead to lower prices? a. news that corporate tax rates will be increased next year. b. news that corporate profits will rise next year, but not by as much as previously believed. c. news that interest rates will rise sharply over the next year. d. all of the above. 12. In the money supply / money demand model, if the interest rate is below the equilibrium interest rate, the market adjusts by: a. people buying bonds which drives bond prices up and interest rates down b. people buying bonds which drives both bond prices and interest rates up c. people selling bonds which drives bond prices down and interest rates up d. people selling bonds which drives both bond prices and interest rates up 13. Suppose that you go to the bank and want to take out a loan. You promise the bank that you will pay back $10,000 in one year and another $10,000 in 2 years. If the bank is willing to lend you money at 6% interest, how much should they be willing to lend you today? a. $17,763 b. $18,860 c. $19,322 d. $21, Consider a company like Kroger that sells groceries versus caterpillar that produces heavy equipment for construction firms. Given what you know about spending patterns during a recession, you should expect a (larger, smaller) decline in the price of Caterpillar than Kroger and that Caterpillar would have a (higher, lower) beta. a. larger; higher b. larger; lower c. smaller; higher d. smaller; lower. 15. Consider a 15 year zero coupon bond with a maturity value of $1000 that sells for $400 today. The annual yield to maturity on this bond is: a. 1.9 % b. 4.5% c. 5.7 d. 6.3%

5 5 16. Assuming stocks reflect their fundamental value, if a company is expected to have below average growth in earnings in the future it should have: a. a beta coefficient greater than one b. a beta coefficient less than one. c. a higher than average PE ratio d. a lower than average PE ratio 17. According to the equation of exchange, which of the following would lead to less inflation? a. an increase in the rate of growth in the money supply or an increase in velocity b. a slower rate of growth in real GDP or a decrease in velocity c. a faster rate of growth in real GDP or an increase in the money supply d. a faster rate of growth in real GDP or a decrease in velocity The graph below shows the number of yen per euro between April 2012 and April Over the past year, the yen has (appreciated, depreciated) relative to the Euro and the amount that citizens in the Euro pay for imports from Japan (increased; decreased). a. appreciated; increased b. appreciated; decreased c. depreciated; increased d. depreciated; decreased 19. Which of the following could explain the change in the value of the yen (relative to the Euro) observed over the past year? a. investors in the Euro zone became pessimistic about investment returns in Japan. b. Japanese demand for goods from the Euro zone fell. c. European demand for goods from Japan rose. d. all of the above

6 6 20. As seen in the above diagram, the U.S. current account deficit dropped from approximately $700 billion to $400 billion during the great recession. Which of the following could have caused this this shrinking current account deficit? a. increased exports or decreased imports b. increased interest payments to U.S. citizens who hold foreign bonds. c. a reduction in U.S. aid to foreign countries d. all of the above 21. Assuming the central bank of the U.S. did not intervene in the exchange market during the great recession, (i.e. there was a zero balance on the official settlements account), the shrinking current account deficit during the great recession means that: a. the U.S. capital account surplus must have grown. b. the U.S. continued borrowing from the rest of the world, but the level of borrowing was reduced. c. the U.S. continued lending to the rest of the world, but the level of lending was reduced. d. none of the above. 22. Suppose interest rate parity holds and the dollar is expected to appreciate by 5% relative to the Euro over the next year. Also, suppose government bonds in the Euro zone pay 6% interest. If interest rate parity holds, U.S. government bonds must pay an interest rate of: a. 5% b. 11% c. 1% d. none of the above.

7 7 23. According to Wall Street Journal (April 3, 2013)..Investors are starting to dial back their positions in euro-zone debt amid concerns that the region's problems are not abating. Italy remains in political limbo and its financial industry is suffering, while Cyprus last month became the fourth nation in the region to receive a bailout.. This increased reluctance to hold euro-zone debt should lead to a. a depreciation of the euro since it would decrease the supply of euros b. a depreciation of the euro since it would decrease the demand for euros c. an appreciation of the euro since it would increase the demand for euros d. an appreciation of the euro since it would increase the supply of euros 24. Suppose the dollar is expected to appreciate by 5 percent over the next year relative to the Euro. Also, suppose 1 year government bonds currently offer an interest rate of 8% in the Euro zone and 4% in the U.S. Based on this information, arbitrage should eventually cause interest rates to (rise, fall) in the U.S. and (rise, fall) in the Euro zone. a. rise; rise b. rise; fall c. fall; fall d. fall; rise 25. Over the past year, the Federal Reserve has been engaged in a program called quantitative easing which had the Fed (buying, selling) approximately $80 billion of government bonds and mortgage backed securities monthly. In turn, this has led to a large (increase, decrease) in the monetary base. a. buying; increase. b. buying; decrease. c. selling; increase. d. selling; decrease. 26. A downward sloping yield curve a. is less common than an upward sloping yield curve b. implies that interest rates on short term bonds are higher than interest rates on long term bonds c. often occurs prior to a recession d. all of the above

8 8 27. According to the theory of purchasing power parity, the number of Brazilian pesos per dollar will rise if : a. Brazilian prices rise relative to U.S. prices b. Brazilian prices fall relative to U.S. prices c. Brazilian interest rates rise relative to U.S. interest rates d. Brazilian interest rates fall relative to U.S. interest rates 28. Suppose initially that the capital and current accounts in the U.S. are in balance. Suppose that investors in the rest of the world believe that financial market returns will be better in the U.S. than elsewhere. This new confidence in the performance of U.S. investments should cause the dollar to (strengthen, relative) to the Euro and eventually cause the U.S. to incur a current account (deficit, surplus). a. strengthen; surplus b. strengthen; deficit c. weaken; surplus d. weaken; deficit 29. Suppose the exchange rate is currently 100 yen per dollar and that the price of gold is $1200 per ounce in the U.S. and 170,000 yen per ounce in Japan. Based on these figures, we should expect to find people buy gold in and resell it in. This will gradually decrease gold prices in and increase gold prices in. a. Japan; U.S. Japan; U.S. b. Japan; U.S. U.S.; Japan c. U.S.; Japan; Japan; U.S. d. U.S.; Japan; U.S.; Japan. 30. Which of the following would simultaneously increase long run aggregate supply and contribute to lower real wages? a. the amount of capital per worker increases b. illegal immigrants are removed from the country c. Social Security is made less generous. d. all of the above. 31. Which of the following would simultaneously increase long run aggregate supply and contribute to higher real wages? a. more immigration is allowed. b. Social Security is made less generous. c. technological innovations improve labor productivity d. all of the above.

9 9 32. If the economy has a recessionary gap, which of the following would be an expansionary policy that would speed up the recovery to full employment? a. lower taxes and increased government spending b. policies that weaken the dollar in foreign exchange markets c. Fed purchases of government bonds d. all of the above 33. When the price level in an economy rises rises, AD will a. fall because the real value of dollar denominated assets falls and creates a wealth effect b. fall because exports will drop and imports will rise c. fall because interest rates rise causing people to postpone consumption d. all of the above.

10 10 Consider the diagram below to answer the next 3 questions: LAS SAS AD 34. At the short run equilibrium described in the above diagram, there is (upward, downward) pressure on real wages because the unemployment rate is (above, below) the natural rate. a. downward; above. b. downward; below c. upward; above. d. upward; below. 35. At the short run equilibrium described in the above diagram, the economy is producing (above, below) potential GDP and the real wage is (above, below) the equilibrium real wage. a. above; above. b. above; below. c. below; above. d. below; below 36. Starting at the short run equilibrium described in the above diagram, as the economy moves to the long run equilibrium, it should experience: a. increases in real wages and prices and decreases in employment. b. decreases in real wages, decreases in prices and increases in employment. c. increases in real wages and prices and increases in employment. d. decreases in real wages, increases in prices and increases in employment.

11 According to the video viewed in class, a. Keynes supports increased government spending in a recession b. Hayek fears that increased government spending during a recession will create a boom that will be followed by a bust. c. Keynes believes that the economy is driven by animal spirits d. all of the above. 38. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the U.S. increases government spending. Considering the likely effect of this on AD, we should expect that in the short run: a. prices rise, real wages fall, and the unemployment rate drops below the natural rate. b. prices rise, real wages rise, and the unemployment rate drops below the natural rate. c. prices fall, real wages fall, and the unemployment rate falls below the natural rate. d. prices fall, real wages rise, and the unemployment rate rises above the natural rate. e. none of the above.