ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING Prof. Bill Even FORM 1. Directions

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1 ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM SPRING 2011 Prof. Bill Even FORM 1 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 52 multiple choice questions. 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. Cell phones or other devices that may be used to store text are not allowed. 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. 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.

2 1. In the evolution of banking, the first function served was as: a. a safekeeper b. a clearinghouse for checks c. an intermediary that connected borrowers and lenders d. none of the above 2. Suppose that an ounce of gold is worth 5 times as much as an ounce of silver. If there are 5 grains of gold in a $1 gold coin and 20 grains of silver in a $1 silver coin, Gresham s law would predict that: a. neither gold or silver coins would circulate as money. b. gold coins would circulate as money, but silver coins would not. c. silver coins would circulate as money, but gold coins would not. d. both gold and silver coins would circulate as money. 3. When a person uses a dollar bill to purchase a candy bar at the store, money is being used as a: a. unit of account b. store of value c. medium of exchange d. all of the above. 4. Which of the following functions of money eliminates the need for barter? a. unit of account b. store of value c. medium of exchange d. none of the above. 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

3 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 $500 of non-bank cash; (ii) the reserve ratio is 2%; (iii) banks always loan out the maximum amount allowed. BALANCE SHEET Reserves $2,000 Demand Deposits $100,000 Loans $80,000 Govt. bonds $23,000 Owner's Equity $5,000 $105,000 $105, Start with the base case balance sheet. If the Fed buys $200 of government bonds to the banking system and the banking system completely adjusts to this change in their balance sheet, the loans will and M1 will. a. increase $200; increase $200 b. decrease $200; decrease $200 c. increase $10,000; increase $10,000. d. decrease $10,000; decrease $10,000 e. none of the above 7. Start with the base case balance sheet. If the Fed increases the reserve ratio from 2% to 4% and the bank system completely adjusts to this change, a. M1 will decrease $50,000 b. the monetary base will remain unchanged c. loans will decrease $50,000 d. all of the above e. both a and c 8. Starting with the base case balance sheet and the 2% reserve ratio, if the public chooses to withdraw $50 from its demand depostits and hold it as cash, after the bank system completely adjusts to this change, a. the monetary base will be unchanged b. M1 will be unchanged c. loans will decrease by $2,500 d. all of the above e. both a and c 9. Starting with the base case balance sheet information, a. the monetary base is $2,500 and M1 is $100,000 b. the monetary base is $2,000 and M1 is $100,000 c. the monetary base is $2,500 and M1 is $100,500 d. none of the above

4 10. If the Federal Reserve wants to raise interest rates, which combination of policies would be most appropriate? The Fed should bonds, the discount rate, and the required reserve ratio. a. buy; lower; lower. b. sell; lower; lower c. buy; raise; raise. d. sell; raise; raise. 11. Holding the coupon rate, maturity value and term of a bond constant, as the price of a bond falls, the yield on the bond: a. could rise or fall; b. falls. c. rises. d. does not change. 12. If a bond sells for a price that is above par, a. the yield will exceed the coupon rate b. the yield will be less than the coupon rate c. the yield will be negative d. the yield to maturity will exceed the current yield 13. Consider a one year bond with a 5% coupon rate and a maturity value of $1000 that sells for $980 today. The yield to maturity on this bond is: a. 5.2% b. 6.1% c. 7.1% d. 8.3% 14. 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 five years and another $10,000 in 6 years. If the bank is willing to lend you money at 10% interest, how much should they be willing to lend you today? a. $12,397 b. $13,221 c. $15,297 d. $16,327 e. $ Consider a 25 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. 2.0 % b. 2.4% c. 2.9% d. 3.7% 16. 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 increase over the next year, but not as quickly as previously believed. c. news that interest rates will rise sharply over the next year. d. all of the above. e. only a and b.

5 17. 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 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 bond prices and interest rates up 18. In the money supply/demand model, the increased acceptability of credit cards is a financial innovation that would: a. increase money supply and reduce interest rates b. decrease money supply and increase interest rates c. increase money demand and increase interest rates d. decrease money demand and decrease interest rates e. none of the above 19. Consider the money supply/demand model and suppose that the U.S. economy is growing so that real GDP is rising over time. If the Federal Reserve has a goal of keeping interest rates constant, it should: a. increase the money supply over time. b. keep the money supply constant over time. c. decrease the money supply over time. d. decrease money demand over time.

6 Stock return XYZ Stock Market index time 20. Consider the diagram above that plots the returns for corporation XYZ s stock return and the return on a stock market index over time. Based on the information provided, it would be safe to conclude that corporation XYZ stock has a. A higher PE ratio than the stock market index b. A lower PE ratio than the stock market index c. A beta coefficient that is greater than one d. A beta coefficient that is less than one. 21. Other things remaining the same and assuming that stocks reflect their fundamental value, we should expect that a company would have a lower priceearnings ratio if interest rates are or the potential for future profit growth is. a. higher; higher b. higher; lower c. lower; lower d. lower; higher 22. According to the equation of exchange, which of the following would lead to increased inflation? a. an increase in the rate of growth in the money supply b. a decrease in the velocity of money c. faster growth in nominal GDP d. all of the above. e. only a and b.

7 23. Between 1/1/2009 and 2/21/2011, the number of U.S. dollars per Australian dollar increased from.71 to This means that over the past 2 years, the U.S. dollar (appreciated, depreciated) relative to the Australian dollar and the amount that U.S. citizens pay for imports from Australian (increased; decreased). a. appreciated; increased b. appreciated; decreased c. depreciated; increased d. depreciated; decreased 24. Suppose interest rate parity holds and one year 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 10% interest. If interest rate parity holds, U.S. government bonds must pay an interest rate of: a. 5% b. 15% c. 2% d. none of the above. 25. 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 5% in the Euro zone and 10% in the U.S. Based on this information, a wise investor would: a. be indifferent between U.S. and Euro bonds since the exchange rate fluctuation will offset the lower interest rate in the Euro zone.. b. prefer U.S. bonds over Euro bonds since they will net a 10% higher rate of return after adjusting for the exchange rate movement. c. prefer U.S. bonds over Euro bonds since they will net a 5% higher rate of return after adjusting for the exchange rate movement. d. none of the above. 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 greater than interest rates on long term bonds c. often occurs prior to a recession d. all of the above

8 27. The Federal Reserve has promised that it will institute quantitative easing over the next several months. This program will have the Fed purchase long term government bonds. Suppose that the yield curve is currently upward sloping. If the Fed announces that it will no longer implement this quantitative easing program, we should expect a. long term interest rates to rise and the yield curve to steepen b. long term interest rates to rise and the yield curve to flatten c. long term interest rates to fall and the yield curve to steepen d. long term interest rates to fall and the yield curve to flatten 28. Based on the supply/demand model for the dollar in foreign currency markets, which of the following would cause the dollar to appreciate relative to the Japanese yen? a. an increase in Japanese demand for U.S. exports. b. an increased desire in Japan to invest in the U.S. stock market. c. an increase in Japanese prices relative to the U.S. d. all of the above. 29. Immediately following the tsunami in Japan, the yen strengthened significantly relative to the dollar. Which of the following could explain this? a. U.S. investors sold their stock holdings in Japan and converted the proceeds into dollars. b. U.S. consumers bought fewer cars from Japan because of supply chain problems c. Japanese investors sold stock holdings in the U.S. and converted the proceeds into yen d. none of the above would cause the yen to strengthen relative to the dollar. 30. When the yen appreciated after the tsunami, the Japanese government decided that the stronger yen could have harmful effects on its economy. Because of this, the Japanese government decided to take action to offset the appreciation. In order to do this, the Japanese government should buy a. dollars which means that Japan would increase its holdings of foreign currency reserves. b. dollars which means that Japan would reduce its holdings of foreign currency reserves. c. yen which means that Japan would reduce its holdings of foreign currency reserves. d. yen which means that Japan would increase its holdings of foreign currency reserves.

9 31. In class, we discussed the fact that China has taken action to keep its currency (weak, strong) relative to the dollar in order to promote exports to the U.S. In order to facilitate this, China is incurring an official settlements account (deficit, surplus). a. weak; deficit b. weak; surplus c. strong; deficit d. strong; surplus 32. Suppose that investors begin to believe that the European stock market will underperform relative to the U.S. This should cause the dollar to relative to the Euro and make U.S. imports from Europe expensive. a. appreciate; less b. appreciate; more c. depreciate; less; d. depreciate; more 33. Suppose initially that the capital and current accounts in the U.S. are in balance. Suppose that investors in the U.S. begin to believe that the stock market in S. Korea will perform incredibly well over the next couple of years. Given the effect on investment flows, imports and exports, we should expect to see the U.S. current account run a and its capital account to run a > a. Surplus; surplus b. Surplus; deficit c. Deficit; deficit d. Deficit; surplus 34. Suppose the exchange rate is currently 2 dollars per Euro and that the price of gold is $1500 per ounce in the U.S. and 800 Euros in the Euro-zone. Based on these figures, we should expect to find people buy gold in and resell it in. This will gradually increase gold prices in and decrease gold prices in. a. Euro-zone; U.S.; Euro-zone; U.S. b. Euro-zone; U.S.; U.S.; Euro-zone c. U.S.; Euro-zone; Euro-zone; U.S. d. U.S.; Euro-zone; U.S.; Euro-zone 35. Suppose that the exchange rate between the dollar and the Euro is fixed at 1 Euro per dollar and there is neither excess supply or excess demand for the dollar. If U.S. inflation rises relative to Europe s and the European banks don t intervene, this will force: a. the U.S. central bank to buy up excess dollars and reduce their holdings of Euros. b. the U.S. central bank to sell dollars and increase their holdings of Euros. c. the U.S. central bank to buy up excess dollars and increase their holdings of Euros. d. the U.S. central bank to sell dollars and decrease their holdings of Euros.

10 36. According to the theory of purchasing power parity, the number of Japanese yen per Euro will fall if: a. Europe s inflation rate exceeds the Japanese inflation rate. b. Europe s inflation rate is less than the Japanese inflation rate. c. Japanese interest rates rise relative to Europe s interest rates. d. both b and c. 37. Which of the following would lead to a larger current account deficit in the U.S.? a. an increase in U.S. exports or U.S. imports. b. an increase in U.S. imports or a decrease in U.S. exports. c. an increase in U.S. exports or a decrease in U.S. imports. d. none of the above. 38. Which of the following would all lead to a smaller capital account surplus in the U.S.? a. decreased purchases of foreign bonds by U.S. citizens, or increased purchases of U.S. bonds by foreign citizens. b. decreased purchases of foreign bonds by U.S. citizens, or decreased purchases of U.S. bonds by foreign citizens. c. increased purchases of foreign bonds by U.S. citizens, or increased purchases of U.S. bonds by foreign citizens. d. increased purchases of foreign bonds by U.S. citizens, or decreased purchases of U.S. bonds by foreign citizens 39. Assuming that the official settlements account has a zero balance, when a country is a net borrower from the rest of the world, the country will have a. a current account surplus b. a capital account surplus c. a current account deficit d. both b and c. 40. Suppose that a country named Libya2 begins its existence in In its first year of existence (2011) it has a current account surplus of $10 b. followed by a current account deficit of $40 billion in 2012 and a current account surplus of $20 billion in Based on these three years of data and ignoring any interest on loans, we can conclude that during 2013 Libya2 is a net (lender, borrower) and by the end of 2013, Libya2 is a net (debtor, creditor). a. lender; debtor b. lender; creditor c. borrower; debtor d. borrower; creditor

11 41. 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 that improve labor productivity d. all of the above. e. only a and b. 42. Which of the following would simultaneously increase long run aggregate supply and contribute to lower real wages? a. more immigration is allowed. b. Social Security is made less generous. c. technological innovations that improve labor productivity d. all of the above. e. only a and b. 43. A decrease in aggregate demand (AD) would be caused by transfers, government spending, or an expectation of future inflation. a. lower; decreased; lower. b. higher; decreased; greater. c. lower; increased; greater. d. none of the above.

12 Consider the diagram below to answer the next 3 questions: LAS SAS AD 44. 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 45. 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. upward; above. b. upward; below. c. downward; above. d. downward; below 46. 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.

13 47. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the U.S. pursues policies that lead to a depreciation in the value of the dollar relative to foreign currencies. 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. b. prices rise, real wages rise, and the unemployment rate drops. c. prices fall, real wages fall, and the unemployment rate rises. d. prices fall, real wages rise, and the unemployment rate falls. e. none of the above. 48. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the U.S. pursues policies that lead to a depreciation in the value of the dollar relative to foreign currencies. Considering the likely effect of this on AD, we should expect that in the long run: a. prices rise, real wages fall, and the unemployment rate drops. b. prices rise, real wages rise, and the unemployment rate drops. c. prices fall, real wages fall, and the unemployment rate rises. d. prices fall, real wages rise, and the unemployment rate falls. e. none of the above. 49. Suppose that the economy currently has an inflationary gap. This means that a. the economy is producing more than potential GDP b. the unemployment rate is below the natural rate of unemployment c. real wages are below the equilibrium real wage d. all of the above.

14 50. According to the assigned reading that discussed the 2008 stimulus package, which of the following were included in the package? a. tax cuts for business and households b. increased spending on infrastructure c. Federal Reserve actions to keep interest rates low. d. all of the above 51. According to discussions in class, during the most recent financial crisis, for the first time, the Federal Reserve used open market operations to purchase: a. mortgage backed securities b. government bonds c. foreign currency d. all of the above 52. According to discussions in class, the most recent recession: a. has finished and the economy is now in expansion b. was started by problems in the housing market and subprime loans c. pushed unemployment up in the U.S. and most of the industrialized world d. all of the above e. only b and c.

15 Eco202, Spring 2011, Midterm 2 Question Form1 Form2 Form3 Form4 1 a a c omit 2 c c c d 3 c c d b 4 c d c c 5 d c a c 6 c c d d 7 d d c d 8 a a c d 9 c c d c 10 d b d a 11 c c omit c 12 b c b b 13 c omit d a 14 omit d c c 15 d d a c 16 d d c d 17 c d a c 18 d b d a 19 b a b d 20 d b d d 21 b c b b 22 a d c c 23 c b a d 24 a c d a 25 b a c b 26 d d b c 27 a c d c 28 d a c a 29 c a a d 30 a d a a 31 a b d a 32 a a a a 33 b a a d 34 d a a a 35 a d b d 36 a a d a 37 b d a b 38 d a a a 39 d b b b 40 a d e d 41 c a d e 42 e c a a 43 a e c c 44 c c b b 45 c c c c

16 46 b b c c 47 a d d a 48 e a e d 49 d d a d 50 d d d d 51 a e d a 52 d a a e