DEPARTMENT OF ECONOMICS, UNIVERSITY OF VICTORIA

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1 DEPARTMENT OF ECONOMICS, UNIVERSITY OF VICTORIA Midterm Exam I (October 09, 2012) ECON204 (A01), Fall 2012 Name (Last, First): UVIC ID#: Signature: THIS EXAM HAS TOTAL 7 PAGES INCLUDING THE COVER PAGE Instructions: Total Marks 45. Duration 50 Minutes. THIS EXAM HAS TWO PARTS. IN PART A, THERE ARE 10 MCQ, WORTH 10 MARKS. IN PART B, THERE ARE SOME SHORT ANSWER AND PROBLEM SOLVING QUESTIONS, WHICH ARE WORTH 35 MARKS. YOU MUST SHOW YOUR ALL WORK IN PART B TO GET FULL MARKS. IF YOU DO NOT SHOW DETAILS, E.G., EXPLANATION, DIAGRAM, MATHEMATICAL DERIVATION, WHERE APPLICABLE, YOU MAY NOT GET FULL MARKS EVEN FOR A CORRECT ANSWER. Use the marks assigned to each question as a guide to allocating your time across questions. Good Luck on Your Exam

2 2 PART A (There are 10 MCQs in this section, worth 10 marks) 01. One reason why the aggregate demand (AD) curve slopes downward is that a. decreases in the price level cause increases in private-sector wealth which lead to increases in desired consumption. b. aggregate expenditure increases as the price level rises. c. increased production results in lower production costs. d. when the price level falls firms must compete more when output increases. e. when the price level falls consumers increase their saving rate. 02. Other things being equal, a country with a high national saving rate may have a long-run growth rate because more saving increases the. a. high; availability of funds, thus lowering the interest rate b. high; interest rate and encourages more investment c. low; consumption in the long run d. low; unemployment and decreases wages in the long run e. high; wealth of people and increases future consumption 03. The aggregate production function shows the for given levels of labour and capital inputs a. marginal product of labour b. the production possibilities boundary c. returns to scale d. total output for society (real GDP) e. marginal product of capital 04. An increase in the government budget surplus, everything else constant, will cause a(n) a. increase in national saving b. decrease in national saving c. decrease in the growth rate d. equal decrease in private investment e. equal increase in private consumption 05. In order for money to be successfully used as a medium of exchange, it must a. all of the responses are correct b. be easily divisible c. be readily acceptable d. be difficult to counterfeit e. have a high value-weight ratio 06. The "precautionary demand" for money arises from the a. fear that interest rates will fall b. fear that interest rates will rise c. uncertainty about when some expenditures will be necessary d. desire to avoid paying interest on credit purchases e. need to make predictable purchases of goods and services

3 3 07. Suppose a student deposits into a downtown bank a $200 cheque that she received from her parents in the suburbs. This transaction alone would a. increase the money supply by an indeterminate amount b. increase the money supply by $1000 if the target reserve ratio was 20 percent c. not change the money supply d. decrease the money supply e. decrease the money supply by $1000 if the target reserve ratio was 20 percent 08. If the economy is currently in monetary equilibrium, an increase in the money supply will a. cause an increase in the demand for money, leading to a lower rate of interest b. cause a reduction in the demand for money, leading to a higher rate of interest c. not change the equilibrium conditions d. cause an excess demand for money and a decrease in the rate of interest e. lead to a movement down the money demand curve to a lower rate of interest 09. Classical economists' belief in the "neutrality of money" led them to argue that a. a change in the quantity of money would change the price level but would not change relative prices b. absolute prices were determined in the real part of the economy c. the allocation of resources was determined by the quantity of money and not by the forces of supply and demand d. a change in the quantity of money would not affect money prices or relative prices e. relative prices have no role in the real allocation of resources 10. Other things being equal, a decrease in the money supply will lead to in real interest rates and, in the short run, in real GDP because. a. a decrease; a decrease, of the decrease in net exports b. an increase; an increase; more money is available for investing in bonds from abroad c. an increase; a decrease; of the decline in domestic investment d. a decrease; an increase; of the increase in domestic investment e. a decrease; a decrease; of the decrease in domestic investment

4 4 PART B (Short answer and problem solving questions) 1. (3X3=09 marks) Define and interpret the followings a. GDP deflator vs CPI GDP deflator is the ratio of the nominal GDP and real GDP: Consumer price index (CPI) is ratio of cost of fixed basket in current period and in the base period: In GDP deflator calculation all goods and services produced by an economy is considered whereas in CPI calculation, a fixed basket of consumer goods and services is only considered. Both are price levels. b. Seigniorage Seigniorage is a government s revenue increasing technique by simply printing more money. In economies where the Central Banks/Monetary Authorities are not independent, governments can print more money to spend without taxes or selling bonds. Printing money to raise revenue causes inflation. Inflation is like a tax on people who hold money. c. Fisher equation and Fisher effect The relationship between the real and nominal interest rate is often called the Fisher equation: The Fisher Effect. An increase in the (expected) inflation rate causes the nominal interest rate to rise by exactly the same amount (one for one)

5 5 2. (9 marks) Let consider a consumer basket contains only two goods, bread and beer, and the table below provides necessary information on it: Year Beer Price of beer Bread Price of bread $5 10 $ $6 10 $ $7 10 $2 a. For each year compute the consumer price index (CPI) (use 2008 as the base year) Year Cost of the basket Index /70 = /70= b. For each year compute the inflation rate from the preceding year. Year Index Inflation rate % %

6 6 3. (9 marks) Suppose that the production function is Cobb-Douglus,, with parameter a. What is the main feature of this production function? The Cobb-Douglus production function exhibits the constant returns to scale: if all factors of production are increased at a certain rate, the output will also be increasing at the same rate. If both labor and capital are doubled: b. What fractions of income do capital and labour receive? Capital share to national income is that is 30% and labour share is =70% c. Suppose that a gift of capital from abroad raises the capital stock by 10 percent. What happens to total output (in percent)? Change in output is So the output increases by 2.9 percent 4. (8 marks) Suppose that the money demand function takes the form Consider the current nominal interest rate is 5%. At what rate will the demand for real balances grow when the output grows at 2 percent rate? Ans. With the 5% interest rate, the demand for real balance is Now the growth in the demand for real balance is The demand for real balances will be growing at the rate 8% if the economy grows at 2 percent rate