Multiple Choice Questions (3 points each) Please answer the questions on the green scantron.

Transcription

1 ECON , Fall 2006 EXAM #2 Multiple Choice Questions (3 points each) Please answer the questions on the green scantron. 1) If the short run aggregate supply curve is vertical, a decrease in money supply would cause: A) a decrease in interest rate but no change in output. B) decreases in both interest rate and output. C) decreases in both price and output. D) a decrease in price but no change in output. 2) Factors that do not affect the demand of money of a household: A) income. B) Fed discount rate. C) interest rate. D) credit cards 3) Consider the labor market where the equilibrium wage is given by w*. If the observed wage w is higher than the optimal wage w*, then: A) Firms would always prefer the low wage w* to high wage w. B) There is a mistake in obtaining the observed wage. C) Labor market is temporarily out of equilibrium and would come back to the equilibrium very soon. D) More unemployment exists in the market than 4) Suppose the production function in Japan is: Y = AK 0.45 L What would you expect the contribution of labor to the total growth? A) B) 0.55 C) roughly 2/3. D) not sure 5) Which of the following leads to an rightward shift in the short-run Phillips curve? I. a reduction in inflationary expectations. II. an increase in the natural rate of unemployment. A) I only. B) II only. C) I and II. D) Neither I nor II. 6) Consider Phillips curve. Federal government expenditures as a percentage of GDP are currently equal to approximately A) 10 percent. B) 20 percent. C) 50 percent. D) 66 percent. 1

2 7) Since 1942, the federal government debt as a percentage of GDP A) steadily increased and now is at its highest point ever. B) hit its highest point near World War II and then generally declined until the early 1980s. C) increased over most of the period following World War II and hit it highest point during the early 1980s, after which is has declined. D) has stayed roughly constant since the mid 1940s. 8) Cigarettes served as money in some POW camps during World War II. Given this fact, we would expect to observe A) no one ever smoking a cigarette. B) people usually resorting to barter rather than using cigarettes as money. C) prices of other goods expressed in terms of cigarettes. D) only government-issued cigarettes being accepted as money. 9) Laffer s curve represents a relationship between real wage and total tax revenue. According to Laffer curve, a lower tax rate may lead to a higher tax revenue. For this argument to be true, it is necessary to have: A) Labor is elastic to changes to real wages.. B) Employers with lower tax rates can hire more workers. C) A lower tax rate will lead to higher GDP and higher tax revenue. D) Less government spending is good for the economy. Answer: A 10) Consider the market for crude oil: Compare the summer market where oil production was near its full capacity, and in the fall market when there is some extra capacity not being used. Which market do you think is more volatile: A) Summer. B) Fall. C) About the same.. D) Cannot tell. Answer: A 11) The reason that Fed can lower the inflation by reducing money supply: A) Fed is independent from the government. B) Fed buys and sells government bonds. C) Velocity and GDP growth rate do not vary fluctuate much. D) Fed adjusts discount rate in a timely manner. 12) A decrease in the quantity of money A) increases interest rates, investment, and aggregate demand. B) raises the interest rate, decreases investment, and decreases aggregate demand. C) lowers the interest rate, increases investment, and increases aggregate demand. D) decreases the interest rate, investment, and aggregate demand. 2

3 13) Which of the following is true regarding the quantity theory of money? I. The theory predicts that in the long run the inflation rate equals the money growth rate minus the growth rate of potential GDP. II. The theory predicts that countries with high growth rates of money will have high inflation rates. III. The long-run U.S. relationship between money growth and inflation supports the theory. A) I and II. B) II and III. C) I and III. D) I, II and III. 14) Henry Ford paid his worker $5 per day in 1914, while the market rate (equilibrium wage) was roughly $2.5 per day. Ford could be paying this higher wage because A) he believed it can attract more productive workers. B) he believed its workers will work harder to avoid being fired. C) he thought the equilibrium wage is too low. D) Both answers A and B are correct. 15) If a firm has capital stock valued at $4,500 at the beginning of the year, purchased capital of $1,500 during the year and had a capital stock valued at $5,000 at the end of the year then we know that A) depreciation equaled $500. B) gross investment equaled $1,500. C) net investment equaled $1,500. D) depreciation equaled $3, ) Suppose women in blue states are more likely to be in the labor force than women in red states, and women s labor supply curve is elastic. Consider a national cut on tax rates. A) tax revenue in blue states decrease more than tax revenue in red states. B) tax revenue in red states decrease more than tax revenue in blue states. C) change in tax revenue has nothing to do with the color of a state. D) none of the above. Answer: A 17) Over the past 100 years, differences of real GDP per person among states in the United States have A) roughly stayed the same. B) increased. C) decreased. D) first decreased and then increased. 18) Suppose that the labor market is currently in equilibrium at a wage rate of $2.60. Suppose that the subsistence wage rate is $2.20. According to the classical theory of growth, which of the following describes subsequent events in the economy? A) The economy is in equilibrium with labor supply equal to labor demand, so the economy stays at this real wage rate. B) Population will decline because labor supply exceeds the subsistence level of labor supply. C) Population will grow because the current real wage rate is above the subsistence wage rate. D) Real wages will continue to grow above the subsistence level. 3

4 19) Suppose the target rate of return is 4 percent and currently the real interest rate is 5 percent. According to the neoclassical theory of growth, which of the following describes subsequent events in this economy? A) Growth stops because the economy is in equilibrium. B) The capital stock increases and the real interest rate remains at 5 percent indefinitely. C) The capital stock increases and the real interest rate falls towards 4 percent D) None of the above answers is correct. 20) Neoclassical growth theory A) predicts that growth rates and incomes per person throughout the world will converge. B) predicts that the faster growing underdeveloped nations will overtake and then surpass the industrial nations. C) predicts that nations that enjoy a technological advantage will maintain that advantage. D) makes no predictions about the relative growth or incomes among countries. Answer: A 21) According to neoclassical growth theory, government can NOT affect GDP growth by: A) improving human capital accumulation. B) developing new technology. C) reducing budget deficit national saving. D) encouraging immigration. 22) When the real interest rate rises A) there is a downward movement along the investment demand curve. B) there is an upward movement along the investment demand curve. C) the investment demand curve shifts rightward. D) the investment demand curve shifts leftward. 23). When the inflation rate is expected to be zero, Steve plans to lend money if the interest rate is at least 4 percent a year and Cindy plans to borrow money if the interest rate is no more than 4 percent a year. Steve and Cindy make a loan agreement for one year at an interest rate of 4 percent a year when the inflation rate is zero. But if Steve and Cindy expect an inflation rate of 1 percent a year, they would be willing to make a loan agreement at a year. A) 1 percent B) 4 percent C) 3 percent D) 5 percent 24). The War on Terror (if it is short run event) causes long run price and long run output. A) up; up B) down; up C) up; same D) down, same 4

5 25). The War on Terror (if it lasts for decades) causes long run price and long run output. A) up; up B) down; up C) up; same D) down, same 5

6 Essay Questions: 1. (15 points) Suppose the reserve ratio r = 0.10, and the currency to deposits ratio c = 1. Suppose Fed buys $100,000 of securities from Bank of America; Bank of America loans this amount to investors. Part of the money would be used in cash and part of the money would be deposited back to the bank by investors. (1) (5 points) In the end, how much additional money is created in the market? (2) (10 points) It takes time to make a loan. Suppose that within a quarter, the bank can only use this money to make one loan. In other words, it takes the bank a quarter to make the first loan of $100,000. It takes another quarter for the money to be deposited back to the bank by the borrower; and the bank uses this deposit to make the second loan. How much additional money is created in the market within a year? Solutions: (1) Initial deposit: D 0 = $100,000/(1 + c) = $50,000 Total amount of deposit = D 0 (1 + c) / (c + r) = $100,000/( 1+0.1) = $90,909 Total money created is: M = (1 + c) D = (1+1) * $90,909 = $181,818 (2) First quarter: Deposit: D 0 = $100,000/(1 + c) = $50,000, For this amount of deposit: reserve R 0 = 0.1 * D 0 = 0.1 * $50,000 = $5,000 loan: L 0 = 0.9 * D 0 = 0.9 * $50,000 = $45,000 Currency: C 0 = $100,000 D 0 = $50,000 Second quarter: D 1 = $45,000/2 = $22,500 R 1 = $22,500 * 0.1 = $2,250 L 1 = $22,500 * 0.9 = $20,250 Currency: C 1 = L 0 D 1 = $45,000 - $22,500 = $22,500 Third quarter: D 2 = $20,250/2 = $10,125 R 2 = $10,125 * 0.1 = $1,013 L 2 = $10,125 * 0.9 = $9,113 Currency: C 2 = L 1 D 2 = $20,250 - $10,125 = $10,125 fourth quarter: D 3 = $9,113/2 = $4,557 R 3 = $4,557 * 0.1 = $456 L 3 = $10,125 * 0.9 = $4,101 Currency: C 3 = L 2 D 3 = $9,113 - $4,557 = $4,557 Total money created within a year is the sum of all deposits and currency. $100,000 + $45,000 + $20,250 + $9,113 = $174,363 6

7 2. (10 points) If the consumption function is given by: C = C * Y, and let average propensity to consume (APC) be APC = C/Y. The saving rate is then s = 1 C/Y. (1) In the US economy, Y = $4,000 in year 1900, and APC = 0.8. What is the value of C 0? (2) In the US economy, Y = $32,000 in year What is the value of APC? (3) Comment on your answers in (1) and (2). Solutions: (1) APC = C/Y = (C Y) / Y = 0.8 = C 0 / $4, Solving for C 0 : C 0 = $200 (2) In year 2000, APC = ($ * $32,000)/$32,000 = (3) According to the consumption model, saving rate now should be 0.244, which contradicts the observed saving rate. The consumption model is not appropriate to describe consumption and saving patterns over time. 7

8 8