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 2014 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 43 multiple choice questions. 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. 3. You may use a calculator. The use of a cell phone is strictly prohibited and considered academic dishonesty. 4. 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. 5. You may not leave the room during the examination period. 6. 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. 7. When you finish, turn in your scantron. You may keep your copy of the exam. 1

2 1. Suppose that an ounce of gold is worth 4 times as much as an ounce of silver. If there are 10 grains of gold in a $1 gold coin and 50 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. 2. When a person uses a dollar bill to purchase a hamburger, money is being used as a. When a company values it inventory in terms of its dollar value, money is being used as. a. unit of account; store of value b. medium of exchange; unit of account c. store of value; medium of exchange d. none of the above 3. 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. Janet Yellen is the current chair of the Federal Reserve d. All of the above 4. During 2013, the Federal Reserve was nearly $85 billion of government bonds every month and kept the federal funds rate 0.5%. a. buying; above b. buying; below c. selling; above d. selling; below 2

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 $1000 of non-bank 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 $30,000 Govt. bonds $23,000 Owner's Equity $15,000 $55,000 $55, Start with the base case balance sheet. If the Fed buys $100 of government bonds from the banking system and the banking system completely adjusts to this change in their balance sheet, reserves will and M1 will. a. increase $100; increase $100 b. increase $100; increase $2,000 c. decrease $100; decrease $100 d. none of the above. 6. Start with the base case balance sheet. If the Fed cuts the reserve ratio from 5% to 4% and the bank system completely adjusts to this change, loans will and the monetary base will. a. increase $10,000; not change. b. increase $10,000; increase $10,000 c. decrease $10,000; decrease $10,000 d. none of the above. 7. Starting with the base case balance sheet and the 5% reserve ratio, if the public chooses to deposit $100 of its cash into demand deposits, after the bank system completely adjusts to this change, a. the monetary base will not change. b. M1 will rise by $2000 b. Loans will rise by $2000 d. all of the above 8. If the Federal Reserve begins selling government bonds in the open market, we should expect the money supply to and interest rates to. a. rise; fall b. rise; rise c. fall; fall d. fall; rise. 3

4 9. 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. 10. If a bond sells for a price that is above par, a. the yield will be negative b. the coupon rate will exceed the yield c. the yield will exceed the coupon rate d. the yield will match the coupon rate. 11. Consider a one year bond with a 4% coupon rate and a maturity value of $1000 that sells for $980 today. The yield to maturity on this bond is: a. 3.9 % b. 4.1% c. 4.6% d. 6.1% 12. Consider a 20 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. 3.3% c. 4.3 d. 4.7% 13. Suppose that you are offered a pay package that includes $10,000 in 2 years and another $10,000 in 5 years. If you can earn a risk free return of 5%, what is the present value of these two payments? a. $15,322 b. $16,906 c. $17,311 d. $18, 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 by less than previously expected. c. news that interest rates will rise sharply over the next year. d. all of the above. 15. 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 4

5 16. If the stock market rises sharply over the next 6 months, you are likely to make LESS on your stock portfolio if you have stocks that have: a. a higher than average PE ratio b. a lower than average PE ratio c. a beta coefficient greater than one. d. a beta coefficient less than one. 17. 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 18. According to the equation of exchange, if the money supply grows by 5% over the next year and velocity is unchanged, inflation will be a. 5% b. 3% if real GDP grows 2% c. 3% if nominal GDP grows 2% d. 2.5% if nominal GDP grows 2% 5

6 The diagram below plots the exchange rate in terms of number of Indian rupees per Chinese yuan since Given the change in the number of rupee per yuan, we can conclude that since 2010, the Chinese yuan has relative to the rupee. Other things being the same, this means that the cost of Chinese goods in India and the the cost of Indian goods in China. a. appreciated; rose; fell. b. appreciated; fell; rose c. depreciated; rose; fell d. depreciated; fell; rose. 20. Suppose that China s currency strengthens relative to the Indian rupee. Which of the following could explain this? a. an increase in China interest rates relative to India s. b. an increase in Indian demand for Chinese exports. c. a higher inflation rate in India than in China. d. all of the above. 6

7 21. Suppose that the U.S. government announces that it may sharply increase taxes on corporate profits. Given the likely impact on stock prices in the U.S., we should probably expect that a. the demand for the dollar would drop as foreign investors cease their purchases of U.S. stocks. This would cause the dollar to weaken. b. the supply of the dollar would drop as foreign investors leave the U.S. market. This would cause the dollar to strengthen. c. the supply of the dollar would increase as foreign investors move into the U.S. stock market. This would cause the dollar to weaken. d. none of the above. 22. Assume that the U.S. had a capital account surplus and a current account deficit. If there is a rapid increase in foreign investment in the U.S., this would cause the U.S. capital account surplus to and the current account deficit to. a. grow; grow b. grow; shrink c. shrink; grow d. shrink; shrink 23. If a country is a net borrower, a. it must be a debtor nation b. its exports will exceed its imports c. it will have a current account deficit d. all of the above 24. 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 Brazilian peso? a. an increase in Brazilian demand for U.S. exports.. b. a decreased desire in the U.S. to invest in the Brazilian stock market. c. a decrease in U.S. prices relative to Brazil. d. all of the above. 25. Based on the theory of interest rate parity, if interest rates in Mexico exceed those in the U.S., a. interest rate parity cannot hold. b. the value of the Mexican peso should fall relative to the dollar. c. the value of the dollar should fall relative to the peso d. inflation in Mexico must be below that in the U.S. 7

8 26. Suppose interest rate parity holds and the dollar is expected to appreciate by 2% relative to the Euro over the next year. Also, suppose government bonds in the Euro zone pay 4% interest. If interest rate parity holds, U.S. government bonds must pay an interest rate of: a. 2% b. 4% c. 6% d. none of the above. 27. Suppose the dollar is expected to appreciate by 3 percent over the next year relative to the Euro. Also, suppose 1 year government bonds currently offer an interest rate of 6% in the Euro zone and 4% 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 U.S bonds will net a 5% higher rate of return after adjusting for the exchange rate movement. c. prefer U.S. bonds over Euro bonds since they will net a 1% higher rate of return after adjusting for the exchange rate movement. d. prefer Euro bonds over U.S. bonds since Euro bonds will net a 1% higher rate of return after adjusting for the exchange rate movement. 28. An upward sloping yield curve a. is more common than a downward 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. none of the above 29. Suppose that a country start with net exports equal to zero. Because of optimism about investments in the country, there is a huge inflow of foreign investment. This would cause the country s currency to and net exports to. a. depreciate; fall b. depreciate; rise. c. appreciate; fall. d. appreciate; rise 30. Suppose that China becomes concerned that its currency has become too strong. It could weaken its currency by having the Chinese Central bank: a. selling the yuan and thus decrease its holdings of foreign reserves. b. selling the yuan and thus increase its holdings of foreign reserves. c. selling the dollar and thus increasing its holdings of foreign reserves. d. selling the dollar and thus decreasing its holdings of foreign reserves. 8

9 31. Suppose initially that the capital and current accounts in the U.S. are in balance. Suppose that investors in Europe begin to believe that U.S. financial markets will outperform theirs. Considering the effect of this on the Euro/$ exchange rate, we should expect that this will cause the dollar to (strengthen, weaken) relative to the Euro and eventually cause the U.S. to incur a current account (deficit, surplus). a. strengthen; surplus b. weaken; surplus c. strengthen; deficit d. weaken; deficit 32. Suppose the exchange rate is currently 15 pesos per dollar and that the price of gold is $1200 per ounce in the U.S. and 150,000 pesos per ounce in Mexico. Based on these figures, we should expect to find people buy gold in and resell it in the other country. This will gradually cause gold prices to in Mexico relative to the U.S. a. U.S.; rise b. U.S.; fall c. Mexico; rise d. Mexico; fall 33. According to the theory of purchasing power parity, the number of Brazilian pesos per dollar will rise if : a. U.S. inflation is greater than Brazilian inflation b. U.S. inflation is less than Brazilian inflation c. U.S. demand for Braziilian goods falls d. none of the above. 34. Which of the following would lead to a larger 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 35. Assuming that the official settlements account has a zero balance, when a country is a net lender to the rest of the world, the country will have a current account and a capital account. a. surplus; surplus b. surplus; deficit c. deficit; surplus d. deficit; deficit 9

10 36. Which of the following would simultaneously decrease long run aggregate supply and contribute to higher real wages? a. an increase in the generosity of transfer programs. b. a decrease in the amount of physical capital. c. technological innovations that improve labor productivity d. none of the above. 37. 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. more immigration is allowed. c. Social Security is made more generous. d. all of the above. 38. A increase in aggregate demand (AD) would be caused by transfers, government spending, or an expectation of future inflation. a. decreased; increased; higher b. decreased; decreased; higher c. increased; increased; lower. d. increased; increased; higher. 10

11 Consider the diagram below to answer the next 3 questions: LAS SAS AD 39. 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. 40. 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 unemployment. b. decreases in real wages, prices and unemployment. c. increases in real wages, prices and unemployment. d. decreases in real wages, increases in prices and unemployment. 41. 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. 11

12 42 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 long run: a. prices rise and the unemployment rate settles at the natural rate. b. prices rise and the unemployment rate settles above the natural rate. c. prices fall and the unemployment rate settles above the natural rate. d. prices fall and the unemployment rate settles at the natural rate. e. none of the above. 43. 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. 12

13 Answers 1 b 2 b 3 d 4 b 5 b 6 a 7 a 8 d 9 c 10 b 11 d 12 d 13 b 14 d 15 c 16 d 17 d 18 b 19 a 20 d 21 a 23 c 24 d 25 b 26 a 27 c 28 a 29 c 30 b 31 c 32 b 33 b 34 a 35 b 36 a 37 b 38 d 39 a 40 b 41 a 42 a 43 d 22 a 13