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

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1 ECO202: PRINCIPLES OF MACROECONOMICS SECOND MIDTERM EXAM Summer 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 37 multiple choice questions (3 points each) and 3 short answer questions worth a total of 30 points. Record your answer on both your scantron and your exam. Your grade for the multiple choice questions is determined entirely upon the answers listed on your scantron. Your scantron will not be returned, so your exam will serve as the record of your answers. 3. You may use a calculator. The use of a cell phone is strictly prohibited and considered academic dishonesty. 4. You have until 9:30 to finish the exam 5. You may not leave the room until you finish the exam. When you finish, turn in your exam and scantron. 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. 1

2 1. Suppose that an ounce of gold is worth 5 times as much as an ounce of silver. If there are 10 grains of gold in a $1 gold coin and 40 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. While money has several functions, the one function that is unique to money (i.e. no other asset can serve this function) is: a. unit of account b. medium of exchange. c. store of value 3. Which of the following statements is true? a. there are 12 districts in the Federal Reserve system b. the Federal Reserve was established in c. Janet Yellen is the chair of the Federal Reserve d. All of the above 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 $13,000 Owner's Equity $5,000 $45,000 $45, 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, demand deposits will and M1 will. a. decrease $100; decrease $100 b. decrease $200; decrease $2000 c. increase $2000; increase $2000. d. none of the above 5. Start with the base case balance sheet. If the Fed increases the reserve ratio from 5% to 10% and the bank system completely adjusts to this change, M1 will and the monetary base will. a. drop $10,000; not change b. drop $20,000; not change c. rise $10,000; rise $10,000 d. rise $10,000; not change. 6. Starting with the base case balance sheet and the 5% reserve ratio, if the public chooses to deposit $100 of its cash into a demand deposit, after the bank system completely adjusts to this change, a. the monetary base will not change b. M1 will rise by $1,900 c. loans will rise by $1,900 d. all of the above 7. If the Federal Reserve buys government bonds and banks always lend the maximum amount possible, we should expect the money supply to and interest rates to. a. fall; fall b. rise; rise c. rise; fall d. fall; rise. 3

4 8. 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. 9. If a bond sells for a price that is above par, a. the yield will be negative b. the yield will exceed the coupon rate c. the yield will be less than the coupon rate d. none of the above; more information is needed to know the yield. 10. Consider a one year bond with a 4% coupon rate and a maturity value of $1000 that sells for $1010 today. The yield to maturity on this bond is: a. 3.0 % b. 3.2 c. 4.0% d. 4.3% 11. 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 $20,000 in 10 years. If the bank is willing to lend you money at 4% interest, how much should they be willing to lend you today? a. $16,732 b. $18,211 c. $21,731 d. $22, Consider a 5 year zero coupon bond with a maturity value of $1000 that sells for $600 today. The annual yield to maturity on this bond is: a. 4.3 % b. 5.7% c. 7.9% d. 10.8% 13. Suppose stock prices reflect their fundamental value. Which of the following would lead to higher prices? a. news that corporate tax rates will be reduced next year. b. news that corporate profits will fall next year, but not by as much as previously believed. c. news that interest rates will fall sharply over the next year. d. all of the above. 14. 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 15. Recently, a financial commentator suggested that investors increase the share of their stock portfolio that is invested in defensive stocks that tend to have a lower than average drop in value when the stock market declines. If you wanted to buy defensive stocks, you should look for stocks with that 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 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 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. According to the equation of exchange, which of the following would lead to higher inflation? a. an increase in the rate of growth in the money supply or a decrease in velocity b. a slower rate of growth in real GDP or an increase 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 18. If a country s currency appreciates, this should cause its imports to and its exports to. a. fall; fall b. fall; rise c. rise; rise d. rise; fall 19. Over the past year, the exchange rate between the Mexican peso and the U.S. dropped from 14 to 13 pesos per dollar. This means that over the past year, the peso (appreciated, depreciated) relative to the dollar and the amount that U.S. citizens pay for imports from Mexico (increased; decreased). a. appreciated; increased b. appreciated; decreased c. depreciated; increased d. depreciated; decreased 5

6 To answer the next 2 questions, refer to the quote below from an article published in the 6/1/2014 Wall Street Journal. Times published in October 2010 about the effects of U.S. monetary policy reducing interest rates during the great recession. The U.S. has grown more attractive as a destination for foreign investment, while Russia and some other emerging markets have faded, according to a survey by A.T. Kearney, a Chicago-based management-consulting firm.... The U.S. attracted $193.4 billion of investment from foreign countires in The fact that the U.S. has become a more attractive destination for foreign investment should have led to: a. a stronger dollar since the demand for the dollar would rise. b. a weaker dollar since the demand for the dollar would fall. c. a stronger dollar since the supply of dollars would rise 21. The U.S. has experienced capital account surpluses and current account deficits for most of the past 30 years. The fact that the U.S. has recently become a more attractive destination for foreign investment should cause the capital account surplus to and the current account deficit to. a. grow; grow b. grow; shrink c. shrink; grow d. shrink; shrink 22. Based on the supply/demand model for the dollar in foreign currency markets, which of the following would cause the dollar to depreciate relative to the Mexican peso? a. a decrease in Mexican demand for U.S. exports.. b. an increased desire in the U.S. to invest in the Mexican stock market. c. an increase in U.S. prices relative to Mexico. d. all of the above. 23. 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 7% interest. If interest rate parity holds, U.S. government bonds must pay an interest rate of: a. 2% b. 7 c. 12% 6

7 24. Suppose the one year interest rate is 5% in the U.S. and 8% in the Euro zone. If interest rate parity holds, the dollar should: a. appreciate by 3% relative to the Euro over the next year b. depreciate by 3% relative to the Euro over the next year. c. appreciate by 13% relative to the Euro over the next year. 25. An upward sloping yield curve a. is less 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. will become flatter if financial markets receive news that interest rates will fall in the future. d. all of the above 26. As discussed in class, the Swiss franc appreciated significantly as a result of the result financial turmoil in the Euro zone. Because of the significant appreciation of the Swiss franc, their exports began to and the central bank decided that it would attempt to offset the appreciation by. a. rise; selling francs which caused their money supply to shink b. fall; buying francs which caused their money supply to fall. c. fall; selling francs which caused their money supply to grow. 27. Suppose the exchange rate is currently 15 pesos per dollar and that the price of gold is $1250 per ounce in the U.S. and 17,000 pesos per ounce in Mexico. 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. Mexico; U.S. Mexico; U.S. b. Mexico; U.S. U.S.; Mexico; c. U.S.; Mexico; Mexico; U.S. d. U.S.; Mexico; U.S.; Mexico. 28. 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. increased purchases of foreign bonds by U.S. citizens, or increased purchases of U.S. bonds by foreign citizens. c. increased purchases of foreign bonds by U.S. citizens, or decreased purchases of U.S. bonds by foreign citizens d. decreased purchases of foreign bonds by U.S. citizens, or decreased purchases of U.S. bonds by foreign citizens. 7

8 29. 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 30. Which of the following would simultaneously increase long run aggregate supply and contribute to lower real wages? a. more immigration is allowed. b. transfer programs are made more generous. c. technological innovations that improve labor productivity 31. Which of the following would simultaneously increase long run aggregate supply and contribute to higher real wages? a. the amount of capital per worker increases b. tax rates on wages are reduced c. Social Security is made more generous. 32. An increase in aggregate demand (AD) would be caused by transfers, government spending, or an expectation of future inflation. a. lower; increased; greater. b. lower; decreased; lower. c. higher; decreased; greater. d. higher ; increased; greater 8

9 Consider the diagram below to answer the next 3 questions: LAS SAS AD 33. 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. below; above. b. below; below c. above; above. d. above; below. 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. upward; above. b. upward; below. c. downward; above. d. downward; below 35. 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 increases in employment. b. increases in real wages and prices and decreases in employment. c. decreases in real wages, decreases in prices and increases in employment. d. decreases in real wages, increases in prices and increases in employment. 36. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the U.S. increases income taxes. Considering the likely effect of this on AD, we should expect that in the short run: a. prices fall, real wages fall, and the unemployment rate falls below the natural rate. b. prices fall, real wages rise, and the unemployment rate rises above the natural rate. c. prices rise, real wages fall, and the unemployment rate drops below the natural rate. d. prices rise, real wages rise, and the unemployment rate drops below the natural rate. 9

10 37. Suppose that the economy starts at a long run equilibrium and is producing at potential output. Now suppose that the U.S. increases income taxes. Considering the likely effect of this on AD, we should expect that in the long run: a. prices fall and the unemployment rate settles above the natural rate. b. prices fall and the unemployment rate settles at the natural rate. c. prices rise and the unemployment rate settles at the natural rate. d. prices rise and the unemployment rate settles above the natural rate. 10

11 1. (10 points) Draw a supply/demand diagram for the dollar in the foreign exchange market. Clearly label what is measured on your axes. Use the diagram to explain how increased in inflation in Venezuela would affect the value of the dollar relative to the Venezuelan Bolivar. Be sure to explain how your graph shows the effect of the Venezuelan inflation. 11

12 2. (10 points) Draw an AS/AD model that shows the economy starting at a long run equilibrium. Label the starting equilibrium in your diagram as point A. During the great recession, consumers lost wealth in the stock market and became less confident about their job security. Illustrate the effect of these shocks on the AS and/or AD curves and label the new equilibrium as point B. Also, as the economy moves from A to B, describe what happens to unemployment and real wages. 3. (10 points) In an attempt to move the economy out of the great recession, both the federal government and the Federal Reserve tried to stimulate the economy with fiscal and monetary policy. Explain what the government was trying to do in terms of either AD or AS (i.e. were they trying to shift one or both curves to the right? The left?). Also, explain how the government could achieve the desired objective with changes in taxes or spending, and how the Fed could achive the objective with changes in interest rates. 12