UNIVERSITY OF TORONTO Faculty of Arts and Science. August Examination 2006 ECO 209Y

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1 UNIVERSITY OF TORONTO Faculty of Arts and Science August Examination 2006 ECO 209Y Duration: 2 hours Examination Aids allowed: Non-programmable calculators only INSTRUCTIONS: Students are required to answer Part I [multiple choice questions] for 50% of the exam mark, and Part II [true/false statements] for 50% of the exam mark. Record all your answers for Part I on the SCANTRON sheet provided and, in addition, on the first page of the examination booklet for Part II for verification purpose. The answer on the SCANTRON sheet will be selected if there is a difference. Page 1 of 7

2 PART I [50%] MULTIPLE CHOICE QUESTIONS INSTRUCTIONS: Multiple choice questions are to be answered using a black pencil or a black or blue ball-point pen on the separate SCANTRON sheet being supplied. Be sure to fill in your name and student number on the SCANTRON sheet! Each question is worth 2.5 marks. No deductions will be made for incorrect answers. Write your answers to the multiple choice questions ALSO on the first page of the examination booklet used for Part II [true/false statements]. Then transfer your answers to each multiple choice question onto the separate SCANTRON sheet. Your answers must be on the SCANTRON sheet. In case of a disagreement, the answer to be marked is the one on the SCANTRON sheet. Use the following information to answer questions 1 and 2 below. Suppose that an economy produces only food, clothing, and books. Data for prices and quantities for year 1 and year 2 are given in the table below. Year 1 Year 2 Quantity Price Quantity Price Food 20 $6 15 $5 Clothing 10 $8 15 $10 Books 5 $10 8 $12 1. If year 1 is the base year, what is the rate of growth of real GDP in year 2? a) 12.0% b) 16.0% c) 18.5% d) 20.0% 2. If year 1 is the base period, what is the approximate value of the GDP deflator for year 2? a) 98.7 b) c) d) Page 2 of 7

3 3. Acme Publishers Ltd. produced 10,000 economics textbooks last year, which it sold at $120 a piece. In order to produce these 10,000 textbooks, Acme hired 12 workers at a cost of $350,000 to operate 5 printers valued at $25,000 a piece. In addition, Acme spent $450,000 in the paper and ink, the only two materials needed to produce these textbooks. Finally, ACME had to pay $75,000 in taxes on the $150,000 profit it made from this venture. Acme s contribution to GDP is a) $500,000 b) $575,000 c) $700,000 d) $750, Suppose that the federal government runs a budget surplus of $20 billion. It collects $100 billion in taxes, and it has the following expenditures: $20 billion in Social Security benefits, $10 billion in interest on the national debt, $10 billion in rent, and $40 billion in wages. The government contribution to GDP is a) $80 billion b) $70 billion c) $50 billion d) $40 billion 5. Net investment = 180; government budget surplus = 40; private saving = 200; net export = 30. The depreciation of the capital stock is a) 20 b) 30 c) 40 d) According to the fixed price model of the economy, an increase in government expenditure has a larger effect on income when a) the interest sensitivity of investment is relatively large b) the marginal propensity to save is relatively large c) the interest sensitivity of money demand is relatively large d) the marginal propensity to import is relatively large e) the tax rate is relatively large 7. Consider the fixed price model of the economy and suppose the marginal tax rate is 0.25 and the fiscal policy multiplier is 3. A $100 billion increase in government expenditure leads to a change in the budget surplus of a) -$100 billion b) -$50 billion c) -$25 billion d) -$10 billion Page 3 of 7

4 8. Consider the fixed price model of a closed economy. If the government has a balanced budget and income is below its equilibrium value, then a) unintended inventory accumulation will occur b) income will exceed aggregate expenditure c) aggregate expenditure will fall d) saving will be smaller than planned investment e) saving will equal planned investment 9. Consider a fixed price model of a closed economy. An increase in savings at each level of disposable income will a) shift the LM curve down b) shift the LM curve up c) shift the IS curve to the right d) leave both the IS and the LM curves unchanged 10. Consider a fixed price model of a closed economy, and suppose that the money supply varies directly with the interest rate. Then, all else equal, a) both the IS and the LM curves will be steeper than when the money supply is fixed b) the IS curve will be flatter and the LM curve will be steeper than when the money supply is fixed c) the IS curve will be steeper and the LM curve will be flatter than when the money supply is fixed d) the LM curve will be steeper than it is when the money supply is fixed 11. Consider a fixed price model of a closed economy, and suppose that consumption demand declines as the interest rate increases. The slope of the IS curve will a) be flatter the more sensitive consumption demand is to changes in the interest rate b) be flatter if the interest sensitivity of consumption is greater than the interest sensitivity of investment c) be steeper if the interest sensitivity of consumption is greater than the interest sensitivity of investment d) not depend on the sensitivity of consumption demand to changes in the interest rate e) depend on the sensitivity of consumption to changes in the interest rate, but it is not possible to answer the question from the information provided 12. In an open economy with fixed prices, flexible exchange rates, and perfect capital mobility, a decrease in the foreign interest rate would cause a) the exchange rate to appreciate and equilibrium income to fall b) the exchange rate to appreciate and equilibrium income to increase c) the exchange rate to depreciate and equilibrium income to increase d) the exchange rate to appreciate with no change in equilibrium income Page 4 of 7

5 13. Suppose that the marginal product of labour is MP N = N, where N is aggregate employment. The aggregate supply of labour is given by the expression N = w, where w is the real wage. What is the equilibrium quantity of employment? a) 12 b) 190 c) 380 d) In February, a farm in Mexico shut down and all of its workers immigrated to Canada, but they did not find employment in a Canadian farm until the summer (June). In March, therefore, the Canadian rate of unemployment while the Canadian rate of employment. [Note: The rate of employment is the fraction of the labour force which is employed.] a) increased; increased b) decreased; decreased c) increased; decreased d) decreased; increased e) increased; remained the same 15. Consider the flexible price model of a closed economy. If the government raises the GST (i.e., an indirect tax) and the Bank of Canada chooses a policy designed to prevent the price level from increasing, then a) output and interest rates will both rise b) output will rise and interest rates will fall c) output and interest rates will both decline d) output will remain unchanged and interest rates will rise e) output will decline and interest rates will rise 16. If nominal GDP is expected to increase by 5% and the rate of inflation to be 2% over the next year, we should expect the real demand for money a) to increase by about 2% b) to increase by about 3% c) to increase by about 5% d) to increase by more than 3% but less than 5% e) to increase by less than 3% 17. Assume that the currency-deposit ratio is 35%, the desired reserve-deposit ratio is 10%, and total money supply is $2,400 billion. What is the amount of high-powered money if there are no excess reserves in the banking system? a) $650 billion b) $800 billion c) $850 billion d) $900 billion Page 5 of 7

6 18. If the Bank of Canada wanted to maintain a constant interest rate after an increase in government spending, it would need to a) buy government bonds in open market operations b) raise reserve requirements c) increase the bank rate d) increase the currency-deposit ratio 19. Suppose that the Bank of Canada buys a painting for the new Governor's office. This will have the same effect on the money supply as a) an increase in the cash reserve ratio b) an increase in the amount of currency the public wishes to hold c) an open market purchase of government bonds d) intervention to prevent the Canadian dollar from falling in price on international markets e) a rise in the bank rate 20. Consider the life-cycle theory of consumption we developed in class. If you are age 20, have an initial wealth of $60,000, and have an expected average annual income of $24,000, how much should you consume each year if you want to retire at age 65 and expect to live until age 80? Assume you wish to leave no estate and to consume an equal amount in each of the next 60 years. a) $24,000 b) $20,000 c) $19,000 d) $18,000 Page 6 of 7

7 PART II [50%] TRUE/FALSE STATEMENTS INSTRUCTIONS: Answer true, false, or uncertain to all the following statements in an examination booklet. Be sure to justify your answers. Marks will be given entirely for your explanations. Analyze the situation in each statement, using a well-labelled diagram when relevant. Each question is worth 10 marks. 1. Consider the fixed price model of a closed economy. An increase in the income sensitivity of the demand for real balances will enhance the effectiveness of fiscal policy. 2. Conservative economists believe that government budget deficits tend to crowd out private investment. Therefore, proposed legislation to force governments to run balanced budgets at all times makes economic sense. 3. If there is perfect capital mobility and prices are fixed, a cut in government spending has a larger effect on equilibrium income under a fixed exchange rate system than under a flexible exchange rate system. 4. Suppose that the supply of labour is given by W/P = g(n) where g(n) is an increasing function of N and the demand for labour is given by W/P = MP N, where MP N is the marginal product of labour, P is the price level, W is the nominal wage rate, and N is the level of employment. Therefore, an unexpected increase in the price level will cause the real wage rate to fall and the equilibrium level of employment to increase. 5. An increase in government spending financed by borrowing from the public will result in a higher rate of inflation than if it were to be financed by borrowing from the Bank of Canada. Page 7 of 7