MACROECONOMICS MC Exam

PrimerPrimer Before Taking the Before Taking the 2005 Macro MC Exam2005 Macro MC Exam Slides 3-7 are a review of the graphs for fiscal policyfiscal policy

and monetary policymonetary policy. The money market graphmarket graph with a vertical MS curvevertical MS curve is

to be used with monetary policyused with monetary policy. The *nominal *nominal interest rateinterest rate is used with this graph.

The loanable funds marketloanable funds market [LFMLFM] [slide 3] is used when there is a change inthere is a change in fiscal policyfiscal policy or when consumers change their saving habitsconsumers change their saving habits. The *real *real interest rateinterest rate is used with this graph.

Slides 8 - 11 show the difference between the difference between the

nominal and real interest ratesnominal and real interest rates. Slide 12 is a breakdown by economic topicbreakdown by economic topic on the 2005

exam.

Re

al I

nte

res

t R

ate

, (p

erc

en

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Quantity of Loanable Funds

Loanable Funds MarketLoanable Funds Market[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy][*Use this graph if there is a chg in savings by consumers or chg in fiscal policy]

[*[*Use theUse the Money Market graphMoney Market graph when there is awhen there is a change in MSchange in MS]]

rr==66%%

DD11

FF11

SS

Starting from a balanced budgetbalanced budget, if theG incr spendingG incr spending or decr Tdecr T to get out ofa recessionrecession, they would now be runninga deficitdeficit and have to borrow, pushing pushing up demand in the LFMup demand in the LFM and increasing increasing the interest ratethe interest rate.

DD22

rr==88%%

FF22

EE11

EE22

Use the “real interest rate”“real interest rate” withLFMLFM, because it is long-termlong-term.Use “nominal interest rate”“nominal interest rate” withmoney marketmoney market, as it is short-termshort-term. BorrowersBorrowers LendersLenders

$$2 T2 T

GG TT

Balanced Budget [G&T=$2 Tr.]Balanced Budget [G&T=$2 Tr.]

$2.2 T$2.2 T $2 T$2 T

YYRR

DDMM

InvestmentDemand

no

min

al

Inte

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ate 88

4

0Money Market QID1QID1

MSMS11

ASASADAD11

PLPL11

8%8%

6%6%

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MSMS22

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If there is aIf there is a RECESSIONRECESSIONMS will beMS will beincreased.increased.

QID2QID2

DDII

Y*Y*

Buy Buy BBondsonds MSMS I.R.I.R. QIDQID ADAD YY//EEmp/mp/PLPL

I want a job I want a job as a Rocketteas a Rockette

Real GDPReal GDP

BuyBuy

FEDERAL RESERVE BANK OF THE U.S.FEDERAL RESERVE BANK OF THE U.S.

EE11E2E2

6%6%

DDII

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Dm

InvestmentDemand

Nom

inal In

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1010%%

8%8%

6%6%

0Money MarketMoney Market QIDQID2 2 AS

10

88

66

0

ADAD22

PL2

MSMS11

PLPL11

MSMS22

If there isIf there isINFLATIONINFLATION,,MS will beMS will bedecreased.decreased.

SellSell

QIDQID11

YY**

““It’s cheaper It’s cheaper to burn moneyto burn moneythan wood.”than wood.”

SellSellBondsBonds MSMS I.R.I.R. QIDQID ADAD Y/EY/Empl.mpl./PL/PL

FEDERAL RESERVE BANK OF THE U.S.FEDERAL RESERVE BANK OF THE U.S.

like““money trees”money trees”

EE11

EE22

Real GDPReal GDP

PLPL SRASSRASADAD22

YYRR YYFF

[[Incr GIncr G;; Decr TDecr T]]

PPL1L1

ADAD11

PLPL22

GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM II.R..R.

TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR

Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion

$2 tr.$2 tr.

““I can’t I can’t get a job.”get a job.”

““NNowow, , this isthis is better.”better.”

GG TT EE11EE22

LRASLRAS

DD11DD22 SS

Loanable Funds MarketLoanable Funds Market

rr=6=6%%rr=8=8%%

RealReal In. RateIn. Rate

FF11 FF22

$2 tr.$2 tr.

$2.2 tr.$2.2 tr.

$2.2 $2.2 $2.2 $2.2

$1.8 $1.8 $1.8 $1.8

Real GDPReal GDP

PL SRASSRAS

ADAD22

YYIIYYFF

[[Decr G; Decr G; Incr TIncr T ]]

PPL1L1

ADAD11

PLPL22

GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM I.I.R.R.

TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR

Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion

$2$2 tril. tril.

GG TT

[like we have[like we have ““money trees”money trees”]]

EE11

EE22

LRASLRAS

Loanable Funds MarketLoanable Funds Market


rr=3=3%%

rr=6=6%%

DD11DD22

FF11FF22

SS

$2 T$2 T triltril..

$2.2 T$2.2 T triltril..

$1.8$1.8 tril. tril...

$$1.81.8

$2.2$2.2 $2.2$2.2

$$1.81.8

Interest Rates• Nominal interest rate [5%]Nominal interest rate [5%]

– Measures interest in terms of the current dollars paid [let’s say 5%5% on a 3-month T-bill]

– Appears on the borrowing agreement [market quote]

– The rate quoted in the news media

• Real interest rate [3%]Real interest rate [3%]– Equals the nominal rate of interest [5%5%] minus the

inflation rate [let’s say 2%2%]– Expressed in dollars of constant purchasing power

[3%3%]

Interest Rates• With no inflation, the nominal and real interest

rates would be identical [let’s say, 3%3%]

• With inflation [2%2%], the nominal interest rate [5%5%] exceeds the real interest rate [3%3%]– If the inflation rate is high enough [6%6%], the real

interest rate can actually be negative [ -1%-1% or 5% - 6%- 6% = -1%-1%]

– The nominal interest would not even offset the loss in spending power because of inflation lenders would lose purchasing power

– This is why lenders and borrowers are concerned more about the real interest rate than the nominal interest rate

NominalNominalInterestInterest

RateRate

RealRealInterestInterest

RateRate

InflationInflationPremiumPremium

= 8%8%6%6%

[[Real I.R.Real I.R. ++ anticipated inflationanticipated inflation == nominal nominal I.R.I.R.]]

+ 2%2%

+ =

NominalNominalInterestInterest

RateRate

RealRealInterestInterest

RateRate

InflationInflationPremiumPremium

-88%%

66%%

22%%

[[Nominal I.R.Nominal I.R. – – inflation rateinflation rate == Real I.R.Real I.R.]]

==

==-

Contents of the 2005 MC ExamContents of the 2005 MC Exam1.1. Basic Concepts: 5 questions, including one on the PPC andBasic Concepts: 5 questions, including one on the PPC and one on Supply and Demand.one on Supply and Demand.2. Global Trade: 7 questions including one on comparative 2. Global Trade: 7 questions including one on comparative advantage, & 4 on appreciation/depreciation.advantage, & 4 on appreciation/depreciation.3. GDP, NIA, Unemployment, Business Cycles, & Inflation: 3. GDP, NIA, Unemployment, Business Cycles, & Inflation: 7 questions including one on figuring an individual’s CPI.7 questions including one on figuring an individual’s CPI.4. AD/AS: 12 questions.4. AD/AS: 12 questions.5. AE: 3 questions on AE terminology, no AE graph 5. AE: 3 questions on AE terminology, no AE graph to interpret.to interpret.

6. Fiscal Policy: 3 questions.6. Fiscal Policy: 3 questions.7. Loanable Funds Market: 2 questions7. Loanable Funds Market: 2 questions8. Money 8. Money and and Banking: no questions.Banking: no questions.9. Money Creation: 4 questions.9. Money Creation: 4 questions.10. Monetary Policy: 7 questions.10. Monetary Policy: 7 questions.11. Phillips curve: 2 questions.11. Phillips curve: 2 questions.12. Schools of Thought: 4 questions.12. Schools of Thought: 4 questions.13. Economic Growth: 3 questions.13. Economic Growth: 3 questions.14. Debt and Deficit: 1 question.14. Debt and Deficit: 1 question.

(*)denotes what percent of students got the question rightBasic ConceptsBasic Concepts(85%)(85%) 1. In a mixed economy, what to produce and how much to produce are determined by: a. a central planning agency c. an international planning agency b. a private planning agency d. markets and the government e. large corporations and small entrepreneurs(84%)(84%) 2. Changes in which of the following factors would affect the growth of affect the growth of an economyan economy. I. Quantity and quality of human and natural resources. II. Amount of capital goods available III. Technology a. I only b. I & II only c. I & III only d. II & III only e. I, II, & III(89%)(89%) 3. If two coats are currently being produced, the opportunity cost ofopportunity cost of producing the third coatproducing the third coat is a. 85 belts b. 75 belts c. 40 belts d. 15 belts e. 10 belts(50%)(50%) 4. The best combination of beltsbest combination of belts & coats& coats for thisfor this economy economy to produce is a. 95 belts & 1 coat b. 85 belts & 2 coats c. 70 belts & 3 coats d. 40 belts & 4 coats e. indeterminate with the available information

0 1 2 3 4

1009585

40B

elts

Bel

ts

CoatsCoats

70

[PPC [PPC for questionsfor questions 3 and 4]3 and 4]

(80%)(80%) 5. Assume that for consumers, pears and apples are substitutespears and apples are substitutes. It is announcedthat pesticides used on most applespesticides used on most apples may be dangerousmay be dangerous to consumers’ health. As a result of this announcement, which of the following market changesfollowing market changes is most likely to occur in the short runshort run in the pear market?

Global TradeGlobal Trade

D1

D2

D

D1

D2 D1D2 D1

D2

SS

S1S1S2S2

S1S1S2S2

SSSS

(a) # of Pears (b) # of Pears (c) # of Pears (d) # of Pears (e) # of Pears

P PPP

P

(71%)(71%) 6. Which of the following best explains why many U.S. economists support why many U.S. economists support free tradefree trade? a. Workers who lose their jobs can collect unemployment compensation. b. It is more important to reduce world inflation than to reduce U.S. unemployment. c. Workers are not affected; only business suffer. d. The long-run gains to consumers & some producers exceed the losses to other producers. e. Government can protect U.S. industries while encouraging free trade.

(16%)(16%) 7. If a country has a current account deficita country has a current account deficit, which of the following must be true? a. It must also show a deficit in its capital account. b. It must show a surplus in its capital account. c. It must increase the purchases of foreign goods & services. d. It must increase the domestic interest rates on its bonds. e. It must limit the flow of foreign capital investment.(59%)(59%) 8. EconEcon can produce either 2 tons of cocoa or 4 cars2 tons of cocoa or 4 cars with 10 units of labor. NomicsNomics can produce either 5 tons of cocoa or 25 cars5 tons of cocoa or 25 cars with 10 units of labor. Based on this information, which of the following is true. a. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cocoa. b. Econ has a comparative advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. c. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. d. Econ has a comparative disadvantage in the production of both goods. e. Neither country has a comparative advantage in the production of either good.

Answer: For Econ, 1 cocoa = 2 cars so, ½ cocoa = 1 car For Nomics, 1 cocoa = 5 cars so, 1/5 cocoa = 1 car

costscosts

costscosts

Econ has a lower op cost for cocoa, 2 cars v. Econ has a lower op cost for cocoa, 2 cars v. 5 cars. So Econ will produce cocoa.5 cars. So Econ will produce cocoa.

Nomics has a lower op cost for cars, 1/5 cocoaNomics has a lower op cost for cars, 1/5 cocoav. ½ cocoa. So Nomics will produce cars.v. ½ cocoa. So Nomics will produce cars.

costscosts

costscosts

(50%)(50%) 9. If Mexico increases their investments in the U.S.,Mexico increases their investments in the U.S., the supply of Mexicansupply of Mexican pesospesos to the foreign exchange marketto the foreign exchange market and the dollar price of the pesodollar price of the peso will most likely change in which of the following ways?

Supply of PesosSupply of Pesos Dollar Price of PesoDollar Price of Pesoa. increase increase

b. increase decreasec. decrease increased. decrease decreasee. decrease not change

(41%)(41%) 10. If the real interest rate in Canada increasesreal interest rate in Canada increases relative to the real interest rate in Japan and there are no trade barriers between the two countries, then for for Canada which of the following will be trueCanada which of the following will be true of its financial capitalfinancial capital, the valuevalue of its currencyof its currency, and its exportsits exports?

Capital FlowCapital Flow CurrencyCurrency ExportsExportsa. Inflow Appreciation Increaseb. Inflow Appreciation Decreasec. Inflow Depreciation Increased. Outflow Depreciation Increasee. Outflow Appreciation Decrease

The higher real IR in Canadawould attract more financialcapital “inflows”“inflows” from overseas, appreciatingappreciating the Canadian dollar, and decreasing itsdecreasing itsexportsexports because they are now more expensive.

As pesos are exchanged for dollars, pesopesosupply increasesupply increase in depository institutions.There is an increase in demand for the dollar and it appreciates, decreasing the decreasing the dollar price of the pesodollar price of the peso.

(51%)(51%) 11. With an increase in investment demand in the U.S.increase in investment demand in the U.S. the real interest ratereal interest rate risesrises. In this situation, the most likely change in the capital stock in the U.S.change in the capital stock in the U.S. and in the international value of the dollarinternational value of the dollar would be which of the following? Capital Stock inCapital Stock in International ValueInternational Value United StatesUnited States of the Dollarof the Dollar a. Increase Decrease b. Increase No change c. Increase Increase d. Decrease Increase e. No change Decrease(64%)(64%) 12. Which of the following would cause the U.S. dollar to cause the U.S. dollar to increase in valueincrease in value compared to the Japanese yen? a. An increase in the money supply in the U.S. b. An increase in interest rates in the U.S. c. An increase in the U.S. trade deficit with Japan d. The U.S. purchase of gold on the open market e. The sale of $2 billion dollars worth of Japanese television sets to the U.S.NIA, GDP, Unemployment, & InflationNIA, GDP, Unemployment, & Inflation(72%)(72%) 13. The major difference between real and nominal GDPdifference between real and nominal GDP is that real GDP a. excludes government transfer payments b. excludes imports c. is adjusted for price-level changes using a price index d. measures only the value of final goods and services that are consumed e. measures the prices of a market basket of goods purchased by a typical urban consumer

More real investment would result in anincrease in real capital stock in the U.S.increase in real capital stock in the U.S.The increase in the real interest rate wouldincrease financial investment demandincrease financial investment demandfor the dollar as it appreciatesfor the dollar as it appreciates.

(67%)(67%) 14. Which of the following statements would be structural unemploymentstructural unemployment? a. New entrants into the labor force have trouble finding jobs. b. Workers leave their current jobs to find better jobs. c. Workers are laid off because AD has declined. d. Workers are fired because their skills are no longer in demand.(52%)(52%) 15. In the country of Agronomia, banks charge 10% interest10% interest on all loans. If the general price level has been increasing at the rate of 4%price level has been increasing at the rate of 4% per year, the real rate of interestreal rate of interest in Agronomia is a. 14% b. 10% c. 6% d. 4% e. 2.5%(67%)(67%) 16. Which of the following best explains why transfer payments are not why transfer payments are not included in the calculation of GDPincluded in the calculation of GDP? a. Transfer payments are used to pay for intermediate goods. b. Transfer payments are a government expenditure, and government expenditures are excluded from GDP. c. Recipients of transfer payments have not produced or supplied goods and services in exchange for these payments. d. Recipients of transfer payments are usually children, and income earned by children is excluded in GDP. e. Recipients of transfer payments are sometimes not citizens of the U.S.(82%)(82%) 17. The unemployment rate measuresunemployment rate measures the percentage of a. people in the labor force who do not have jobs b. people in the labor force who have a part-time job but are looking for a full-time job c. people who do not have jobs and have given up looking for work d. people in the adult population who do not have jobs e. people in the adult population who have temporary jobs

Consumers in this economy buy only two goods–hot dogs & hamburgers.Step 1. Fix the basket. What percent of income is spent on each. Consumers in this economy buy a basket of:

4 hot dogs and 2 hamburgers4 hot dogs and 2 hamburgers

Step 2. Find the prices of each good in each year. YearYear Price of Hot DogsPrice of Hot Dogs Price of HamburgersPrice of Hamburgers 20012001 $1 $1 $2$2 20022002 $2 $2 $3$3

Step 3. Compute the basket cost for each year. 2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $82001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8 2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $142002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14

Step 4. Choose one year as a base year (2001) and compute the CPI 2001 ($8/$8) x 100 = 1002001 ($8/$8) x 100 = 100 2002 (14/$8) x 100 = 1752002 (14/$8) x 100 = 175Step 5. Use the CPI to compute the inflation rate from previous year 2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%(175-100)/100 x 100 =75%Or, Or, ChangeChange $14-$8 ($6)$14-$8 ($6) Original $8 x 100 = 75%Original $8 x 100 = 75%

(42%)(42%) 18. Suppose that a typical consumer buys the following quantities of thesebuys the following quantities of these three commodities in 2000 and 2001three commodities in 2000 and 2001.

CommodityCommodity QuantityQuantity 2000 per2000 per Unit PriceUnit Price 2001 per2001 per Unit PriceUnit PriceFood 5 units $6.00 $5.00Clothing 2 units $7.00 $9.00Shelter 3 units $12.00 $19.00

Which of the following can be concluded about the CPI for this individual from concluded about the CPI for this individual from 2000 to 20012000 to 2001? a. It remained unchanged. c. it decreased by 20% b. It decreased by 25%. d. It increased by 20% e. It increased by 25%.(Answer)(Answer) Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]

Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, for dollar value of $100. CPI for dollar value of $100. CPI =125 =125

ChangeChange $100-$80 [$20]$100-$80 [$20]Original = $80 x 100 = 25%; so the CPI for this individual is Original = $80 x 100 = 25%; so the CPI for this individual is 25%25%..

(46%)(46%) 19. Which of the following is included in the computation of GDPincluded in the computation of GDP? a. Government transfer payments b. Purchases of used goods c. Child care tasks by householders d. Total value of business inventories e. Additions to business inventories

AD/ASAD/AS(96%)(96%) 20. Under which of the following conditions would consumer spending increaseconsumer spending increase? a. Consumers have large unpaid balances on their credit cards. b. Consumers’ wealth is increased by changes in the stock market. c. The government encourages consumers to increase their savings. d. Social Security taxes are increased. e. Consumers believe they will not receive pay increases next year.

This includes produced items that were notsold and all produced goods count in GDP.

Some of (d.) was produced the previous year.

(79%)(79%) 21. An increase in which of the following will increase aggregate demandincrease aggregate demand? a. Taxes b. Government spending c. Federal funds rate d. RR e. Discount rate

(71%)(71%) 22. A favorable supply shockfavorable supply shock, such as a decrease in energy prices is most likely to have which of the following short-run effects on the PL and outputshort-run effects on the PL and output. Price LevelPrice Level OutputOutput a. Decrease No effect b. Decrease Increase c. Increase Increase d. Increase Decrease e. No effect No effect

(51%)(51%) 23. Assume that the economy is at full-employment equilibrium in the diagram to theright. Which answer would lead to stagstagflationflation? a. Leftward shift of the SRAS curve only b. Rightward shift of the SRAS curve only c. Leftward shift of the AD curve only d. Rightward shift of the AD curve only e. Rightward shift in both the SRAS curve and the AD curve

LRASLRASSRASSRASADAD

Y* Real GDPY* Real GDP

PLPL11

SRASSRAS22

PLPL22

YYRR

(61%)(61%) 24. A change in which of the following will cause the short-run AS curve to shiftshort-run AS curve to shift? I. The price level II. Government spending III. The cost of all inputs a. I only b. II only c. III only d. I & II only e. I, II, & III(65%)(65%) 25. In an economy with a horizontal AS curvehorizontal AS curve, an increase in government spending will cause output and PLoutput and PL to change in which ways? Output Price Level a. Decrease Increase b. Increase Increase c. Increase No Change d. No change Increase e. No change No change(65%)(65%) 26. The AD curve is downward slopingAD curve is downward sloping because as the PL increasesas the PL increases the a. purchasing power of wealth decreases b. demand for imports decreases c. demand for interest-sensitive expenditures increases d. demand for domestically produced substitute goods increases e. real value of fixed assets increases(52%)(52%) 27. Which of the following events will most likely cause an increase in bothincrease in both the price level and real gross domestic productthe price level and real gross domestic product? a. The prime rate increases. b. Exports increase. c. Income taxes increase. d. Crude oil prices decrease. e. Inflationary expectations decrease.

This would cause an increase in AD, incr PL and Y.This would cause an increase in AD, incr PL and Y.

(57%)(57%) 28. If an economy’s AS curve is upward slopingAS curve is upward sloping, an increase in governmentincrease in government spendingspending will most likely result in a decrease in the a. real output b. PL c. interest rate d. unemployment rate e. budget deficit(47%)(47%) 29. An increase in which of the following will lead to lower inflationlower inflation and lower unemploymentand lower unemployment? a. exports b. AD c. Labor productivity d. Government spending

(54%)(54%) 30. An unanticipated decrease in ADunanticipated decrease in AD when the economy is in equilibrium will result in a. a decrease in voluntary unemployment b. a decrease in the natural rate of unemployment c. a decrease in AS d. an increase in unplanned inventories e. an increase in the rate of inflation

(34%)(34%) 31. Which of the following would be true if the actual rate of inflation were lessactual rate of inflation were less than the expected rate of inflationthan the expected rate of inflation a. Inflation had been under-predicted. b. The real interest rate had exceeded the nominal interest rate. c. The real interest rate had been negative. d. People who borrowed funds at the nominal interest rate during this time period would lose. e. The economy would expand because of the increased investment and spending.

[would lead to an increase in AS, lowering PL & unemployment]

[with job loses, unsold inventory would stack up]

Borrowers could now get cheaper loans but they have already agreed to the higher rates.a. Inflation was over-predicted. b. The real interest rate was less than the nominal. c. The real would be positive.e. Lower inflation means less corporate profits than expected, lay-offs, less Ig, contracted GDP, & less spending.

Aggregate ExpendituresAggregate Expenditures(70%)(70%) 32. Which of the following can be considered a leakage leakage from the circular flowfrom the circular flow of economic activity? a. Investment b. Government expenditures c. Consumption d. Exports e. Saving (76%)(76%) 33. An increase in the marginal propensity to consumeincrease in the marginal propensity to consume causes an increase increase inin which of the following? a. Marginal propensity to save b. Spending multiplier c. Saving rate d. Exports e. Aggregate supply

(44%)(44%) 34. In an economy with lump-sum taxes and no international sector, assume that the AS curve is horizontalAS curve is horizontal. If the MPC is equal to 0.8MPC is equal to 0.8, which of the following will necessarily be true? a. The APC will be less than the MPC. b. The government expenditure multiplier will be equal to 5. c. A $10 increase in consumption spending will bring about an $80 increase in DI. d. Wealth will tend to accumulate in the hands of a few people. e. The economy will be running a deficit, since consumption expenditures exceed personal saving.

An increase in MPC means a decr in MPS, and a larger ME

1/.2 = 1/.2 = MME of “5”E of “5”

Fiscal PolicyFiscal Policy(64%)(64%) 35. Crowding outCrowding out is best described as which of the following? a. The decrease in full-employment output caused by an increase in taxes b. The decrease in consumption or private investment spending caused by an increase in government spending c. The decrease in government spending caused by a decrease in taxes d. The increase in the amount of capital outflow caused by the increase in government spending e. The increase in the amount of capital inflow caused by the increase in government spending(51%)(51%) 36. An increase in government spendingincrease in government spending with no change in taxes leads to a a. lower income level b. lower price level c. smaller money supply d. higher interest rate e. higher bond price (39%)(39%) 37. If investors feel that business conditions will deterioratebusiness conditions will deteriorate in the future, the demand for loans and real interest ratedemand for loans and real interest rate in thein the loanable fundsloanable funds marketmarket will change in which of the following ways in the short run? Demand for LoansDemand for Loans Real Interest RateReal Interest Rate a. Increase Increase b. Increase Decrease c. Decrease Increase d. Decrease Decrease e. Decrease Not change

Incr in G causes incr in I.R. in LFM, decr “C” and “Ig”.

Starting from a bal. bud., G would now run a deficit and have to borrow in the LFM, pushing up the I.R.

The “negative profit expectations”cause firmsto decr Ig & not borrow as much, decr the I.R.

Loanable Funds MarketLoanable Funds Market(44%)(44%) 38. Assume that a perfectly competitive financial market for loanable funds is in equilibrium. Which of the following is most likely to occur to the QD and QS of loanable fundsQD and QS of loanable funds if the government imposes an effective interest rate ceilinginterest rate ceiling? QDQD QSQS a. Increase Increase b. Increase Decrease c. No change No change d. Decrease Increase e. Decrease Decrease

(48%)(48%) 39. Assume that the supply of loanable funds increases in Japan. The international value of Japan’s currency and Japan’s exports will most likely change in which of the following ways? International Value ofInternational Value of Japan’sJapan’s Japan’s CurrencyJapan’s Currency ExportsExports a. Decrease Decrease b. Decrease Increase c. Increase Decrease d. Increase Increase e. Not change Not change

There would be increased QD for the lower thanequilibrium I.R., but the ceiling restricts QS.

SSDDLoanable Funds Market Loanable Funds Market

r=8%r=8%

r=6%r=6%

QDQDQSQS


QQ

The increase in yen supply would lower the I.R., depreciating the yen & making Japanese goods cheaper which would increase Japan’s exports.


DDSS

r=8%r=8%

SS22

r=6%r=6%

Money CreationMoney Creation (87%)(87%) 40. Under a fractional reserve banking systemfractional reserve banking system, banks are required to a. keep part of their demand deposits as reserves b. expand the money supply when requested by the central bank c. insure their deposits against losses and bank runs d. pay a fraction of their interest income in taxes e. charge the same interest rate on all their loans(72%)(72%) 41. If a commercial bank has no ER and the RR is 10%, what is the value of new loans this single bank can issue if a new customer deposits $10,000? a. $100,000 b. $90,333 c. $10,000 d. $9,000 e. $1,000

AssetsAssets LiabilitiesLiabilities Total Reserves: $15,000 DD: $100,000

Securities: $70,000Loan: $15,000

(37%)(37%) 42. A commercial bank is facing the conditions given above. If the RR is 12%RR is 12% and the bank does not sell any of its securities, the maximum amount ofmaximum amount of additional lendingadditional lending this bank can undertake is a. $15,000 b. $12,000 c. $3,000 d. $1,800 e. 0(53%)(53%) 43. Assume the RR is 20%RR is 20%, but banks voluntarily keep some excess reserveskeep some excess reserves. A $1 million increase in new reserves$1 million increase in new reserves will result in a. an increase in the MS of $5 million c. decrease in MS of $1 millionb. an increase in the MS of less than $5 million d. decrease in the MS of $5 millione. a decrease in the MS of more than $5 million

TThe he TR: $15,000, Securities: $70,000TR: $15,000, Securities: $70,000[loan][loan] & & Loan: $15,000 total up to the $100,000 DD.Loan: $15,000 total up to the $100,000 DD.This bank This bank would havewould have to keep $12,000 of to keep $12,000 of their $100,000 in RR. With TR of $15,000, their $100,000 in RR. With TR of $15,000, they have $3,000 in ER to loan.they have $3,000 in ER to loan.

They could increase MS by $5 M, but They could increase MS by $5 M, but they are keeping some in ER, so MS they are keeping some in ER, so MS will increase by less than $5 million.will increase by less than $5 million.

Monetary PolicyMonetary Policy(60%)(60%) 44. When the U.S. government engages in deficit spendingU.S. government engages in deficit spending, that spending is primarily financed byfinanced by a. increasing the required reserves ration b. borrowing from the World Bank c. issuing new bonds d. appreciating the value of the dollar e. depreciating the value of the dollar

(75%)(75%) 45. When the Fed buys government securitiesFed buys government securities on the open market, which of the following will decrease in the shortdecrease in the short runrun? a. Interest rates b. Taxes c. Investment d. The amount of money loaned by banks e. The money supply

(57%)(57%) 46. When a central bank sells securitiescentral bank sells securities in the open market, which of the following set of events is most likely to follow? a. An increase in the MS, a decrease in interest rates, and an increase in AD b. an increase in the MS, an increase in interest rates, and a decrease in AD c. An increase in interest rates, an increase in the government budget deficit, and a movement toward trade surplus d. A decrease in the MS, an increase in interest rates, and a decrease in AD e. A decrease in the MS, a decrease in interest rates, and a decrease in AD

Fed buying bonds incr MS, which decr the I.R.

(41%)(41%) 47. The federal funds ratefederal funds rate is the interest rate that a. the Fed charges the federal government on its loans b. banks charge one another for short-term loans c. banks charge their best customers d. equalizes the yield on government bonds and corporate bonds e. is equal to the inflation rate

(46%)(46%) 48. Assume that the government implements a deficit-reduction policygovernment implements a deficit-reduction policy that results in changes in aggregate income and output. Then the Fed engages in monetary policy actionsmonetary policy actions that reverse the changesreverse the changes in income and output caused by fiscal policy action. Which of the following sets of changes in taxestaxes, government government spendingspending, the RRRR, and the discount ratediscount rate is most consistent with these policies?

GovernmentGovernment RequiredRequiredTaxesTaxes SpendingSpending Reserve RatioReserve Ratio Discount RateDiscount Rate

a. Increase Increase Decrease Increase b. Increase Decrease Decrease No change c. Increase Decrease Increase Decrease d. Decrease Increase No change Increase e. Decrease Decrease Decrease Increase

(53)(53) 49. If the Fed institutes a policy to reduce inflationFed institutes a policy to reduce inflation, which of the following is most likely to increase? a. Tax rates b. Investment c. Government spending d. Interest rates e. GDP

The G would increase T and decr G to reduce the deficit which would reduce AD.To reverse this & incr AD, the Fed would decr the RR & not chg the DR to lower the I.R.

[Decreasing the Discount Rate would have been better but it is not a choice here]

Decr the MS to combat inflation would incr the I.R.

(43%)(43%) 50. To stimulate investmentstimulate investment in new plant and equipment without increasing the level of real output, the best policy mix is to a. decrease the MS and increase government spending b. increase the MS and decrease government spending c. decrease the MS and increase income taxes d. increase the Ms and decrease income taxes e. decrease income taxes and increase government spending

Phillips CurvePhillips Curve(74%)(74%) 51. According to the short-run Phillips curveshort-run Phillips curve, there is a trade-off between a. interest rates and inflation b. the growth of the MS and interest rates c. unemployment and economic growth d. inflation and unemployment e. economic growth and interest rates

(22%)(22%) 52. According to the long-run Phillips curvelong-run Phillips curve, which of the following is true? a. Unemployment increases with an increase in inflation. b. Unemployment decreases with an increase in inflation. c. Increased automation leads to lower levels of structural unemployment in the long run. d. Changes in the composition of the overall demand for labor tend to be deflationary in the long run. e. The natural rate of unemployment is independent of monetary and fiscal policy changes that affect AD.

By decr the I.R., Ig would incr & incr AD & output, but decr G would decr output.

Infl

atio

nIn

flat

ion

UnemploymentUnemployment

LRPCLRPC

Y*Y*

School of Economic ThoughtSchool of Economic Thought(65%)(65%) 53. The classical economistsclassical economists argued that involuntary unemployment would be eliminated by a. increasing government spending to increase AD b. increasing MS to stimulate investment spending c. self-correcting market forces stemming from flexible prices and wages d. maintaining the growth of the MS at a constant rate e. decreasing corporate income taxes to encourage investment

(52%)(52%) 54. According to the theory of rational expectationrational expectation, a fully anticipated fully anticipated expansionary monetary policyexpansionary monetary policy will a. increase potential output b. increase unemployment c. have no impact on real output d. promote the production of consumer goods over capital goods e. result in deflation

(35%)(35%) 55. According to Keynesian analysisKeynesian analysis, if government expenditures and taxesgovernment expenditures and taxes are increased by the same amountare increased by the same amount, which of the following will occur? a. AS will decrease. b. AS will increase. C. AD will be unaffected. d. AD will decrease. e. AD will increase.(46%)(46%) 56. If the economy is operating at full employmenteconomy is operating at full employment and there is a substantial increase in the MSincrease in the MS, the quantity theory of moneyquantity theory of money predicts an increase in a. the velocity of money b. real output c. interest rates d. unemployment e. PL

Because the ME is larger than the MT.

Consumers would anticipate higher inflation &Consumers would anticipate higher inflation &at contract time ask for higher wages than inat contract time ask for higher wages than inthe past.the past. Firms would not experience increasing Firms would not experience increasingprofits so the economy would not expand.profits so the economy would not expand.

Debt and DeficitDebt and Deficit(91%)(91%) 57. Federal budget deficits occurdeficits occur when a. more money is being spent on entitlement programs than has been allocated b. the IRS spends more than it collects in taxes in a given year c. the federal government spends more than it collects in taxes in a given year d. high levels of unemployment use up tax collections e. interest payments on the national debt increase from one year to the next

Economic GrowthEconomic Growth(46%)(46%) 58. The long-run growth rate of an economylong-run growth rate of an economy will be increased by an increaseincreased by an increase in all of the following EXCEPT a. capital stock b. labor supply c. real interest rate d. rate of technological change e. spending on education and training

(63%) 59. An increase in which of the following is consistent with an outward shift of the production possibilities curve? a. Transfer payments b. Aggregate demand c. Long-run aggregate supply d. Income tax rates e. Exports

This would decrease investment & hurt economic growth.

Better technology & more or better resources increase both the PPC and the LRAS.

AD2

AD1 AD

AD

D1

AS1AD2

AD1ASASASAS22

ASAS11

ASAS22 ASAS

(a) Real GDP (b) Real GDP (c) Real GDP (d) Real GDP (e) Real GDP

PL PLPLPL

PL

(51%)(51%) 60. If AD and AS represent AD and AS curves, respectively, and the arrows indicate the movement of the curves, which of the following graphs best illustrates long-run economic growthillustrates long-run economic growth?

ASAS11 AS2

The EndThe End

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MACROECONOMICS MC Exam