Final Review
Session
Fall 2015 EC252
Tips
– Again, bring calculator and additional pencils
– 2 hours, 50 questions, 100 points
– Mostly cover 11.4-15, but also have some conceptual questions on previous
chapters
– Review practice final, textbook, slides and homework questions
– Read questions carefully.
11.4 The Federal Reserve
– What are the two key policy targets for the Fed?
– What is liquidity ?
– What is reserve requirement?
– What is the federal fund market? What is federal funds rate? What is the connection
between federal fund rate, short-run interest rate and long-run interest rate?
– What changes demand in federal fund market?
1.
Economic expansion or contraction
2.
Changing liquidity needs
3.
Changing deposit base
4.
Changing reserve requirement
5.
Changing interest paid by the Fed for deposits at the Fed
Assuming all else equal, if there is a contraction in the quantity of bank account balances, it
will
cause:
A) a leftward shift in the demand curve for reserves.
B) a rightward shift in the demand curve for reserves.
C) an upward movement along the demand curve for reserves.
D) a downward movement along the demand curve for reserves.
Answer: A
If there is a change in the federal funds rate from a target rate due to an increase in the
demand for reserves, the Fed can maintain the target by:
A) causing the supply curve of reserves to shift to the right.
B) causing a downward movement along the supply of reserves curve.
C) causing an upward movement along the supply of reserves curve.
D) causing the supply curve of reserves to shift to the left.
Answer: A
11.4 The Federal Reserve
– What is an open market sale? How is it going to affect FFR? How is it going to
affect reserves? How is it going to affect M2? How about inflation rate?
– What is an open market purchase? How is it going to affect FFR? How is it going
to affect reserves? How is it going to affect M2? How about inflation rate?
– The Fed’s toolbox: OMO, reserve requirement, interest on reserve, discount
window, QE. What are they? How are they used?
– Real interest rate = Nominal interest rate – Inflation rate
Realized real interest rate = Nominal interest rate – Realized inflation rate
Expected real interest rate = Nominal interest rate – Expected inflation rate
If the Fed wants to increase the federal funds rate through open market operations, it
________.
A) increases tax rates
B) decreases tax rates
C) sells bonds
D) buys bonds
Ans: C
If the realized real interest rate in an economy is 6%, the realized inflation rate is 8%, and the
expected inflation rate is 8%, then the nominal interest rate in the economy is:
A) 14%.
B) 20%.
C) 8%.
D) 2%.
Ans: A
12 Short-run Fluctuation
– What is an expansion? What is a recession? What is a depression?
– What are the three properties of economic fluctuation?
– How do consumption, investment and GDP co-move?
12 Short-run Fluctuation
– How is labor market affected in the SR fluctuation under flexible wage and rigid
wage ?
Which of the following is likely to happen if investors in an economy become optimistic
following the discovery of huge mineral reserves?
A) Real wages will fall.
B) Prices will fall.
C) Consumption will increase.
D) Unemployment will increase.
Ans: C
The marginal product of a country's workers falls during winters due to excessive cold. Which of the
following is likely to happen in this case, assuming all else equal?
A) The country's labor demand curve will shift to the right in winter.
B) The country's labor demand curve will shift to the left in winter.
C) There will be an upward movement along the labor demand curve.
D) There will be a downward movement along the labor demand curve.
Answer: B
12 Short-run Fluctuation
– What are the three schools of thoughts on economic fluctuation? What do they
say and what are the sources for fluctuation in each?
– How does multiplier work?
– How does recovery shift supply and demand curve in labor market?
The diagram below shows the labor demand and labor supply curves for an economy.
Refer to the figure above. The labor market is currently at point E. Which
of the following is likely to happen if a recession hits the economy
assuming that wages are flexible?
A) The labor market equilibrium will move from E to G.
B) The labor market equilibrium will move from E to H.
C) The labor market equilibrium will move from E to D.
D) The labor market equilibrium will move from E to F.
Ans: C
Refer to the figure above. The economy is currently at E. Which of the following is likely to
happen if a recession hits the economy? Assume that wages are downwardly rigid.
A) The labor market equilibrium will move from E to G.
B) The labor market equilibrium will move from E to H.
C) The labor market equilibrium will move from E to D.
D) The labor market equilibrium will move from E to F.
Ans: A
13 Countercyclical Policy
– Monetary Policy by the Fed
•
Short-term interest rates, especially the federal funds rate.
•
Bank reserves
– Expansionary Monetary Policy: lower interest rate stimulates C and I. May lead
to higher inflation rate. Higher bank reserves drives down short run interest rate
(why?)
– Expansionary monetary policy can lead to higher inflation. Why?
13 Countercyclical Policy
– Contractionary monetary policy: slows down growth in bank reserves, raises
interest rates, reduces borrowing, slows growth in the money supply, and
reduces the rate of inflation. Why?
– Why zero lower bound + deflation can be a problem?
– Taylor Rule:
Federal funds rate = Long-run federal funds rate target +1.5(Inflation rate –
Inflation rate target) + 0.5(Output gap in % points)
Identify the correct statement.
A) Countercyclical monetary policy stimulates the economy during a recession by shifting the
labor demand curve to the left.
B) Countercyclical fiscal policy stimulates the economy during a recession by shifting the labor demand curve
to the left.
C) Countercyclical monetary policy slows down the growth rate of an economy during an expansion by
shifting the labor demand curve to the right.
D) Countercyclical fiscal policy stimulates the economy during a recession by shifting the labor demand curve
to the right.
Answer D
If the long-run real interest rate falls, ________.
A) the demand for loans decreases
C) investment by firms increases
Answer: C
B) investment by firms decreases
D) unemployment increases
According to the Taylor Rule, for a given inflation rate, ________.
A) every percentage point increase in the inflation rate increases the federal funds rate by 1.5
percentage points
B) every percentage point increase in the nominal interest rate increases the federal funds rate by
1 percentage point
C) if bank reserves double, the federal funds rate should double
D) if nominal output doubles, the federal funds rate should double
Answer: A
Which of the following is true?
A) Investment growth tends to be high when consumption growth is high.
B) Investment growth tends to be high when GDP growth is low.
C) Consumption growth tends to be high when GDP growth is low.
D) Unemployment growth tends to be high when GDP growth is high.
Ans: A
13. Countercyclical Policy
– Fiscal Policy—government expenditure, tax, automatic stabilizer, how do they
work?
– Expansionary and contractionary fiscal policy: what do they entail?
– What is a government expenditure multiplier?
If the value of a government-taxation multiplier is 1.8, which of the following is likely to be true if
all other variables remain unchanged?
A) A $1 reduction in taxation increases gross domestic product by $1.80.
B) A $1 increase in taxation increases gross domestic product by $1.80.
C) A $1.80 reduction in taxation increases gross domestic product by $1.80.
D) A $1.80 increase in taxation increases gross domestic product by $1.80.
Answer: B
Which of the following is an example of a discretionary fiscal policy during a recession?
A) A decrease in transfer payments to unemployed workers
B) A decrease in money supply to lower the federal funds rate
C) An increase in tax rates to increase revenue
D) A temporary tax cut to boost consumption
Answer: D
14. Trade
– What is absolute advantage? What is comparative advantage?
– Current account = (Net exports) + (Net factor payments from abroad) + (Net
transfers from abroad)
– (Current account) + (Financial account) = 0
Consider two economies, Beta and Zeta. Each farmer in Beta can grow 1,000 pounds of apples in a year
or 500 pounds of oranges. Each farmer in Zeta can grow 400 pounds of apples or 1,200 pounds of
oranges in a year.
Refer to the scenario above. The opportunity cost of producing one pound of apples in Beta is:
A) 1/2 pounds of oranges.
B) 2 pounds of oranges.
C) 10 pounds of oranges.
D) 15 pounds of oranges.
Answer: A
Refer to the scenario above. Which of the following statements is true?
A) Beta has a comparative advantage in producing apples.
B) Zeta has absolute advantage in producing apples.
C) Beta has a comparative advantage in producing oranges.
D) Zeta has an comparative advantage in producing apples.
Answer: A
The table below shows the payments received from foreigners by the residents of Laborland and the
payments made to foreigners by Laborland's residents during a certain year.
Refer to the table above. Laborland's net exports equal
________.
A) -$18 billion
B) -$20 billion
C) $18 billion
D) $25 billion
Answer: A
Refer to the table above. Laborland's net factor payments from abroad equal ________.
A) -$18 billion
B) -$20 billion
C) $20 billion
D) $25 billion
Answer: C
Refer to the table above. Based on this information, we can conclude that Laborland has a ________.
A) budget deficit
B) trade surplus
C) current account deficit
D) current account surplus
Answer: C
15. Open Economy
– Definition of nominal exchange rate?
– Three different exchange rate regimes?
– Foreign exchange market: what determines supply and demand?
– Definition of real exchange rate?
– How real exchange rate affects net export, GDP and employment?
– How does nominal exchange rate and monetary policy affect real exchange
rate?
Assume that the dollar price of a U.S. basket is $2 and the Mexican price for a U.S. basket is 40
pesos. On the other hand, the Mexican price for the Mexican basket is 100 pesos. Given this
information, the dollar price for the Mexican basket will be:
A) $5.
B) $8.
C) $10.
D) $12.
Answer: A
If the dollar is undervalued against the peso, it implies that:
A) quantity of dollar supplied in exchange of pesos equals the quantity of dollars demanded in
exchange of pesos in the foreign exchange market.
B) quantity supplied of dollar in exchange of pesos exceeds the quantity of dollars demanded in
exchange of pesos in the foreign exchange market.
C) quantity supplied of dollar in exchange of pesos is less than the quantity of dollars demanded in
exchange of pesos in the foreign exchange market.
D) the exchange rate between the dollar and the peso is flexible.
Answer: C