Final Examination
ECON 4020/ SPRING 2005
Instructor: Dr. M. Nirei
1:30 – 3:20 pm, April 28, 2005
Name:
Part I (45 points; Mark your answers in a SCANTRON)
(1) The GDP deflator is equal to:
a.
b.
c.
d.
the ratio of nominal GDP to real GDP
the ratio of real GDP to nominal GDP
real GDP minus nominal GDP
nominal GDP minus real GDP
(2) The value added on an item produced means:
a.
b.
c.
d.
a firm’s profit on the item sold
the value of the labor inputs in the production of an item
the value of firm’s output less the value of its costs
the value of firm’s output less the value of the intermediate goods that the
firm purchases
(3) If GDP (measured in billions of current dollars) is $5,465, consumption is $3,657,
investment is $741, and the government purchases are $1,098, then net exports
are:
a.
b.
c.
d.
$131
-$131
$31
-$31
(4) The real interest rate is the:
a.
b.
c.
d.
rate of interest actually paid by the consumers
rate of interest actually paid by the banks
rate of inflation minus the nominal interest rate
nominal interest rate minus the rate of inflation
(5) The reduction in investment brought about by the increase in the interest rate
caused by increased government spending is called:
a.
b.
c.
d.
a budget deficit
monetary policy
the identification problem
crowding out
(6) In the classical model with fixed income, if the demand for goods and services
is less than the supply, the interest rate will:
a.
b.
c.
d.
increase
decrease
remain unchanged
either increase or decrease, depending on whether consumption is greater than or
less than investment
(7) According to the Fisher effect, the nominal interest rate moves one-for-one with
changes in the:
a.
b.
c.
d.
Inflation rate
Expected inflation rate
Ex ante real interest rate
Ex post real interest rate
(8) In a small open economy, starting from a position of balanced trade, if the
government increases domestic government purchases, this produces a tendency
toward a:
a. Trade surplus
b. Trade deficit
c. Budget surplus
d. Stagflation
(9) If the number of dollars per yen rises, this is called a(n):
a.
b.
c.
d.
Appreciation of the dollar
Appreciation of the yen
Increase in the terms of trade
Decrease in the terms of trade
(10) The value of net exports is also the value of:
a. Net investment
b. Net saving
c. National saving
d. The excess of national saving over domestic investment
(11) When the real exchange rate rises (i.e. appreciates) :
a.
b.
c.
d.
Exports will decrease but imports will be unaffected
Imports will decrease but exports will be unaffected
Exports will increase but imports will decrease
Imports will increase but exports will decrease
(12) To reduce the money supply, the Federal Reserve:
a.
b.
c.
d.
Buys government bonds
Sells government bonds
Creates demand deposits
Destroys demand deposits
(13) If there are 100 transactions in a year and the average value of each transaction
is $10, then if there is $200 of money in the economy, transaction velocity per
year is
a.
b.
c.
d.
0.2
2
5
10
(14) The natural rate of unemployment is:
a.
b.
c.
d.
The average rate of unemployment around which the economy fluctuates
About 15% of the labor force
A rate that never changes
The transition of individuals between employment and unemployment
(15) Unemployment caused by the time it takes workers to search for a job is called:
a. Insider unemployment
b. Voluntary unemployment
c. Frictional unemployment
d. Efficiency unemployment
(16) If s is the rate of job separation, f is the rate of job finding, and both rates are
constant, then the unemployment rate is approximately: (Answer: C)
f
s+ f
f +s
b.
f
s
c.
s+ f
s+ f
d.
s
a.
(17) The Solow growth model describes:
a. How output is determined
a. The static allocation of economy’s output
b. How savings, population growth, and technological progress affect output
over time
c. How unemployment is created
(18)
The major force of economic growth of income per person is:
a.
b.
c.
d.
Productivity growth
Money supply growth
Employment growth
Import growth
(19)
In the face of an adverse supply shock, an accommodating monetary
policy would result in:
a.
b.
c.
d.
Permanently higher output level
Permanently lower price level
Permanently lower output level
Permanently higher price level
(20) According to the quantity equation, if the velocity of money and the supply of
money are fixed, and the price level increases, then the quantity of goods and
services purchased:
a.
b.
c.
d.
Increases
Decreases
Does not change
May either increase or decrease
(21) The IS-LM model takes:
a.
b.
c.
d.
National income as exogenous
The price level as exogenous
The interest rate as exogenous
National income and the price level as exogenous
(22) According to the Keynesian-cross analysis, if MPC stands for marginal
propensity to consume, then a rise in taxes of ∆T will:
a.
b.
c.
d.
Decrease equilibrium income by ∆T
Decrease equilibrium income by ∆T /(1 − MPC )
Decrease equilibrium income by (∆T )( MPC ) /(1 − MPC )
Not affect equilibrium income at all
(23) The effect of tax-cut in the IS-LM model will be :
a.
b.
c.
d.
Interest rate rises and income falls
Interest rate falls and income rises
Interest rate falls and income falls
Interest rate rises and income rises
(24) In a small, open economy with a floating exchange rate, an effective policy to
increase equilibrium output is to:
a.
b.
c.
d.
Increase government spending
Increase taxes
Increase the money supply
Decrease the money supply
(25) In a fixed exchange rate system, the monetary policy is:
a.
b.
c.
d.
Fully effective
Fully ineffective
Partially effective
Partially ineffective
(26) The time between a shock to the economy and the policy action responding to
that shock is called the:
a. Automatic stabilizer
b. Time inconsistency of policy
c. Inside lag
d. Outside lag
(27) The fact that traditional method of policy evaluation do not take into account the
impact of policy on expectations is known as :
a.
b.
c.
d.
Stabilization policy
The political business cycle
The Lucas critique
Okun’s law
(28) Monetary policy rules that target nominal variables would target any of the
following except the:
a.
b.
c.
d.
Price level
Money supply
Unemployment rate
Nominal GDP
(29) According to the traditional viewpoint, a tax cut without a cut in government
spending would result in:
a.
b.
c.
d.
Decrease in domestic interest rate and depreciation of domestic currency
Decrease in domestic interest rate and appreciation of domestic currency
Increase in domestic interest rate and depreciation of domestic currency
Increase in domestic interest rate and appreciation of domestic currency
(30) According to the theory of Ricardian equivalence, a tax cut that has no plans to
reduce government spending results in:
a.
b.
c.
d.
Increase in public saving and increase in private saving
Decrease in public saving and increase in private saving
Decrease in public saving and decrease in private saving
Increase in public saving and decrease in private saving
Part III (40 points)
Choose two topics from below and discuss each of them in one page
A.
B.
C.
D.
E.
Principle of Classical Dichotomy in the long-run equilibrium in reference to
the determination of nominal exchange rate by the Fisher effect and to the
determination of price level in the quantity theory of money
Causes and propagation mechanism of the Great Depression of the United
States
Different mechanisms of monetary transmission in a closed economy, in a
small open economy under floating exchange rate, and in a small open economy
under fixed exchange rate
Mundell's trilemma and its implication for the U.S. and EU economies
Lucas critique and the role of expectation on the effects of monetary expansion
and of tax cut
A.
The classical dichotomy means theoretical separation of nominal and real variables in
classical economics, and it implies that nominal variables do not affect real variables. An
example of its application is the quantity theory of money, which claims that money
supply only affects nominal GDP but does not affect real GDP. Real GDP is determined
by economic fundamentals such as technology and endowments of labor and capital in
the long run equilibrium, and hence an increase in money supply only affects the price
level. Another example is the Fisher effect which claims that inflation rate only affects
nominal interest rate but does not affect real interest rate. The real interest rate is
determined by fundamentals such as the long-run demand and supply of goods and
services, and hence a change in inflation rate affects only the nominal interest rate with
leaving the real interest rate unaffected.
B.
The Great Depression was triggered by a stock price crash, which caused a downward
shift of consumption function via worsened consumer confidence. The decreased
consumption caused decrease in income as well as deflation. The deflation exacerbated
the initial recession in two ways. First, the deflation decreased the nominal revenue of
firms and households, and caused difficulty for debtors in repaying their debts. This
caused a further shrink in investments and consumption (debt-deflation theory).
Secondly, an expectation for further deflation was set in, and caused an increase in ex
ante real interest rate, which further decreased investment. The worsened credit positions
of debtors caused failure in banking system, which prolonged the depression.
C.
In a closed economy, an increase in money supply leads to an increase in income in the
short run. The transmission mechanism of the money supply to income in this case is
that the increased money supply decreases the interest rate in the money market, which in
turn increases investment demand. In a small open economy, this transmission
mechanism through the investment does not take effect, since the interest rate is fixed at
the world level. However, an increase in money supply does cause an increase in income
in a small open economy under floating exchange rate. The transmission mechanism
here is that an increase in money supply depreciates the currency and increases net export
demand. This mechanism is shut down under the fixed exchange rate, however, because
the monetary authority will be forced to buy back its increased money supply to maintain
the exchange rate. Thus both monetary transmission mechanisms via interest rate and via
exchange rate do not take effect in a small open economy under fixed exchange rate.
D.
Mundell’s trilemma states that a policymaker cannot achieve the following three
objectives: perfect capital mobility, fixed exchange rate, and autonomous monetary
policy. This is because, under the perfect capital mobility, a commitment on a certain
level of exchange rate necessarily determines the level of money supply. In the U.S., the
capital mobility and monetary policy are achieved, but the exchange rate has to
experience fluctuations. In the EU economies where the currency is made common
within the region, there is no exchange rate fluctuation (obviously, since they use the
common currency), but the central bank of a country cannot control their money supply
independently from other central banks.
E.
Lucas critique points out a possibility that an economic policy may change people’s
expectation and alter the underlying economic relations which the policymaker intended
to exploit. One example is a monetary expansion. Given that the short-run Phillips curve
is downward sloping, the central bank can reduce the unemployment rate by raising the
inflation. However, if the households and firms expect that the inflation is coming, then
the rise in expected inflation rate shifts up the Phillips curve and leaves the
unemployment rate unaffected by the monetary expansion. Another example is a tax cut.
Given an upward sloping consumption function, an increase in disposable income due to
the tax cut will increase consumption. However, if the households expect that the
government will raise the tax in future to pay for the increased debt due to the tax cut,
then it shifts the consumption function down and offsets the effect of increased
disposable income on consumption.
(end of Final Exam sheets)