Economics 109
1
Introduction to Economics
Nov. 1, 2001
Midterm
Name: ________________________________
TA’s Name: _____________________________
Part I. (20 points) Choose the best answer and mark it on your Scantron sheet.
1. Equilibrium exists when
a. there is no government intervention in the market.
b. the demand curve intersects the quantity axis.
c. the supply curve intersects the price axis.
x. the quantity demanded equals the quantity supplied.
e. All of the above conditions are necessary for equilibrium.
2. Which of the following is an example of a durable good?
a. a shirt
x. a television
c. a bottle of hair spray
d. a bath towel
e. a gallon of milk
3. Suppose that in 1988 the economy produced 10 shirts at $5 each and 5 hamburgers at $2 each. In 1989
the economy produced 15 shirts at $6 each and 10 hamburgers at $3 each. The value of real GDP produced
in 1989 using 1988 as the base year is
x. $95.
b. $120.
c. $75.
d. $60.
e. $100.
4. Suppose that the price level is 100 in 1993, 115 in 1994, 125 in 1995. Over the period 1993 to 1995, we
can say that the price level has ________ while the inflation rate has __________.
a. decreased, increased
b. increased, increased
x. increased, decreased
d. increased, remained constant
e. decreased, remained constant
5. Suppose you notice that when the price level falls, the real value of your money increases. This induces
you to increase your level of consumption. This is an example of the
x. wealth effect.
b. interest rate effect.
c. real effect.
d. income effect.
e. international trade effect.
6. In the short run, why are prices sticky?
a. Because auction prices adjust slowly to demand changes.
x. Because custom prices adjust slowly to demand changes.
c. Because workers adapt rapidly to wage changes.
d. Because all prices are fixed in the short run.
e. All of the above are correct answers.
7. Which of the following is an example of a contractionary fiscal policy?
a. increased defense spending
x. increased taxes
c. decreased taxes
d. increased spending on highways
e. a decrease in the money supply
8. Which of the following is an example of an automatic stabilizer?
a. an increase in defense spending during an expansion
b. a decrease in social security benefits during a recession
c. an increase in welfare benefits during an expansion
x. a decrease in unemployment benefits paid out during an expansion
Economics 109
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Introduction to Economics
Nov. 1, 2001
e. an increase in taxes during a recession
9.Suppose that both wages and prices increase by 7%. If people believe that they are better off because
their wages increased, they suffer from
a. price illusion.
x. money illusion.
c. wage illusion.
d. real illusion.
e. nominal illusion.
10. If nominal GDP is $500 and the money supply is $125, then the velocity of
money is
a. 0.25.
b. 2.
x. 4.
d. 1.
e. 8.
11. Between November 1943 and November 1944, the monthly inflation rate in Greece was 365%. This is
an example of
a. deflation.
b. superinflation.
x. hyperinflation.
d. disinflation.
e. unanticipated inflation.
12. High levels of inflation are often caused by
a. excessive money creation used to pay for a government budget surplus.
b. excessive borrowing from the public used to pay for a government budget surplus.
c. excessive borrowing from the public used to pay for a government budget deficit.
x. excessive money creation used to pay for a government budget deficit.
e. None of the above are true
13. The rate at which banks lend to each other is called ________.
a. the discount rate
x. the federal funds rate
c. the prime rate
d. the real interest rate
e. the lending rate
14. Money serves as a unit of account because
a. it eliminates the problem of a double coincidence of wants.
b. its value is preserved between transactions.
c. it can be used for exchanges.
x. prices are quoted in terms of money.
e. Money does not serve as a unit of account.
15. Which of the following groups is primarily responsible for setting monetary policy, such as openmarket operations?
a. The Federal Reserve Banks
b. The Board of Governors of the Federal Reserve
x. The Federal Open Market Committee
d. The Commercial Banking Association
e. The Supreme Court
16. Which of the following is a contractionary monetary policy?
a. an increase in taxes
b. a decrease in the reserve requirement
c. a decrease in government spending
x. an open market sale of bonds
e. a decrease in the discount rate
17. In the last thirty years, the University of California’s share of California state General Fund
expenditures has
a. stayed approximately constant
Economics 109
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Introduction to Economics
Nov. 1, 2001
b. slowly crept upward as state legislators recognized the importance of higher education to the state
economy
x. trended downward nearly falling to half the level of what it was in the latter sixties
d. cycled, rising in recessions and falling in booms
e. None of the above, UC is funded totally from student fees.
18. Nominal GDP in current( this year’s) dollars is converted into real GDP in constant dollars by dividing
by
a. the consumer price index, CPI
b. the index of Dow Jones Industrials
c. the GDP inflator
x the GDP deflator
e the inflation rate
19. The US president who repealed economic scarcity and sought to have it all, i.e. both “butter and guns”
was
a. Franklin Delano Roosevelt
b. Harry S. Truman
c. Dwight D. Eisenhower
x. Lyndon Baines Johnson
y. William Jefferson Clinton
20. Amongst the news this fall indicating economic difficulties were
a. The rate of inflation in the CPI was 0.4% in September
b. Unemployment insurance claims hit 450,000 in September, a nine year high
c. US care sales declined 8.7% in September
x. All of the above
y. b and c are true, not a
Part II (10 points) Fill in the blanks with the best answer using the vocabulary below.
1.
2.
3.
4.
5.
If a price index is 50 in 1998 and 60 in 1999, the rate of inflation between the two years is
___20______ percent.
The value of a price index in the base year is ___100____________.
An increase in autonomous consumption will shift the consumption function __upward__________.
Using taxes and government spending to control the level of GDP is known as Keynesian
__fiscal___________ policy.
Money solves the problem of double coincidence of wants that would regularly occur under a system
of ___barter___________.
Vocabulary
0
10
16
20
33
50
100
150
200
500
1000
2000
3333
5000
Part III. (20 Points) Answer both questions.
barter
budgetary
classical
debt
deflationary
downward
fiscal
growth
markets
military
monetary
social
unknown
upward
Economics 109
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Introduction to Economics
Nov. 1, 2001
The production possibility frontier illustrated below shows the division of national output, as measured
by real GDP, into possible combinations of two goods: (1) domestic consumption of goods and
services, including homeland safety, denoted “butter”, and (2) the waging of expeditionary wars
abroad, denoted “guns.
Expeditionary
Wars Abroad:
“Guns”
US Production Possibility Frontier
In real GDP
B
A
Opportunity cost
Domestic Goods and Services: “Butter”
a.
b.
2.
If point A represents this country on September 10, label point B for our position on
November 1.
Use vertical lines in combination with points A and B to indicate the opportunity cost,
As measured in “butter”, for the war in Afghanistan.
The description of monetary policy at the web site for the Board of Governors of the Federal Reserve
(http://www.federalreserve.gov) states that the Fed “uses the tools of monetary policy …. to adjust the
supply of reserves.”
a. Suppose the Fed engages in open market operations, purchasing government securities in the
secondary market. Illustrate, in the figure below, the effect this has on the supply of reserves and
on the federal funds rate.
b. In the last nine months, has the federal funds rate been rising or falling? __falling__________
Federal
Funds
Rate
Supply of Reserves by Fed
Demand for Reserves
By Commercial Banks
Jan 2001
Oct. 2001
Quantity of Reserves
Part IV. (30 points) Answer both questions.
Economics 109
1.
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Introduction to Economics
Nov. 1, 2001
Compare the depression of the 1930’s with the possible recession of 2001-2002.
a.
What are some of the similarities in trends of the major expenditure components of GDP? Are
there any similarities in the causes that lie behind these trends?
b.
Is there any difference in the potential for fiscal policy? Why?
c.
What is a change in institutions (or policy) that makes the banking system less unstable today?
When Roosevelt was elected and took office, what kind of holiday did he declare?
2.
There is a great deal of uncertainty about everyday life in the United States these days. Contributing to
this uncertainty are questions about how well the economy is doing and what might lie ahead. The
most recent data from the US Department of Commerce was released yesterday on Halloween and
shows an advance estimate of a 0.4 % decline in real GDP (at an annual rate) for the third quarter of
2001.
a.
What is meant by real GDP?
b.
What must happen in the fourth quarter of this year for the US economy to officially be in
recession?
c.
We are already one third of the way through the fourth quarter. What kind of monthly indices or
statistics can you monitor to track the economy? What kind of behavior would you expect from
each of these measures if the economy is moving into a recession?
1. Answer
a.
b.
c.
(a)
OUTLINE
(1) GDP, C, I; (2) fear
Keynes a new voice
(1)FDIC; (2) Bank Holiday
Real GDP fell dramatically in the great depression of the 1930’s. Preliminary estimates show it
fell in the third quarter of 2001. Most observers expect it will fall in the fourth quarter as well. Investment,
or spending by firms on plant and equipment, a component of GDP fell in the thirties and has been falling
for over a year. Consumption, spending by consumers, fell during the great depression, with as much as a
quarter of the work force unemployed. Growth in consumption has been slowing for over a year and, at the
current rate of deceleration, could decline in the fourth quarter. So there is weakness in expenditure in the
private economy, not yet as weak as in the great depression.
A common and unpredictable cause is the psychology of consumers and businesses. People were
alarmed at the severity and length of the great depression, and fearful of our seeming inability to recover.
Once again the country is plunged into a new era, with uncertain prospects for the country and the
economy. As was the case in the great depresion, once again the greatest thing to fear is fear itself, which
can suppress spending by consumers and businesses.
(b)
Keynes and his recommendation for government deficit spending was a new and controversial
idea in the 1930’s. National income accounting and the collection of numbers necessary to track the
Economics 109
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Introduction to Economics
Nov. 1, 2001
economy were in the process of invention during the great depression. In contrast, today Keynesian fiscal
policy has been turned to quickly this fall as a partial remedy for our economic difficulties.
(c)
The creation of the Federal Deposit Insurance Corporation in 1934 and insuring accounts up to
$100,000 means that now, consumers consider banks a sfe place to kkep money. In contrast, in the great
depression, there was a financial crisis, with runs on banks, bank closings and bank faiures. The situation
was so chaotic the President Roosevelt declared a “bank holiday” or time out to help restore order in the
banking system.
2.
(a)
OUTLINE
a.
real GDP
b.
decline for 2 consecutive quarters
c.
(1) Index of leading indicators, (2) Index of consumer confidence, (3) unemployment rate
Real GDP is aggregate expenditure measured in constant dollars, i.e. corrected for price changes,
and is a measure of output. It is calculated by dividing nominal GDP by a price index, i.e by the GDP
Deflator.
(b)
A recession is a decline in real GDP for two consecutive quarters so if GDP declines again in the
fourth quarter of this year, which seems highly likely, the economy will officially be in recession.
(c)
Monthly indicators of the progress of the economy include (1) the index of leading economic
indicators, which tends to fall between the peak of the boom and the trough of a recession; (2) the index of
consumer confidence follows a similar pattern, rising during expansions and falling during recessions. It is
a gauge of how consumers are feeling about the economy and hence indicates what may happen to
consumption expenditures; (3) the unemployment rate rises during a recession and falls during a recovery.
Other monthly indicators can be used as well. These were prominently featured in class, beginning with
lectures 5 and 6.