BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
Lahore School of Economics
Macroeconomics I
Winter Term 2010
Quiz 1: BSc. 2, Section B
Instructions: Answer all questions in the spaces provided below. For full marks, make sure to
show all calculations. Calculators, pencils, pens, rulers, etc. cannot be shared and cell phones
cannot be used as calculators. Total points: 94
MCQs
1. All economic models must involve simplifications because
A. economists would be unable to command high salaries if their models were so simple
that anyone could understand them
B. human behavior is very erratic and unpredictable
C. reality is too complex to understand in its entirety, so we must reduce it to a level
that we can understand
D. they always try to duplicate all possible information and cover all possible variables that
might influence decision making
E. we must rely on value judgments and ignore reality
2. A surplus occurs whenever
A. price is greater than equilibrium price
B. quantity supplied exceeds quantity demanded at the equilibrium price
C. quantity demanded is greater than quantity supplied
D. the problem of scarcity of a good is solved
E. some of the buyers would be willing and able to pay even more for it than they have to
at the equilibrium
3. If there is a shortage in the market for automobiles, then
A. producers’ inventories are rising
B. prices should begin to rise
C. the demand curve will shift to restore equilibrium in the market
D. the supply curve will shift to restore equilibrium in the market
E. prices are expected to fall
4. If one dollar is initially equal in value to one Euro and demand for Euros increases, then each
dollar will be worth
A. more than one Euro, and European imports will be relatively cheaper in the United
States
B. less than one Euro, and European imports will be relatively more expensive in
the United States
C. more than one Euro, and European imports will be relatively more expensive in the
United States
D. less than one Euro, and European imports will be relatively cheaper in the United States
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
E. the same as the Euro, and there will be no change in the relative value of imports or
exports
5. An economic variable that is measured per unit of time, such as spending per year, is known as
a(n)
A. stock variable
B. periodic variable
C. expectations variable
D. flow variable
E. constant variable
6. Which of the actions below will not increase GDP?
A. Bears prowl suburban areas, overturning garbage cans so that the town must hire more
sanitation workers to clean up.
B. Vandals spray paint all over brick buildings, increasing business for paint removal
workers.
C. An installer of automobile tires takes a knife to the tires of cars parked in his
neighborhood.
D. A homemaker spends $20 taking the family to lunch at Burger King instead of spending
the $20 to buy food to prepare at home.
E. A consumer has a tune-up done on his pick-up truck at the local garage.
7. Use the following data to calculate GDP: consumption = $2000; gross investment = $600;
government purchases = $500; net exports = -$40; transfer payments = $340.
A. GDP = $2720
B. GDP = $3060
C. GDP = $3140
D. GDP = $3400
E. GDP cannot be determined due to insufficient data
8. The economy is in equilibrium while the government budget is in surplus and saving is greater
than investment. According to the circular flow model,
A. imports are greater than exports
B. imports are less than exports
C. imports equal exports
D. imports could be greater than or equal to exports
E. it is impossible to determine given the information
9. The Consumer Price Index is a measure of the
A. cost of a market basket of consumer goods and services relative to its cost in
some base year
B. change in the average price of a market basket of “necessary” goods and services
C. annual inflation rate in the producers’ goods market
D. change in the average price level of all final goods and services
E. average price of all goods and services relative to their price last year
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
10. If real GDP equals $200 billion this year and nominal GDP equals $300 billion, the price level
since the base year has increased
A. $100 billion
B. $200 billion
C. 50 percent
D. 100 percent
E. 33 percent
11. A major difference between the CPI and the GDP price index is that the CPI includes
A. all domestically produced goods and the price index includes only a sample of
domestically produced goods
B. all domestically produced goods and the price index includes a sample of goods
consumed, including imported goods
C. only a sample of domestically produced goods and the price index includes all
domestically produced goods
D. a sample of goods consumed, including imported goods, and the price index
includes all domestically produced goods
E. a sample of all goods consumed that are domestically produced, and the price index
includes all goods produced
12. Personal income is
A. NDP minus indirect business taxes
B. NDP minus depreciation minus taxes
C. national income minus taxes
D. national income plus income received but not earned minus income earned but
not received
E. national income minus income received but not earned plus income earned but not
received
13. People who are not currently employed, but say they want a job, are counted as unemployed
only if they
A. have previously held a job
B. are actively seeking employment
C. are willing to accept a reasonable offer
D. are between 16 and 65 years of age
E. are willing to accept any offer of employment
14. Suppose U = the number of adults who are unemployed; E = the number of adults who are
employed; and NLF = the number of adults not in the labor force. Which expression would
equal the unemployment rate?
A. U/(E + NLF)
B. U/E
C. U/(U + E)
D. U/(U + E – NLF)
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
15. Full employment
A. exists when everyone in the economy has a job
B. exists when everyone who wants a job has one
C. exists when the unemployment rate is zero
D. exists when everyone in the labor force has a job
E. will always include some unemployment
16. Which of the following would lead to the most inflation?
A. Both aggregate demand and aggregate supply increase.
B. Both aggregate demand and aggregate supply decrease.
C. Aggregate demand increases and aggregate supply decreases.
D. Aggregate demand decreases and aggregate supply increases.
E. Aggregate supply increases.
17. If two parties to a loan contract agree that the lender should earn an 8 percent increase in
purchasing power as a result of a loan, and the inflation rate is 5 percent, what is the nominal
interest rate?
A. 13 percent
B. 8 percent
C. 5 percent
D. 3 percent
E. 1 percent
18. A system in which people trade goods they don’t want to consume for goods they do want to
consume is called
A. an indirect exchange economy.
B. a commodity money system.
C. a barter system.
D. a fiat money system.
19. One cost of an unanticipated inflation is that it
A. transfers wealth from lenders to borrowers
B. transfers wealth from borrowers to lenders
C. decreases menu costs
D. increases the purchasing power of money
20. Hyperinflation refers to a situation in which
A. prices are rising extremely rapidly
B. prices are falling extremely rapidly
C. the price level is extremely high
D. the price level is extremely low
E. the price level is negative
21. Deflation refers to
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BSc II Section B
A.
B.
C.
D.
E.
Macroeconomics Winter 2010
Quiz 1 (B)
decreasing relative prices
a decreasing price level
a slowing down of the rate of inflation
a slowing down of the rate of relative price decreases
a federal government policy of running budget surpluses
Short Questions
1. The rate of inflation can be controlled by controlling the rate of growth of money supply in the
economy. How true is this statement? What are the assumptions involved? Explain in the light
of Quantity Theory of Money Demand. (5 + 5 = 10 points)
QTM  MV = PT
The answer should stress the following points:
a. Definition of Velocity and the fact that it is constant
b. ‘T’ or ‘Y’ can be used interchangeably and depends on the real variables such as Capital, Labor
and Technological progress; it is exogenous variable in the model
c. Use the % change form of the equation: ΔM/M + ΔV/V = ΔP/P + ΔY/Y
d. If % in Velocity is zero, then inflation can be measured as ΔM/M – ΔY/Y
e. Inflation can be controlled in two ways which should be explained in detail by the students
By controlling the rate if money growth OR by making sure that money dupply increase is
followed by an increase in real output, which determines ‘Y’.
2. Suppose money demand function is defined as follows:
M/P = 1000 + 0.2Y – 1000i. Are the signs consistent with the theory? For the given values of Y as
2000 and ‘i’ as 0.10, calculate the velocity of money. (Hint: Use Quantity theory of Money
Demand)
Suppose nominal money supply = 2600. Calculate the Price level (determined in the money
market).
Now suppose MS increases to 3000 with constant values of ‘i' and Y. How does the inflation rate
change? What are the implications of the increase in MS? (8 + 3 + 7 = 18 points)
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
Solution:
Higher interest rate will propel the consumers to save more and reduce money demand. Similarly, higher
income increases money demand, especially for transaction purposes. Signs are consistent with the
theory.
M/P = 1000 + 0.2 (2000) – 1000 (0.1) = 1300
MV = PY  M/P = Y/V  1300 = 2000/V  V = 1.54
Money supply = Money demand
2600 = M/P = 1300  P = MS/1300 = 2600/1300 = 2
If MS increases to 3000, Price level = 3000/1300 = 2.31
Inflation rate = (2.31 – 2)/2 = 15.5%
If money supply increases without any increase in the income or output level, then inflation rate will
increase because rise in money supply will not be utilized in any development work or increase the
factors of production such as technology, capital and efficient labor. Students should emphasize that ‘i'
and ‘V’ are kept constant. If these values change, then the interpretation would be different.
3. The country of Myrule has produced the following quantities of gauges and potatoes.
1994:
Gauges: 8000 @ Rs 4
Potatoes: 6000 @ Rs 8
1995:
Gauges: 10000 @ Rs 3
Potatoes: 5000 @ Rs 14
a. Using a ‘fixed-weight’ price index, with 1994 as base year, what are the prices indices for 1994
and 1995? What is the inflation rate using this index?
1994 price index = 1.00
1995 price index (Considering the new prices) = base year output at current prices / base year
output at base year pices
= 8000 x 3 + 6000 x 14 / 8000 x 4 + 6000 x 8 = 108000/80000 = 1. 35
Inflation rate = 35%
b. Using a ‘variable-weight’ price index, with 1994 as the base year, what are the price indices for
1994 and 1995? What is the inflation rate using this index?
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
1994 price index = 1.00
1995 price index (Considering the new quantities) = current year output at current year prices /
current year output at base year prices
= 10000 x 3 + 5000 x 14 / 10000 x 4 + 5000 x 8 = 100000/80000 = 1.25
Inflation rate: 25%
c. Analyze the differences in the inflation rate.
(6 + 6 + 5 = 17 points)
Fixed weight index only updated the prices of the goods keeping relative and respective
importance of the goods at the same level as in the base year. That thus, overestimated the
increase in the cost of living.
Variable weight index kept the prices at the same level while taking into account the new
quantities or the new ‘relative imprtance’ placed by the consumers on the respective goods. This
gets us rid of the substitution bias but underestimates the increase in the cost of living.
4. Given data:
GDP = 1000, G = 200, S = 200, I = 50 and BD = 150
Calculate Consumption, Disposable income and personal savings. Analyze and explain any
stable relationships among the variables. (5 + 3 + 2 = 10 points)
GDP = C + I + G + NX
S – I = BD + NX  200 – 50 = 150 + NX  NX = 0
C = 1000 – 200 – 50 – 0 = 750
YD = Y – TA + TR = 1000 – a
BD = TR + G – TA  150 = (TR – TA) + 200  (TR – TA) = – 50  YD = 1000 + (TR – TA) =
1000 – 50 = 950
Personal Savings: 1000 – 950 = 50
5. Using the saving and investment identity in the national income accounting to explain what
happens to saving-investment balance in each of the following cases: (4 + 4 + 4 + 6 = 18 points)
a. Higher output as a result of better productivity.
b. Businesses face higher taxes
c. The government increases spending temporarily for a one year project
d. The average educational level indicating higher capital productivity in future.
S – I = NX + BD; savings as a function of ‘Y’
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BSc II Section B
Macroeconomics Winter 2010
Quiz 1 (B)
a. Higher output will increase the production and the savings will rise as well. Higher savings can be used
for financing higher planned investment. The final change in the identity can only be seen when the
magnitude of increase in the ‘savings’ and ‘investments’ is known.
b. Higher taxes decrease the disposable profits of the business sector which decreases the desired
investments. Lower investments will cause income to fall which will reduce the savings as well. Again,
the final change depends on the magnitudes of decrease.
c. In this case, the budget deficit increases leading to fall in government savings. As savings fall, less
finance is available for investment purposes.
d. Increase in capital productivity will increase the planned investments causing an increase in expected
real output. That will increase the savings as well. The final change in the identity depends on the
magnitude of increase in the ‘savings’ and ‘investments’.
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