Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
PART I : Multiple Choice, 10 points (each question is worth ½ point).
1.
In the short run which of these causes an increase in output and an ambiguous impact on overall prices?
A.
an increase in oil prices and a decrease in taxes
B.
technological improvement and reduction in the required reserve ratio
C.
a wage increase and the Fed selling bonds
D.
increase in the discount rate and an increase in taxes
Answer: B
2.
Which of the following supports empirical evidence that wages are sticky?
A.
minimum wage laws
B.
contracts between employers and employees
C.
efficiency wage theory
D.
imperfect information of the market clearing wage on the part of the firm
E.
all of the above
Answer: E
3.
People with higher income will generally have a ______ average propensity to consume, even if they have the same marginal propensity to consume as lower income individuals.
A.
higher
B.
lower
C.
the same
Answer: B
4.
Which of the following if TRUE of a change in dividend payments?
A There is no substitution effect because a change in dividend payments does not change the trade-off between work and leisure
B There is no income effect because a change in dividend payments does not change the trade-off between work and leisure
C There is no substitution effect because a change in dividend payments does not change a household’s permanent income
D There is no income effect because a change in dividend payments does not change a household’s permanent income
Answer: A
5.
The policy mix that would cause the interest rate to increase and investment to decrease, but have an indeterminate effect on aggregate output, is a mix of
A.
Expansionary fiscal policy and expansionary monetary policy
B.
Contractionary fiscal policy and expansionary monetary policy
C.
Expansionary fiscal policy and contractionary monetary policy

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
D.
Contractionary fiscal policy and contractionary monetary policy
Answer: C
6.
Which of the statements about Social Security is false?
A.
Social Security payments are funded by taxes on income.
B.
Social Security payments are a relatively lnsignificant portion of retirement income
C.
Social Security payments have never gone down when prices increase
D.
Only some of Social Security payments go to retired people
E.
None of the above
Answer: B
7.
At low levels of output, the economy can expand with little or no increase in the overall price level because
A.
At low levels of output the aggregate supply curve is negatively sloped
B.
People will be expecting the price level to fall
C.
There is excess demand so prices are kept low
D.
Firms likely hold excess labor and capital, and production can be increased without causing input prices to increase
Answer: D
8.
The Phillips Curve shows
A.
the negative relationship between inflation and the unemployment rate
B.
the positive relationship between inflation and the unemployment rate
C.
the positive relationship between inflation and the money supply
D.
the negative relationship between inflation and output
E.
None of the above
Answer: A
9.
The Orcs are preparing to war against the Humans and have increased the government’s military spending. The likely impact on Orcland of such an increase will be
A.
Decrease in Y, increase in r, and increase in I.
B.
Increase in Y, decrease in r, and decrease in I.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
C.
Increase in Y, decrease in r, and increase in I.
D.
Increase in Y, increase in r, and decrease in I.
Answer: D
10.
When the government attempts to use stabilization policy, it can sometimes end up intensifying booms and busts instead of smoothing them due to
A.
recognition lag
B.
implementation lag
C.
response lag
D.
All of the above.
Answer: D
11.
According to the life-cycle theory of consumption, if Uncle Bo left you $100,000 tomorrow you would
A.
save all of the $100,000 for consumption when you are old.
B.
spend the entire $100,000 this year.
C.
Spend an amount this year equal to $100,000 times your marginal propensity to consume.
D.
Spend a small amount of the $100,000 in each year of your life.
Answer: D
12.
When commercial banks lend money, the loans appear as ___________ on the bank’s balance sheet.
A.
A liability
B.
An asset
C.
retained earnings
D.
all of the above
Answer: B
13.
An intended goal of expansionary fiscal and monetary policy is
A.
A decrease in interest rates.
B.
A decrease in the price level.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
C.
The equalization of the distribution of income.
D.
An increase in the level of aggregate output.
Answer: D
14.
During a period of high inflation, the Federal Reserve is likely to
A.
Decrease the money supply.
B.
Lower the discount rate.
C.
Buy treasury bonds on the open market.
D.
Decrease the unemployment rate
Answer: A
15.
When firms are _____, the short run aggregate supply curve becomes vertical.
A.
Operating at a low level of output
B.
Operating at a high level of output
C.
Operating at an intermediate level of output.
D.
Not producing.
Answer: B
16.
Which of the following statements about short run aggregate supply curve is FALSE?
A.
it is the sum of all individual supply curves in the economy
B.
If wages lag prices in the short run, the AS curve will be upward sloping.
C.
Increasing output can be accomplished without large cost increases at low levels of aggregate output.
D.
As the economy moves closer to full capacity, the curve is almost vertical.
Answer: A
17.
Which statement pertaining to financial markets is FALSE?
A.
People who own shares of stock own a portion of a company.
B.
A firm can finance an investment project by issuing bonds.
C.
When stock prices increase, investment rises because firms can raise more money per share to finance investment projects.
D.
None of A, B and C are false.
E.
All of A, B and C are false.
Answer: D
18. According to the classical economists, those who are not working
A. have chosen not to work at the market wage
B. are unable to find a job at the current wage rate
C. are too productive to be hired at the current wage
D. have given up looking for a job, but would accept a job at the current wage if one were
offered to them.
Answer: A
19. Which of the following statement about wage rates is FALSE?
A.
Changes in the wage rate have both an income effect and a substitution effect.
B.
When the wage rate increases, consumption also increases.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
C.
Households look at expected future real wage rates as well as the current real wage rate in making their consumption and labor supply.
D.
The real wage rate is the wage rate expressed in current dollars.
Answer: D
20. The accelerator effect is the tendency for investment to _____ when aggregate output
_____ .
A.
increase, decrease.
B.
increase, increases
C.
decrease,increases
D.
increase, does not change.
Answer: B

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
PART II : Short Answer, 12 points (each question is worth 3 points).
1.
Suppose the economy experiences a negative cost shock, at a time when the Federal Reserve initiates a contractionary monetary policy. Draw a graph illustrating this situation. In equilibrium, what happens to the price level and aggregate output?
Answer:
P
AS
’
AS
AD’
AD
Y
1
Y
0
Y
2.
The Phillips Curve represents the relationship between the inflation rate and the unemployment rate. In 1974, the price of imports increased substantially and again in 1979. What could you predict on the relationship between the inflation rate and the unemployment rate?
Source: textbook chapter14, 269p-270p,274p
Answer: As a result of import price increases which led to shifts in aggregate supply, the relationship between the inflation rate and the unemployment rate was erratic (no clear trade off).
3.
Using the three panel diagram, explain why the AD curve is downward sloping.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
As the price level increases, the interest rate increases, investment decreases, and GDP falls.
4.
During 1999 and 2000, a debate raged over whether the United States was below potential GDP.
Then, the Federal Reserve decided to boost the economy. What would you expect? Illustrate using an aggregate supply and aggregate demand diagram.
Source: textbook chapter13, 257p,245p
Answer: figure13.5 A shift of the Aggregate Demand Curve When the Economy is on the Nearly
Flat part of the AS curve
Part III Read the following article and answer the questions below
Inflation is on the way, with or without growth
1 November 2009 - Issue : 858
Coming out of this dreadful recession may become equally as difficult as being deep in it. The question here is to choose an economic and monetary policy mix to fight on two fronts. For one thing, policies should make sure that the economies will not return to a deeper recession, and, secondly, this policy mix must secure a low inflation growth path.
Is it possible to have both? Let’s see to this. On the face of it, those two goals seem to be the same but they are not. Inflation usually accompanies any growth period, but western economies found some 10 years ago that this is not always a must. Growth can evolve without inflation pressures and in this way it can last longer that in the past, when the fight to control inflation killed growth as well. Now all the major western central banks have set inflation “targets” and whenever consumer price changes exceed those targets, they take measures. This is exactly where we are at the present conjuncture.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
1. (2 points) The article says that “the policy mix should make sure that the economies will not return to a deeper recession” and also that “this policy mix should insure a low inflation growth path”. What policy might achieve this? Illustrate using Aggregate Demand and Aggregate
Supply curves.
The desired increase in output together with low inflation can be achieved by anything that would shift the AS curve outward to the right. Examples would be anything that would decrease costs such as removal of energy taxes, lowering of payroll taxes, investments that would improve technologies or productivities, etc.
2. (2 points) The article says that policies to promote growth usually promote inflation. What policies to increase growth would result in this outcome? Illustrate using AD and AS diagram.
Any policy that shifted the AD curve to the right (expansionary fiscal or monetary policy) would result in both price increases and increased output.

Name: Second Prelim
ECON 1120 – Professor Steven Kyle
Section Number or TA Name: November 12, 2009
3. (4 points) The article refers to inflation targeting. Describe what is meant by “inflation targeting”. In contrast, suppose the authorities adopted a policy of “deficit targeting”.
Describe what is meant by this.
See chapter 15 of the text for the answer to this question. 2 points are given for a correct description of inflation targeting and 2 points for a correct description of deficit targeting.
Inflation targeting is when the monetary authorities (e.g. the Federal Reserve) pick a target range for the level of inflation (e.g. 2-4%) and conduct expansionary or contractionary monetary policy to achieve the target level, with contractionary policy happening when the inflation target is exceeded and expansionary policy when inflation is lower than the target range.
Deficit targeting is when fiscal policy (i.e. taxing and spending voted on by
Congress and signed and executed by the President and the Executive Branch) is automatically adjusted to keep the fiscal deficit (G-T) within certain limits. When the target deficit is exceeded then either spending is cut or taxes are raised to achieve the target.