Test 1: Introductory Macroeconomics
Date: 11/11/05
Name:
Part 1: Multiple choice (Each question is worth 3 points)
1. If President George W. Bush wanted to decrease aggregate demand, which of
the following would he tend to favor?
a. An increase in government spending, because it will increase the size of ANSWER:
the public sector.
______
b. A decrease in government spending, because it keeps the public
sector small.
c. An increase in transfer payments, because it has a larger multiplier
than tax changes.
d. An increase in taxes, because it makes the public sector larger.
2. President Clinton, at the beginning of his administration, increased personal
income taxes on individuals with relatively high incomes. How will this
change the consumption schedule?
a. It will shift and become steeper.
b. It will shift and become flatter.
c. It will shift in a parallel manner.
d. It will remain fixed as the economy moves along the schedule.
3.
The banking system receives a new cash deposit of $250,000. Total deposits
eventually rise by $1 million. The value of the reserve ratio is
a. 10%
b. 20%
c. 25%
d. 50%
4. If depositors become worried about the safety of their deposit accounts, they
may trigger a
a. deposit surplus.
b. bank run.
c. fiscal policy crisis.
d. required reserve increase.
ANSWER:
______
ANSWER:
______
ANSWER:
______
5. The United States is presently running a large trade deficit. This trade deficit
may be connected to the government’s budget deficit because
a. a large budget deficit means the country is saving less and so our
ANSWER:
savings may not be enough to finance investment here.
b. high government spending can increase interest rates which causes
______
investment to fall.
c. countries that have large budget deficits often have high tariffs.
d. a large budget deficit means the economy grows less in the short run.
6. Assume that the banking system has $200 billion in reserves. There are no
excess reserves in the system. If the reserve requirement is increased from
10 percent to 12 percent, what will happen to the level of reserves in the
system?
ANSWER:
a. There will now be a deficiency of $40 billion in reserves.
b. There will now be a deficiency of $20 billion in reserves.
______
c. There will now be $20 billion in excess reserves.
d. There will now be $40 billion in excess reserves.
7. If investment spending is relatively insensitive to changes in the interest rate,
then the most effective expansionary policy would be
ANSWER:
a. a reduction in required reserves.
b. Fed purchases of government securities.
______
c. a personal income tax increase.
d. a personal income tax cut.
8.
A major advantage of monetary policy over fiscal policy is that monetary
a. policy affects all sectors of the economy equally.
b. policy can be put into effect more quickly.
c. policy, once implemented, takes effect more quickly.
d. authorities see the need for policy more quickly.
ANSWER:
______
9.
If in fiscal year 2001, the federal government receives $1,990 billion in
revenues and spends $1,865 billion for goods and services, the national debt
will
ANSWER:
a. increase by $1,990 billion.
b. increase by $115 billion.
______
c. decrease by $115 billion.
d. decrease by $1,865 billion.
10. Which of the following individuals would be most likely to support a
balanced budget amendment to the constitution?
a. “Christmas is when children ask Santa Claus for things and their
parents pay for them. Deficits is when adults ask government for
things and their children pay for them.”—Richard Lamm
b. “In a boom, inflation can be caused by allowing unlimited credit to
support excited enthusiasm of business speculators. But in a slump
government expenditure is the only sure means of obtaining quickly a
rising output.”
—J.M. Keynes
c. “If we face a recession we should not lay off employees. Employees are
not guilty; why should they suffer?”—Akio Morita
d. “Underbalancing the budget during a depression is not primarily a
deliberate policy but a practical necessity.”—Gunnar Myrdal
ANSWER:
______
Part 2: Free-response questions
Question 1 (40 points)
The table below describes Macronesia’s economy.
GDP
Taxes
1000
1200
1400
1600
1800
2000
Consumption (C) Gov. spending (G) Investment (I) Net exports (X-IM)
300
200
-100
200
900
300
200
-100
200
1000
300
200
-100
200
1100
300
200
-100
200
1200
300
200
-100
200
1300
300
200
-100
200
1400
A) In the table below, enter what total demand is at any level of output .
(3 points)
Total demand
GDP
1300
1400
1500
1600
1700
1800
1000
1200
1400
1600
1800
2000
What is equilibrium output in Macronesia? (3 points) ____1600_____
Graph total demand below. Label the demand line D0 and label the
equilibrium E0. (4 points)
Total demand / supply
2000
$6
D0
1800
$5
D1
Price (per barrel)
1600
$4
1400
$3
1200
$2
E0 = E1
$1
1000
0
800 1200
1000
1,200 1400
1,600 1600
2,000 1800
2,400 2000
2,800 3,200
Quantity (in barrels)
GDP
B) Now suppose that Macronesia changes its previous fixed tax into a tax on
income. The chart describing Macronesia becomes:
GDP
Taxes
1000
1200
1400
1600
1800
2000
Consumption (C) Gov. spending (G) Investment (I) Net exports (X-IM)
300
200
-100
-100
1050
300
200
-100
0
1100
300
200
-100
100
1150
300
200
-100
200
1200
300
200
-100
300
1250
300
200
-100
400
1300
What is the tax rate on income? (3 points) ______1/2_______
What is the equilibrium income level now? (3 points) _____1600______
Graph the new demand line on the above graph. Label the demand line D1 and
label the equilibrium E1. (4 points)
C) Now compare the effects of a decrease in government spending from 300 to 0
if there were fixed taxes to what would happen in Macronesia if there were
variable taxes.
Under fixed taxes:
GDP
Taxes
1000
1200
1400
1600
1800
2000
Consumption (C) Gov. spending (G) Investment (I) Net exports (X-IM)
0
200
-100
200
900
0
200
-100
200
1000
0
200
-100
200
1100
0
200
-100
200
1200
0
200
-100
200
1300
0
200
-100
200
1400
Under variable taxes:
GDP
Taxes
1000
1200
1400
1600
1800
2000
Consumption (C) Gov. spending (G) Investment (I) Net exports (X-IM)
0
200
-100
-100
1050
0
200
-100
0
1100
0
200
-100
100
1150
0
200
-100
200
1200
0
200
-100
300
1250
0
200
-100
400
1300
What would equilibrium output be under fixed taxes? (4 points) ___1000___
What would equilibrium output be under variable taxes? (4 points) ___1200___
D) Using what you found about output changes in part C), what is the multiplier
in the economy with fixed taxes? What is the multiplier in the economy with
variable taxes? Show your work. (4 points each)
Fixed taxes: GDP down by 600 when G down by 300, so the multiplier is 2
Variable taxes: GDP down by 400 when G down by 300, so the multiplier is 4/3
E) In which economy is the multiplier higher? Why? (4 points)
The multiplier is higher in the economy with the fixed taxes. When there are
variable taxes, taxes fall when income falls so that the negative effect of the
decrease in government spending on output is partially offset by the fall in taxes.
Question 2 (30 points)
The Macronesian government has two fiscal policy tools: government spending
(G) and fixed taxes (T). The Central Bank of Macronesian has one monetary
policy tool that it uses: control of the Macronesian money supply.
A) Suppose that Macronesia is in a recession. The government and Central Bank
want to help by pursuing an expansionary policy, but they don’t want investment
to fall. Which policy is best suited to meeting these goals? (5 points)
a) Increase the money supply
b) Increase G
c) Decrease T
d) Increase G and decrease T
ANSWER:
______
B) Now analyze the effects of the policy that you chose in part A). Show how
the money-market and goods market graphs look after the policy change by
shifting any curves that need to be shifted. Be clear about which curves you have
shifted. (10 points)
Goods market:
Money market:
Real Expenditure
Interest rate
S
S’
D
45
C + I + G + (X – IM)
(lower i)
C + I + G + (X – I M )
Re
al
Ex
pe
nd
itu
re
i
i
0
1
S
Real GDP
S’
Quantity of Money
D
C) In the chart below, describe how the variables have changed in the new
equilibrium after the policy change. Use ↑ to indicate an increase, ↓ to indicate a
decrease, and ↔ to indicate no change. (5 points)
Money suppply: ↑
Government spending: ↔
Taxes: ↔
Output: ↑
Interest rates: ↓
D) After getting out of the recession, Macronesia is growing at its target growth
rate. Suppose now that the government of Macronesia wants to reduce its budget
deficit without causing output to fall. If the Central Bank and the government
coordinate policies, can they achieve this goal? If not, why not? If so, what
combination of policies would work? (10 points)
A combination of a reduction in government spending (or an increase in taxes)
and an increase in the money supply would accomplish this goal. The reduction
in government spending reduces the deficit and the expansionary monetary policy
ensures that output does not fall. This is actually the combination of policies that
occurred during President Clinton’s first budget, which was designed to reduce
the deficit. At the same time, expansionary monetary policy helped ensure output
growth stayed strong.