FINAL EXAM (120 Points = 35 + 85)
201 Macroeconomics Winter 2006
Northwestern University
Prof. Gordon
TA : Jesse De Lille
NAME :
MULTIPLE CHOICE SOLUTION SHEET (35 Points)
1. C
21. E
2. C
22. C
3. B
23. B
4. D
24. B
5. C
25. A
6. B
26. B
7. C
27. A
8. B
28. B
9. A
29. B
10. A
30. A
11. C
31. C
12. B
32. C
13. A
33. A
14. D
34. A
15. C
35. C
16. D
17. C
18. D
19. A
20. B
MULTIPLE CHOICE QUESTIONS
1. Which of the following is not an asset for a bank?
a.
b.
c.
d.
excess reserves
holdings of US government securities
checking account balances held by depositors
mortgage loans made by the bank
2. Which of the following does not belong in M1?
a.
b.
c.
d.
the coins in your pocket
Jodi’s checking account
the cash in the vault in the bank downtown
the travelers’ check that Scott has left over from last summer
3. Two myths about the Great Depression of the 1930s are that the Fed _______ while
Roosevelt’s New Deal ________.
a. reduced interest rates too much; raised taxes too much
b. did nothing; ended the Depression
c. raised interest rates too much; made the Depression worse
d. raised interest rates too much; reduced taxes too much
4. The following combination of phrases is the best description of the Japanese economy
in the 1990s: ________ housing prices and _________ GDP deflator
a. rising, falling
b. rising, rising
c. falling, rising
d. falling, falling
5. Which of Randy’s assets is most liquid?
a.
b.
c.
d.
the US savings bond his grandparents gave him
his collection of 1950s baseball cards
the $20 bill in his pocket
the 100 shares of Microsoft stock he bought last fall
6. Government spending equals 500, investment equals 300, C = 120 + 0.4*DI,
NX = 600 – 0.04*Y, T = 0.15*Y. What is equilibrium GDP?
a.
b.
c.
d.
1834
2171
2352
3362
7. Contrasting the government budget balance, Norway has __________ and the United
States has __________.
a. a large budget deficit, a large budget deficit
b. a large budget deficit, a large budget surplus
c. a large budget surplus, a large budget deficit
d. a large budget surplus, a large budget surplus
8. A side effect of a ____ in taxes and ______ in government spending is called
________.
a. cut, cut, crowding in
b. cut, increase, crowding out
c. increase, cut, crowding out
d. increase, increase, crowding in
9. The aggregate supply curve will shift following changes in all but which of the
following?
a.
b.
c.
d.
the price level
wage rates
technology and productivity
available supplies of factories and machines
10. If, at the full-employment level of income, consumers’ savings plans coincide with
firms’ investment plans, then
a. the equilibrium level of income will be equal to the full employment level of
income
b. there will be an inflationary gap
c. firms will find their inventories increasing
d. the economy will be producing less than potential output
11. Which of the following was not a cause of the transition from a Federal government
budget surplus in 1999 to a big deficit in 2004?
a. Crash in the stock market
b. Cuts in income tax rates
c. Purchase of U. S. government debt by foreign central banks
d. Spending on Iraq war and homeland security
12. Critics of the Fed claim that the Fed ___________ in the late 1990s and _______ in
the period 2001-04.
a. raised interest rates too much; reduced interest rates too much
b. didn’t raise interest rates enough; reduced interest rates too much
c. raised interest rates too much, didn’t reduce interest rates enough
d. didn’t raise interest rates enough; didn’t reduce interest rates enough
13. Depreciation explains the difference between
a.
b.
c.
d.
GNP and NNP
NNP and national income
GDP and national income
savings and investment
14. Value added by a single firm is measured as total sales revenue
a.
b.
c.
d.
e.
minus factor payments (labor and capital)
plus indirect business taxes
plus depreciation
minus the purchase of intermediate goods
a and d
15. Consider a situation in which real GDP is constant but a boom in the
stock market increases household wealth by $200 billion. The result is
___________ in personal consumption expenditures, ___________ in the
personal saving rate, and ____________ in Federal income tax revenues.
a.
b.
c.
d.
an increase, an increase, an increase
a decrease, a decrease, a decrease
an increase, a decrease, an increase
an increase, an increase, a decrease
16. A partial solution to the large U. S. current account deficit is
a.
b.
c.
d.
Lower private saving and a higher government deficit
Lower private saving and a lower government deficit
Higher private saving and a higher government deficit
Higher private saving and a lower government deficit
17. Additions to inventory
a.
b.
c.
d.
add to next year’s GDP when the goods are actually sold
are simply ignored when calculating GDP
add to current GDP
are priced at zero since they have not been sold
18. If the minimum reserve requirement ratio for all bank deposits is 5%, then the
maximum multiple creation of deposits by the banking system as whole following a
cash deposit of $2000 would be
a.
b.
c.
d.
$100
$2100
$2105
$40,000
19. The Fed is most likely to hit its target for
a.
b.
c.
d.
federal funds rate
quantity of bank deposits
level of GDP
rate of inflation
20. An open market sale will result in all but which one of the following?
a.
b.
c.
d.
decrease in the quantity of reserves
higher price level
increase in interest rates
lower investment spending
21. A depreciation of the dollar normally causes
a.
b.
c.
d.
e.
f.
Higher net exports
Lower net exports
Higher inflation
Lower inflation
a and c
a and d
22. Open market operations give the Fed the strongest control over
a.
b.
c.
d.
interest rates on corporate bonds
the interest rate on 10-year government securities
the federal funds rate
mortgage interest rates
Figure 23
23. From Figure 23, one can infer that
a. Honduras will be willing to trade bananas for corn at a unit ratio of no less than
2 corn: 1 banana.
b. Honduras will be willing to trade bananas as long as the unit exchange ratio
is greater than 1/2 corn:1 banana.
c. Honduras has no potential to gain from trade.
d. Honduras will be unwilling to trade at an exchange ratio.
Figure 24
24. In Figure 24, the solid lines represent the respective production possibilities curves for
the United States and Mexico. Which graphs show the correct consumption possibilities
curves (dashed lines) after an agreement is reached to trade 1 unit of wheat for 1 unit of
petroleum?
a. (1) and (4)
b. (1) and (2)
c. (2) and (3)
d. (3) and (4)
Figure 25
25. In Figure 25, AB represents the production possibilities of Pestoland and
CD that of Pastaland. Pestoland has a comparative advantage in pasta because it
a. gets more pasta from a given decline in pesto than Pastaland does.
b. gets more pesto from a given decrease in pasta production.
c. can produce more pasta than Pastaland.
d. can produce more pasta and pesto than Pastaland.
26. In Figure 25, it is probably true that wages are
a. equal in Pestoland and Pastaland.
b. greater in Pestoland than Pastaland.
c. greater in Pastaland than in Pestoland.
d. higher in pasta production than in pesto production in both countries.
27. If a currency decreases in value as a result of government decree rather than market
forces, the process is known as
a. devaluation.
b. depreciation.
c. deflation.
d. degeneration.
28. The purchasing power parity theory of exchange rate determination maintains that
a. the exchange rate between two nations' currencies is determined by the percent of
gold that backs each nation's currency.
b. the exchange rate between two nations' currencies adjusts to reflect differences in
the price levels in the two nations.
c. in the short run, exchange rates are determined by central bank intervention in the
currency markets.
d. the exchange rate between two currencies is determined by the debt that each
nation owes to the World Bank.
29. Because the United States has had substantial deficits in its trade of goods and
services, it has also necessarily had surpluses in
a. the federal budget.
b. the sales of assets to foreigners.
c. the sales of military goods.
d. its gold supplies.
Figure 30
30. Of the graphs in Figure 30, where the broken line represents the fixed exchange
rate, which one shows a reduction in the price level in Japan that would reduce a
balance of payments deficit?
a. 1
b. 2
c. 3
d. 4
31. Of the graphs in Figure 30, which one shows the effects on the exchange rate of
an expansion of GDP in Japan?
a. 1
b. 2
c. 3
d. 4
32. As the U.S. dollar's foreign exchange value falls, we should expect to see
a. more Americans travelling abroad.
b. American import levels rising.
c. more foreigners visiting the United States.
d. increased foreign investment by American firms.
33. Theoretically, when a currency depreciates one can predict that
a. the price level will rise and real GDP will rise.
b. the price level will fall and real GDP will fall.
c. real GDP will rise, but price change is not predictable.
d. the price level will rise, but real GDP change is not predictable.
34. For a major country with extensive capital flows and flexible exchange rates, what is
the effect of a decrease in interest rates?
a. a currency depreciation and increased net exports
b. a currency depreciation and reduced net exports
c. a currency appreciation and increased net exports
d. a currency appreciation and reduced net exports
35. Expansionary fiscal policy in an open economy with flexible exchange rates has a
a. greater effect than in a closed economy
b. similar effect in a closed economy
c. smaller effect than in a closed economy.
d. greater effect than monetary policy
SHORT ANSWER SECTION (85 Points)
1. The following economy has only four goods (Q1, Q2, Q3, and Q4), and each of
these goods has a corresponding price.
P1 Q1 P2 Q2 P3 Q3 P4 Q4
20 1.5 25 1
18 3
30
2004 1
25 4
25
2005 1.5 22 1.8 20 1
a. Calculate nominal GDP in 2004, and nominal GDP in 2005.
2004: 20+37.5+18+90=165.5
2005: 194
b. What is the percentage change in nominal GDP from 2004 to 2005?
Use the logarithm formula.
194/165.5 = 17.2%. OR In logs 100*LN(194/165.5) = 15.9%
c. Calculate real GDP in 2004, and in 2005 using 2004 prices.
2004: 165.5
2005: 22+30+25+75=152
d. What is the percentage change in real GDP using 2004 prices?
Use the logarithm formula.
152/165.5-1= -8.15% In logs 100*LN(152/165.5) = -8.16%
e. Calculate the GDP deflator in 2005.
194/152*100= 127.6 (give full credit for decimal answer 1.276)
2. CPI on December 16th, 2001 equals 180. CPI on March 16th, 2006 equals 205.
a. Calculate the average annual rate of inflation during this time period, using
the logarithm or exponential formula.
100*LN(205/180)/4.25= 3.06%
b. The current hourly wage for Boeing workers is $30. The worker’s union is
negotiating wage increases with Boeing’s management. What hourly wage
should the union demand if it wants to increase the purchasing power (i.e., the
real wage) of its members by 1.75% when they use as a prediction of next
year’s inflation the average CPI inflation between 12/16/2001 and 03/16/2006.
30*1.0306*1.0175= 31.46
3. The following table gives you data on disposable income and consumption in 2003
and 2004, and gives you disposable income in 2005. IMPORTANT: you have to
assume that the marginal propensity to consume is the same in 2003, 2004, and 2005.
In this fictitious economy taxes are fixed, there is no foreign trade, the government
runs a budget surplus of 150 in the year 2005, and equilibrium GDP equals 1800 in
2005.
DI
C
2003 800 600
2004 1000 750
2005 1375
a. What is total investment in this economy in 2005?
C=a+b*DI = 0.75*DI
I=S+T-G
T-G = 150, C=0.75*1375= 1031.25
S= 1375-1031.25=343.75
I=343.75+150 = 493.75
b. What is government spending in this economy in 2005?
T = 1800-1375 = 425,
G = 425-150 = 275
Also G = 1800 –C – I = 1800 – 1525 = 275
4. The following economy has income-dependent taxes and income-dependent net
exports. (T0 = 100 and NXa = 400). Investment is constant and equals 140, and
government spending equals 160.
Y Taxes Savings Net Exports
400 200
110
360
600 250
200
340
a. Write down the consumption function for this economy. (C=a+b*DI)
Row1: DI=200, C=90
Row2: DI= 350, C=150 b=MPC=60/150 = 0.4, a=10
C= 10 + 0.4*DI
b. Write down the tax function for this economy. (T=T0 + t*Y)
T = 100 + t*Y
T = 100 + 0.25*Y
200=100+t*400, t = 0.25
c. Write down the net export function for this economy. (NX=NXa - nx*Y)
NX= 400 – 0.1*Y
d. Calculate equilibrium GDP.
Y = (a – b*T0 + I + G + NXa) / (1 – b + b*t + nx)
Y = (10-0.4*100+140+160+400) / (1-0.4+0.4*0.25+0.1) = 670/0.8=837.5
e. Calculate the government budget balance at equilibrium GDP.
T-G = 100+0.25*837.5 – 160 = 149.375
f. By how much does equilibrium GDP change when we increase both taxes (T0)
and government spending by 100?
.
Change in Y = 100*mG + 100*mT = 100/0.8 – 100*0.4/0.8 = 125 – 50 = 75
g. If we want to increase GDP by 75, by how much do we have to change
investment?
75 = change in I * mI, change in I = 75*0.8 = 60
h. (Harder): Midterm elections are coming up, and the government wants to give the
economy a boost without deteriorating the government budget. In this economy
this is possible. Equilibrium GDP has to grow by 100. You have to find the
change in government spending (∆G) and the change in taxes (∆T0) such that:
1) equilibrium GDP grows by 100, and
2) the government budget balance stays the same.
100 = ∆G*mG + ∆T0*mT
and ∆G = ∆T = ∆T0 + t*100
Hence: ∆T0 = 100 (1-t*mG) / (mG + mT) = 91.67
∆G = 91.67 + 0.25*100 = 116.67
i. There are two ways to reduce taxes: you can either reduce the autonomous taxes
(T0) or you can reduce the tax rate (t) of the tax function. Suppose you reduce the
tax rate (t) that you calculated in part b by 0.05. By how much do you have to
change T0 in order to get the same change in equilibrium GDP that you get by
reducing the tax rate (t) by 0.05?
1) reduce t by 0.05: Y = 670/0.78= 858.97, change in Y of 858.97 - 837.5 = 21.5
2) in order to get an increase in Y of 21.5,
you need to reduce T0 by 21.5*(0.8/0.4)= -43
j.
(Harder): Suppose you increase the income tax rate from the rate you
calculated in part b by 0.06.
Calculate equilibrium GDP and total government tax
revenue. Call this amount T*. Alternatively, if the government wanted to
keep the income tax rate constant at the rate you calculated in part b, how
much would it have to increase autonomous taxes (To) to generate the same
amount of tax revenue as T*.
100 + (0.25+0.06)*Y1 = T0’ + 0.25*Y2
Y1 = 670/0.824 = 813.1
100+0.31*813.1= 352.1
Y2 = (710 – 0.4 * T0’) / 0.8
352.1 = T0’ + 0.25/0.8 *(710 – 0.4 * T0’) = T0’ + 221.9 – 0.125 * T0’
130.2 = 0.875* T0’
T0’ = 148.8
So, you have to increase T0 by 48.8
5. After the exams are graded Jack, Audrey, and Mike want to buy Easter gifts for
their relatives. Jack takes $150 of currency out of his money box and spends it at
Borders. Borders then deposits the $150 into its checking account at Chase. Audrey
draws $80 from her checking account, and spends it at Macy’s. Macy’s keeps the $80
as currency in their vault. Mike takes $1000 of currency out of his money box and
distributes it among his grand children, who all deposit the money into their savings
accounts.
Extra information: The reserve requirement on checking accounts is
10%, the reserve requirement on savings accounts is 5%.
a. What is the immediate, short-run effect on M1 of all these transactions?
Be explicit: give the short-run effect on M1 of all three transactions.
1) $150 has no effect on M1, 2) $80 has no effect on M1, 3) M1 falls by $1000.
b. What is the immediate, short-run effect on M2 of all these transactions?
Be explicit: give the short-run effect on M2 of all three transactions.
No short run effect on M2
And just as in section, we assume for the next two questions that the public does not hold
currency, it puts all its money on bank accounts (i.e. assume the money multiplier equals
the inverse of the reserve requirement).
c. What is the long run effect on M1?
∆M1LR = ∆C + ∆DLR = -1070 + (150/0.1 – 80/0.1) = -370
d. What is the long run effect on M2?
∆M2LR = ∆M1LR + ∆SavAccLR = -370 + 1000/0.05 = 19630
6. Consider the following economy: (8Points)
C = 300 + 0.6(Y – T)
T = 50 + 0.2Y
I = 300 + 0.1Y – 25*r
X = 400
G = 600
IM = 100
r=6
r is the interest rate in percentage points. (In this case, the interest rate is 6%)
A. Find equilibrium GDP. (2Points)
Y = 1320/(1 -.1-.6+.12) = 3142.85
B. The government cuts the income tax rate to 10%. When this is the only change to the
equations, what is the new equilibrium GDP? (2Points)
Y = 1320/(1-.1-.6 + 0.06) = 3666.67
C. Now consider the effect of the tax cut (where government spending is still G = 600)
on interest rates and currency exchange rates. Pick the plausible new values for the
following items. (Hint: given the change in taxes, do the items go up or down in value?
Note that they do not necessarily all go up or all go down.) (2Points)
r: 4 or 7
X: 350 or 500
IM: 200 or 50
Answer: The correct values are r = 7, X = 350 and IM = 200. Therefore, equilibrium
GDP is
Y = 1175/(0.36) = 3263.89
D. Considering your answers in parts B and C, what effect do interest rates and currency
exchange rates have on fiscal expansionary policies? (2Points)
Answer: They reduce the increase in GDP because interest rates go up. This reduces
investment and the resulting appreciation in currency reduces net exports. This limits the
impact of expansionary policies.
7. Consider the following demand and supply for cars in Oceania and Eastasia. (These are
the only two countries in the world. The prices in the equations are denominated in
dollars, even though each country has its own currency.): (11Points)
Oceania
Demand: Q = 170 – 7P
Supply: Q = -30 + 18P
Eastasia
Demand: Q = 320 – 10P
Supply: Q = -20 + 10P
A. What are the equilibrium quantities and prices (in dollars) for cars in both
countries when there is no trade? (1Point)
Answer: Oceania: P = 8, Q = 114
Eastasia: P = 17, Q = 150
B. Oceania and Eastasia sign a free trade pact. What is the price of a car in each
country (in dollars)? What quantity is exported and which country is exporting?
Hint: Set total quantity demanded equal to total quantity supplied. Then solve for
the common price (price will be the same in each country). (2Points)
Answer: Set total demand equal to total supply. In equilibrium, the common
price of cars is $12. The supply in Oceania is 186 while demand is 86. Thus, Oceania
will be exporting 100 cars. We can verify this by checking Eastasia’s supply and demand
at $12. Qd = 200 while Qs = 100.
C. Oceania enters a recession as aggregate demand falls. Which one of the
following could represent the new demand equation in Oceania? (2Points)
Q = 180 – 10P
Q = 160 – 5P
Q = 140 – 7P
If this is the only one of the 4 equations to change, what is the new equilibrium
price of cars in the two countries? How many cars are exported and which
country is exporting? Hint: use the new Oceania demand equation and then
repeat the process in part B.
Answer: The correct new equation is Q = 140 – 7P. In equilibrium, P =
$11.33 in both countries. Oceania is still exporting. The number of cars exported
is 113 (rounding down).
D. After the recession ends, demand in Oceania returns to the original level above.
Arguing that they need to protect domestic industries from foreign competitors,
the government of the country importing in equilibrium passes a tariff of $2 on
each car imported. What are the new equilibrium price(s), quantities supplied,
and quantities demanded in both countries? Hint: A tariff will only increase the
price in the country where it is levied. The difference in equilibrium prices
between the two countries will be equal to the tariff ($2). Set the quantity
exported in the exporting country equal to the quantity imported by the importing
country and solve for the equilibrium price.(2Points)
Answer: The tariff will be assessed in Eastasia. The new equilibrium price in
Eastasia is $13.11. The quantity imported by Eastasia will be 77.7. Demand in
Eastasia is 188.8 and supply is 111.1. The price in Oceania will be $11.11, with
supply equaling 170 and demand equaling 92.22.
E. What quota on imports by the importing country would produce the identical
equilibrium result? (2Points)
Answer: A quota of 77.7 cars would produce the same result.
F. What tariff on imports would lead to the equilibrium result derived in part A?
Hint: Total exports/imports equal zero in part A. (2Points)
A tariff of $9, which would be equivalent to a quota of zero imports, will
produce the result in A.
8. Jesse takes $1000 of U. S. dollar currency out of his moneybox in his native
Belgium and brings it to the United States, where he deposits it at the
Lasalle Bank in Evanston. All banks in the United States are required to
hold 5% of their deposits as reserves and all U. S. bank customers hold U.
S. dollar currency in the amount of 35% of their total holdings of deposits
in the United States. Assuming that the consequences of Jesse's action do
not lead to any American bank customers taking currency or checks outside of
the United States, calculate the effect of Jesse's action on:
(1) Total U. S. bank deposits
(2) Total U. S. holdings of currency
(3) Total U. S. money supply (M2)
Answer. Deposit multiplier is 1/.4 or 2.5. Deposits increase by 2500,
currency increases by .35*2500 = 875, money supply increases by 1.35*2500 or
3375.