Douglas, Spring 2007
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Econ 202 Midterm 2
1. The classical dichotomy and doctrine of money neutrality assert that changes in the money supply
a. affect both nominal and real variables.
b. affect neither nominal nor real variables.
c. affect nominal variables, but not real variables.
d. do not affect nominal variables, but do affect real variables.
2. If a country has a trade surplus
a. it has positive net exports and positive net capital outflow.
b. it has positive net exports and negative net capital outflow.
c. it has negative net exports and positive net capital outflow.
d. it has negative net exports and negative net capital outflow.
3. Suppose some country had an adult population of 50 million, the labor-force participation rate was 60
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percent, and the unemployment rate was 5 percent. What were the number of people employed and the
number of people in the labor force?
a. 27.5 million, 30 million
b. 28.5 million, 30 million
c. 30 million, 31.5 million
d. 30 million, 32.5 million
Suppose that banks desire to hold no excess reserves and that the Fed has set a reserve requirement of 10%. If
you deposit $3,000 in currency into your United Bank checking account,
a. United’s required reserves increase by $300.
b. United will be able to lend out an additional $2,700.
c. United’s assets and liabilities will both increase by $3,000.
d. All of the above are correct.
If the nominal interest rate is 6%, in which case would you earn the lowest after-tax real rate of interest?
a. Inflation is 4 percent; the tax rate on interest income is 25 percent.
b. Inflation is 3 percent; the tax rate on interest income is 33 percent.
c. Inflation is 2 percent; the tax rate on interest income is 50 percent.
d. The after-tax real interest rate is the same for all of the above.
Suppose a bank has a 10 percent reserve requirement, $4,000 in deposits, and has loaned out all it can given
the reserve requirement.
a. It has $40 in reserves and $3,960 in loans.
b. It has $400 in reserves and $3,600 in loans.
c. It has $444 in reserves and $3,556 in loans.
d. None of the above is correct.
The money supply in Tazland is $100 billion. Nominal GDP is $800 billion and real GDP is $200 billion.
What are the price level and velocity in Tazland?
a. the price level and velocity are both 8
b. the price level is 8 and velocity is 4
c. the price level and velocity are both 4
d. the price level is 4 and velocity is 8
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Econ202 Exam 2, Spring 2007
Douglas
8. Tony, a U.S. citizen, uses some previously obtained Portuguese currency (escudo) to purchase a bond issued
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by a Portuguese company. This transaction
a. increases U.S. net capital outflow by more than the value of the bond.
b. increases U.S. net capital outflow by the value of the bond.
c. does not change U.S. net capital outflow.
d. decreases U.S. net capital outflow.
Which of the following actions would have the combined effect of raising the money supply and raising the
money multiplier?
a. The Fed sells bonds and raises the reserve requirement ratio.
b. The Fed sells bonds and lowers the reserve requirement ratio.
c. The Fed buys bonds and raises the reserve requirement ratio.
d. The Fed buys bonds and lowers the reserve requirement ratio.
Unemployment that occurs because it takes time for workers to search for jobs that suit their tastes and skills
is called
a. the natural rate of unemployment.
b. cyclical unemployment.
c. structural unemployment.
d. frictional unemployment.
Which of the following games might a risk-averse person be willing to play?
a. A game where she has a 60% chance of winning $1 and a 40% chance of losing $1.
b. A game where she has a 50% chance of winning $1 and a 50% chance of losing $1.
c. Both A and B.
d. Neither A nor B.
A company is considering building a new shampoo factory. Its board of directors meets and decide that the
factory is not a profitable investment. If interest rates fall after the meeting
a. the present value of the factory rises, and the board should reconsider its decision.
b. the present value of the factory rises, which only confirms the board’s decision.
c. the present value of the factory falls, and the board should reconsider its decision.
d. the present value of the factory falls, which only confirms the board’s decision.
Unemployment insurance
a. reduces laidoff workers’ job-search intensity and raises unemployment.
b. reduces laidoff workers’ job-search intensity and lowers unemployment.
c. increases laidoff workers’ job-search intensity and raises unemployment.
d. increases laidoff workers’ job-search intensity and decreases unemployment.
Which of the following is included in M2 but not in M1?
a. currency
b. demand deposits
c. savings deposits
d. All of the above are included in both M1 and M2
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Econ202 Exam 2, Spring 2007
Douglas
Figure 32-6
15. Refer to Figure 32-6. Supposing that the Mexican economy starts at r0 and E1. Which of the following is
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consistent with the effects of capital flight?
a. the shift from D0 to D1 in Panel A
b. the shift from NCO0 to NCO1 in Panel B
c. the shift from S0 to S1 in Panel C
d. All of the above shifts are consistent with the effects of capital flight.
When the dollar appreciates, U.S. goods become
a. less expensive relative to foreign goods, which makes exports rise and imports fall.
b. less expensive relative to foreign goods, which makes exports fall and imports rise.
c. more expensive relative to foreign goods, which makes exports rise and imports fall.
d. more expensive relative to foreign goods, which makes exports fall and imports rise.
The theory of efficiency wages explains why
a. setting wages at the equilibrium level may increase unemployment.
b. it may be in the best interest of firms to offer wages that are above the equilibrium level.
c. the most efficient way to pay workers is to pay them according to their skills.
d. it is efficient for firms to set wages at the equilibrium level.
Annie knows that people in her family die young, and so she buys life insurance. Harry knows he is a lousy
driver and so he increases his automobile insurance.
a. These are both examples of adverse selection.
b. These are both examples of moral hazard.
c. The first example illustrates adverse selection, and the second illustrates moral hazard.
d. The first example illustrates moral hazard, and the second illustrates adverse selection.
You are promised a payment of $400 in n years. In which case is the present value the highest?
a. n equals 3 years and the interest rate is 6%
b. n equals 3 years and the interest rate is 5%
c. n equals 2 years and the interest rate is 6%
d. n equals 2 years and the interest rate is 5%
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Econ202 Exam 2, Spring 2007
Douglas
20. When the money market is drawn with the value of money on the vertical axis, an increase in the money
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supply creates an excess
a. supply of money causing people to spend more.
b. supply of money causing people to spend less.
c. demand for money causing people to spend more.
d. demand for money causing people to spend less.
A citizen of Saudi Arabia uses previously obtained U.S. dollars to purchase apples from the United States.
This transaction
a. increases Saudi net capital outflow, and increases U.S. net exports.
b. increases Saudi net capital outflow, and decreases U.S. net exports.
c. decreases Saudi net capital outflow, and increases U.S. net exports.
d. decreases Saudi net capital outflow, and decreases U.S. net exports.
Mary buys a bond that pays 6%, and then inflation is higher than expected. Because of the unexpectedly high
inflation, her real interest rate is
a. higher than she’d expected, and the real value of the bond rises.
b. higher than she’d expected, and the real value of the bond falls.
c. lower than she’d expected, and the real value of the bond rises.
d. lower then she’d expected, and the real value of the bond falls.
Current U.S. currency is
a. fiat money with intrinsic value.
b. fiat money with no intrinsic value.
c. commodity money with intrinsic value.
d. commodity money with no intrinsic value.
The variable that links the market for loanable funds and the market for foreign-currency exchange is
a. net capital outflow.
b. national saving.
c. exports.
d. domestic investment.
During a hyperinflation the real domestic value of a country’s currency
a. falls and its nominal exchange rate depreciates.
b. falls and its nominal exchange rate appreciates.
c. rises and its nominal exchange rate depreciates.
d. rises and its nominal exchange rate appreciates.
Other things the same, a higher real interest rate raises the quantity of
a. domestic investment.
b. net capital outflow.
c. loanable funds demanded.
d. loanable funds supplied.
Latoya, an unpaid homemaker who works as a volunteer at the local Red Cross and is currently not looking
for a paid job, is counted by the Bureau of Labor Statistics as
a. employed and in the labor force.
b. unemployed and in the labor force.
c. unemployed and not in the labor force.
d. not in the labor force.
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Econ202 Exam 2, Spring 2007
Douglas
28. The country of Sylvania has a GDP of $900, investment of $200, government purchases of $200, and net
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capital outflow of negative $100. This means that
a. consumption equals $700.
b. consumption equals $600.
c. consumption equals $500.
d. saving equals $300.
A country has $100 million of net exports and $170 million of saving. Net capital outflow is
a. $70 million and domestic investment is $170 million.
b. $70 million and domestic investment is $270 million.
c. $100 million and domestic investment is $70 million.
d. $100 million and domestic investmetn is $170 million.
If the government of India implemented a policy that reduced national saving, its real exchange rate would
a. depreciate and Indian net exports would rise.
b. depreciate and Indian net exports would fall.
c. appreciate and Indian net exports would rise.
d. appreciate and Indian net exports would fall.
The price level rises from 120 to 126 during 2006. What is the 2006 inflation rate?
a. 3%
b. 5%
c. 6%
d. 4.9%
An increase in the U.S. real interest rate induces
a. Americans to buy more foreign assets, which increases U.S. net capital outflow.
b. Americans to buy more foreign assets, which reduces U.S. net capital outflow.
c. foreigners to buy more U.S. assets, which reduces U.S. net capital outflow.
d. foreigners to buy more U.S. assets, which increases U.S. net capital outflow.
If the reserve ratio is 5 percent, $1,000 of additional reserves can create up to
a. $25,000 of new money.
b. $20,000 of new money.
c. $19,000 of new money.
d. $5,000 of new money.
An increase in the price level makes the value of money
a. increase, so people want to hold more of it for transaction purposes.
b. increase, so people want to hold less of it for transaction purposes.
c. decrease, so people want to hold more of it for transaction purposes.
d. decrease, so people want to hold less of it for transaction purposes.
About what percentage of GDP are U.S. imports?
a. less than 1 percent
b. about 4 percent
c. about 7 percent
d. over 10 percent
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Econ202 Exam 2, Spring 2007
Short Answer. Answer in the space provided.
Douglas
PRINT NAME:
36. Suppose that one UK pound (£1) currently costs two U.S. Dollars ($2). Wool prices are currently £500/ton in Aberdeen,
Scotland, and $1500/ton in Denver, Colorado. The nominal UK exchange rate is __ ______ per _______, and the real
UK exchange rate is ___ _____________ per _____________.
In a real sense, you might say that the (circle one: DOLLAR, POUND) is “undervalued” relative to the other currency.
Explain exactly what you mean by “undervalued” in the space below:
An arbitrageur could make money by buying wool in (city name:)______________and selling it in ________________.
The arbitrageur’s profit per ton of wool would be £__________. (Show calculations:
This arbitrage activity would tend to increase the (circle one: SUPPLY, DEMAND) of pounds in foreign exchange
markets, which would cause the pound to (APPRECIATE, DEPRECIATE) against the dollar.
This arbtrage activity would cause shift the (SUPPLY, DEMAND) of wool in Denver to shift
(RIGHTWARD, LEFTWARD), and drive the Denver price of wool (HIGHER, LOWER). Illustrate the effect of the
arbitrage activity on the Denver wool market in the space below, using a graph. Be sure to label the axes and all curves.
The currency and wool markets will adjust until the real UK exchange rate equals ________________. The new
equilibrium nominal exchange rate for the pound could be: $2.50, $1.50, £0.40 (circle one).
Suppose that, after the wool and currency markets adjust to equilibrium, you find that sheep shearers in Denver are paid
$7 per hour, and sheep shearers in Aberdeen are paid £5 per hour. Does Purchasing Power Parity hold in the
sheep-shearer labor market? (YES, NO). Explain why or why not:
Explain why the market for sheepshearer labor might move to PPP more slowly than the wool market.
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Econ 202 Midterm 2
Answer Section
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SHORT ANSWER
36. ANS:
nominal e = 2 dollars per pound; real E = 2x(500/1500) = .67 US tons per UK ton.
The POUND is undervalued because £500 worth of dollars buys less wool than $1500 worth of pounds does.
Use $1000 worth of pounds to buy a ton in ABERDEEN, sell in DENVER for $1500. Profit = $500 = £250.
DEMAND for pounds increases, causing it to APPRECIATE.
SUPPLY of wool in Denver shifts RIGHTWARD, driving the price in Denver LOWER.
Markets will adjust until the UK real exchange rate E = 1. (PPP)
The new equilibrium exchange rate for the pound (in $/£ of course) will be higher, so it might be $2.50.
NO, PPP does not hold. Denver sheepshearers were paid less than their Scottish counterparts even before the dollar
depreciated, and the real difference will be even greater afterward.
The sheepshearer market will adjust more slowly (if at all) because it is harder to trade sheep shearing services than
wool, and so arbitrage will be weaker.
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