Released Exam 2000

Question 2

2. Which of the following transactions would represent an addition
  to a nation's current gross domestic product? (A) Ms. Smith purchases
  a share of stock in an automobile company. (B) A retailer increases
  her stock of imported (C) The government increases its domestic
  purchases of food for use by the military. corporauonse s s oes om
  year s inventory. (E) A mother sells her car to her daughter.

  • A nation’s current domestic product includes final goods and services produced during that year.

  • It does not include financial transactions like the purchase of stock simply because that is just a transfer of ownership (nothing has been produced).

  • Second hand sales also aren’t included since the product was originally counted when it was first produced (nothing has been added to our economy).

  • If a retailer increases her stock of imported shoes (she is buying goods not produced in the U.S. and, therefore, they aren’t counted in GDP).

  • If the government increases its purchases, GDP will increase since production has obviously increased.

Question 7

7. According to the Keynesian savings schedule, when aggregate
  income increases by a given amount, savings will (A) remain the same
  (B) decrease by the amount of the change in income (C) increase by the
  amount of the change in (D) increase by less than the amount of the
  change in income Increase y more change in income amoun

  • Remember, you can do two things with your income: spend or save it.

  • Y = C + S.

  • Thus, if income increases by a given amount, savings will increase, but not by the entire amount since you will consume some of that additional income.

Question 10

10. When consumers hold money rather than bonds because they expect
  the interest rate to increase in the future, they are holding money
  for which of the following purposes? (A) Transactions B Unforeseen
  expenditures (C) Speculation (D) liquidity (E) Exchange

  • If people hold money because they think interest rates are going to rise in the future, they are speculating that rates will increase so that they will benefit from holding the money. Thus, the purpose of money is that of speculation.

    The Demand for Money • Why would people want to hold money— that is,
have a demand for money? • Transactions demand: for the purpose of
making everyday market purchases. • Precautionary demand: for
unexpected market transactions or for emergencies. \*Speculative
demand: to be able to take advantage of an investment opportunity in
the near future.

Question 16

8 E 30 - 13 21 25 QUANTITY OF X PRODUCED 16. On of diagram above
  showing an economy's production possibilities curve for two goods,
  which of following statements must be true? I. The opportunity cost of
  moving from point P to point R is 10 units of Y. Il. opportunity cost
  of moving from point R to point P is 8 tmits of X. opportunity cost of
  moving from Q to point R is O units of Y.

  • Opportunity cost is a measure of what must be forgone in order to have more of something else.

  • When moving from point P to R we must give up units of Y (10 units) to have more X, and when moving from point R to P we must give up units of X (8 units) to have more Y.

  • The opportunity cost of moving from Q to R is nothing simply because at Q some of our resources were underemployed.

  • This means that we won’t have to give up anything to produce more of X or Y.

Question 21

Questions 19-21 refer to the graph below that shows an economy's
  aggregate expenditures, assuming no foreign sector and that government
  expenditures are initially zero. Full Employment $500 $100 450 $1,000
  Consumption Plus Investment Investment $2,000 REAL NATIONAL INCOME

21. The minimum increase in government spending necessary to reach
  full employment is (A) $2,000 (C) $500 (E) $100

  • To determine the minimum increase in government spending necessary to reach full employment, we must first calculate the spending multiplier.

  • The spending multiplier (m) = [1 / (1 – MPC)], where MPC is the marginal propensity to consume.

  • MPC (b) is simply the slope of the expenditures function.

  • The slope of the line above is (1000 – 500) / (1000 – 0) = 500/1000 = 1/2.

  • Thus, the spending multiplier (m) = [1 / (1 – ½)] = [1 / (1/2)] = 2.

  • Now that we know the multiplier and know that we want to increase income by 1000 (2000 –1000), we can simply solve for the change in government spending.

  • 1000 = 2 x (Change in government spending). Therefore, the change in government spending to eliminate this recessionary gap must be 1000 / 2 = $500

    FIGURE 27.6 The Multiplier and the Slope of the AE Curve ,200 The
multiplier is I -0.75 ,400 ,200 I ,200 450 line 11400 Q) CN The
multiplier is -2 -0.5 ,300 line AEI Real GDP (billions of 2002
dollars) 1,200 1,300 Real GDP (billions of 2002 dollars) (a)
Multiplier is 4 (b) Multiplier is 2 Imports and income taxes make the
AE curve less steep and reduce the value of the multiplier. In part
(a), with no imports and income taxes, the slope of the AE curve is
0.75 (the marginal propensity to consume) and the multiplier is 4. But
with imports and income taxes, the slope of the AE curve is less than
the marginal propensity to consume. In part (b), the slope of the AE
curve is 0.5. In this case, the multiplier is 2.

Question 26

26. Which of the following constitutes the largest component of the
  United States money supply (Ml) ? (B) Checkable deposits (demand
  deposits) money (D) Coins Large certificates of deposit (E)

  • M1 consists of currency (coins and paper money) and checkable (demand) deposits.

  • Out of these two components, checkable (demand) deposits constitute the largest component of the United States money supply.

    Money Defined: Ml Ml is the narrowest definition of the U.S. money
supply Consists of: Money, MI= Currency + Checkable Deposits Currency:
Coins and paper money ( in the hands of the public) Token money: All U
.S. coins in circulation are considered token money. The intrinsic
value, the actual value of the metal contained in the coin, is less
than the face value of the coin (This prevents people from melting
down the metal for its value) — Paper money: About 46 00 of U .S.
money supply (all of it in the form of Federal Reserve Notes). Issued
by the Federal Reserve System (U .S. central banks) Checkable
deposits: Deposits in commercial banks and thrift or savings
institutions on which checks of any size can be drawn. — Largest
component of the Ml money supply(520 0) due to the safety and
convenience checks allow. — Example: You don'tmail currency to pay a
bill, it is safer and convenient to send a check instead. 13-5

Question 30

30. Which of the following changes will occur to the demand for
  United States dollars and the inter- national value of the dollar in
  the short run if investcrs in the United States and abroad increase
  their purchases of United States governrnent bonds? (A) (B) (C) (E)
  Demand for Dollars Decrease Decrease Decrease Increase International
  Value Of the Decrease Increase No change Increase

  • If investors increase their purchases of United States government bonds, they are going to be demanding more dollars.

  • As the demand for dollars increases (demand curves shifts to the right), the international value of the dollar also increases.

Question 31

31. As nations specialize in production and trade in intemational
  markets, they can expect which of the following domestic improvements?
  I. Allocation of domestic resources . Standard of livin Ill.

  • Trade results in specialization and, thus, an improved allocation of domestic resources and an increased standard of living (since more can be produced as a result of trade).

  • Trade means that you are depending on someone else for a good or service. Therefore, trade does not result in self-sufficiency.

Question 35

35. In the simple Keynesian aggregate expenditure model of an
  economy, changes in investrnent or govemment spending will lead to a
  change in which of the following? (B) The level of ( terestrates (D)
  The aggregate supply curve (E) The demand for money, unless the
  econorny slips into tir liquidity trap

  • Investment spending is one of the components of aggregate demand.

  • Thus, a change in investment will result in a change in the level of output and employment since the AD curve will be shifting.

    A liquidity trap is a situation, described in Keynesian Economics,
in which injections of cash into the private banking system by a
central bank fail to decrease interest rates and hence make monetary
policy ineffective. Liquidity trap - Wikipedia\_trap

    Liquidity Trap The demand for money is a decreasing function of the
rate of interest Higher the rate of interest lower the demand for
money for speculative motive and less money would be kept as inactive
balance and vice versa. The LP curve becomes perfectly elastic at very
low rate of interest Rate Liquidity Trap Of interest Speculative

Question 40

40. If the money stock decreases but nominal gross domestic product
  remains constant, which of the following has occurred? (A) Income
  veloci of mone has increased. (B) ome velocity money (C) Price level
  has increased. (D) Price level has decreased. (E) Real output has

  • MV = PQ.

  • Since PQ does not change and M ↓, V must ↑ in order for the equation to remain balanced.

    The Equation of Exchange or Quantity Theory of Money MV PQ was the
comerstoneof Classical theory. $ received MxV-PxQ 1. Velocity is
stable. 2. The amount of goods/services that can be produced is fixed
in the short run. 3. If the Fed increases the MS by 15%, we will see a
proportional 15% increase in prices. 4. V and Q aren't in the equation
& a change in MS will result in a change in P.

    Monetarism MV = FQ With this "Monetarist Rule" in effect (2 or 3%)
and a constanct V, the rate of inflation would be zero.

Question 44

44. Policymakers concerned about fostering long-run growth in an
  economy that is currently in a reces- sion would most likely
  recornmend which of the following combinations of monetary and fiscal
  policy actions? Monetary Policy (A) Sell bonds (B) Sell bonds (C) No
  change (E) Buy bonds EiæLE.Qlicy Reduce taxes Raise taxes Raise taxes
  No change

  • If we are in a recession, we are going to want to implement expansionary policies.

  • Thus, we would want to buy bonds and do nothing with regards to fiscal policy.

  • The effects of expansionary fiscal policy are partially negated due to the crowding-out effect.

  • In addition, since fiscal policy results in higher interest rates, our long-run growth would actually be slowed since investment would decrease.

Question 55

55. Compared to expansionary monetary policies adopted to counteract
  a recession, expansionary fiscal policies tend to result in (A) (D)
  (E) less public spending lg Interest rates ower pnces a high rate of
  economic growth decreased investment by foreign countries

  • Expansionary fiscal policies result in the government running on a budget deficit since G > T.

  • As the government borrows money to finance their budget, the demand for loanable funds increases (shift to the right).

  • This increased demand causes interest rates to rise (thereby crowding out some private investors).

  • So, while expansionary monetary policy results in lower interest rates due to an increase in the money supply, expansionary fiscal policy results in higher interest rates (thereby negating some of the intended effect of the policy).

Qusetion 56

56. According to the monetarists, which of the following is true of
  expansionary fiscal policy? (A) It will cause interest rates to rise
  and crowd out private investment spending. so ong as national debt.
  (C) It should be used only when some resources are unemployed and the
  inflation rate is (D) It will decrease aggregate income. (E) It will
  increase aggregate income as long as the money supply is decreased at
  a slow, steady rate.

  • Monetarists dislike expansionary fiscal policy because of crowding out.

  • In addition, they dislike fiscal policy in general because it is too slow!

    The Business Context BKEY402 Two macro theories Keynesianism
Monetarism Gov to manage demand in a complex economy Trade off between
unemployment & Inflation Gov has a minimal role in a complex economy
No long run trade off between unemployment & Inflation Inflation is
caused by increases in the Money Supply

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