Released Exam 2000

# Question 2

• 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

• 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

• 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.

# Question 16

• 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

• 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

# Question 26

• 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.

# Question 30

• 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

• 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

• 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.

# Question 40

• MV = PQ.

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

# Question 44

• 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

• 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

• Monetarists dislike expansionary fiscal policy because of crowding out.

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