201_winter08_final solutions.pdf

7/30/2019 201_winter08_final solutions.pdf

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Econ 201 Final Winter 2008 SOLUTIONS

1 Multiple Choice - 50 Points

(In this section each question is worth 1 point)1. Suppose a waiter deposits his cash tips into his savings account. As a result of only this

transaction:(a) M2 increases.(b) M1 decreases.(c) M2 decreases.(d) M3 increases.

2. Mark Twain said:(a) It is easy to write 30 pages in 2 days(b) It is easy to write 2 pages in 30 days(c) It is easy to write 2 pages in 2 days(d) It is easy to write 30 pages in 30 days(e) (a) and (b)(f) (c) and (d)

3. On 11/04/04, a euro was worth $1.287, and on 03/07/08, a euro was worth $1.535. Usingnatural logarithms to calculate the total percent change between these two dates (not annu-alized), which is true?(a) The dollar appreciated by 19.3%(b) The dollar appreciated by 17.6%(c) The dollar depreciated by 17.6%(d) The dollar depreciated by 19.3%

4. Suppose the economy is in equilibrium and the central bank sells bonds. What happens tothe equilibrium quantity of money and interest rates in the short term?(a) Quantity will go up, interest rates will go up.(b) Quantity will go up, interest rates will go down.(c) Quantity will go down, interest rates will go up.(d) Quantity will go down, interest rates will go down.

5. The survey that produces the monthly data on the unemployment rate is based on(a) A survey of employers(b) A survey of employees(c) A survey of households

(d) A survey of individuals(e) (b) and (d)(f) (a) and (c)

6. Suppose that Crimson Bank has excess reserves of $800 and the reserve ratio is 20%. If Nielsdeposits $1,000 of cash into his checking account at Crimson Bank, and then Crimson Banklends $600 to Mary, what is the most that Crimson Bank can lend to Professor Gordon?(a) $200 (b) $800 (c) $1000 (d) $2400


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Pg. 27. Consider the market for loanable funds. Other things being equal, an increase in taxes on

savings and investment income will:(a) shift demand to the right and increase the interest rate.(b) shift demand to the left and decrease the interest rate.(c) shift supply to the right and decrease the interest rate.(d) shift supply to the left and increase the interest rate.

8. American jobs are lost to:(a) China in manufacturing(b) China in information technology services(c) India in manufacturing(d) India in information technology services(e) (b) and (c)(f) (a) and (d)

9. Which of the following will not cause the AD curve to shift to the left?(a) Higher income tax rate

(b) Lower stock of physical capital(c) Open-market purchase(d) Lower government spending(e) (b) and (c)

10. An example of a double coincidence of wants is:(a) a car mechanic who wants a TV finding an owner of an electronics storewho wants a car repaired.(b) a car dealer who wants a TV finding an electronics store owner who wants money.(c) an electronics store owner who wants car repairs finding a car mechanic who wants money.(d) all of the above are examples.

11. What is the main reason that the government does not bail out the households who faceforeclosure on their mortgages?(a) Fear of higher inflation(b) Fear of lower output(c) Moral hazard(d) Bankruptcy of the mortgage banking industry

12. Advocates of free trade claim that(a) Import competitors are winners and consumers are losers(b) Consumers are losers and import competitors are losers(c) Consumers are losers and export producers are winners(d) Consumers are winners and export producers are winners

13. If a bank has deposits of $100,000, loans of $200,000, cash on hand of $10,000, and $15,000on deposit at the Federal Reserve, then its reserve ratio is:(a) 5% (b) 10% (c) 12.5% (d) 25%

14. If the nominal quantity of money is $4 trillion, real output is $10 trillion, and the price levelis 2, then the velocity of money is:(a) 1 (b) 2 (c) 4 (d) 5


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15. To the money supply, the Fed could .(a) decrease; lower the discount rate(b) increase; raise the federal funds rate(c) decrease; conduct open-market purchases

(d) increase; lower the required reserve ratio16. Japans lost decade and todays U.S. mortgage meltdown have one thing in common, which

is:(a) Falling housing prices.(b) Aggressive use of stimulative monetary and fiscal policy.(c) Insolvent banks.(d) Use of cash for most transactions.

17. An increase in the price level(a) increases the nominal demand for money.(b) decreases the nominal demand for money.

(c) does not affect the nominal demand for money.(d) shifts the nominal demand for money to the left.

18. The money demand curve is because a lower interest rate .(a) upward-sloping; increases the opportunity cost of holding money.(b) downward-sloping; increases the opportunity cost of holding money.(c) upward-sloping; decreases the opportunity cost of holding money.(d) downward-sloping; decreases the opportunity cost of holding money

19. If the economy is suffering from a recessionary gap, the Fed should conductmonetary policy by the money supply.(a) expansionary; decreasing

(b) expansionary; increasing(c) contractionary; decreasing(d) contractionary; increasing

20. In the readings for Chapter 19, there is a debate in Business Week about the desirability ofletting the dollar depreciate. Which of the following is not an argument in favor of lettingthe dollar depreciate?(a) It will make U.S. exports more competitive.(b) It will make U.S. imports more expensive.(c) It will defuse protectionist pressure.(d) It will attract more investment for the U.S. stock market.

21. Deflation depresses aggregate demand because of(a) The wealth effect(b) The expectations effect(c) The income effect(d) The consumption effect


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Pg. 4

22. Suppose the AD, LRAS, and SRAS curves in the economy are

Real GDP

Aggregate

Price

Level

LRAS

SRAS

AD

Y

If real GDP in the economy is at Y and the central bank wants to change real GDP in theshort-run to be equal to potential GDP it should:(a) Buy bonds on the open market.(b) Sell bonds on the open market.(c) Do nothing.(d) Tell the government to print more money.

23. Economists argue that money is neutral:(a) in both the short and long run.(b) in the short run only.(c) in the long run but does have an impact on the price level.(d) in the long run but has no impact on the price level.

24. When an economy moves from autarky to free international trade, in the export sector(a) consumer and producer surplus both rise and the economy as a whole gains.(b) consumer surplus rises, producer surplus falls, and the economy as a whole gains.(c) consumer surplus falls, producer surplus rises, and the economy as a wholegains.(d) the decrease in either consumer surplus or producer surplus is sufficiently large to causenet losses for the economy.

25. Initially, the nominal exchange rate is 0.7 euros per $, and the price index for both the U.S.and the euro area are each 100. Over the following 10 years, the annual U.S. inflation rate is3.5% per year, and that of the euro area is 2.5% per year. What must the nominal exchangerate be after 10 years to maintain the initial real exchange rate?(a) 0.5 euros per $(b) 0.62 euros per $(c) 0.7 euros per $(d) 0.77 euros per $

26. The three main monetary policy tools are:(a) interest rates, taxes, government purchases, and transfers.(b) currency, near-moneys, and reserve ratio.(c) deposit insurance, discount rate, and money multiplier.(d) reserve requirements, the discount rate, and open-market purchases.


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Pg. 5

For the next three problems, consider the following chart showing supply and demand forcalculators.

Quantity of

calculators

Price of

calculators

$300

$50

35 50 60

PW = $100

$120

$150

Domestic supply

Domestic demand

A

B

C G H

K L

I J

F

27. The world price, PW, equals $100. When the economy moves from autarky to free trade,consumer surplus rises by area and producer surplus falls by .(a) B + K + L; B(b) B + C + K + L; B + C + K + L(c) B + C+ H + I + K + L; B + C + H + I(d) B + C + G + H + I + J + K + L; B + C

28. The world price, PW, equals $100. The government imposes a quota restricting imports to25 calculators. If the import licenses are granted to foreigners, the net loss due to the import

quota is equal to areas:(a) K + L(b) G + J(c) G + H + I + J(d) G + H + I + J + K + L

29. The world price, PW, equals $100. The government imposes an import tariff of $20 per calculator.Compared with the free trade situation, the tariff leads to a deadweight loss equal to areas:(a) K + L(b) G + J(c) G + H + I + J(d) There is no deadweight loss, since the tariff revenue the government receives offsets any losses.

30. The CPI in September, 2007, was 208.3, and it was 211.2 in December, 2007. The annualizedgrowth rate between September and December was:(a) 1.38% (b) 2.44% (c) 3.84% (d) 5.53%


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31. In the absence of international capital flows, the equilibrium interest rate in the U.S. marketfor loanable funds is 3%, while in Germany it is 7%. International borrowing and lending be-tween the United States and Germany may result in a common interest rate ofand .

(a) 4%; capital inflows to the United States matching the capital outflows from Germany(b) 3%; massive capital inflows from Germany into the United States(c) 5%; capital outflows from the United States matching the capital inflows intoGermany(d) 7%; massive capital inflows from the United States into Germany

32. All else being equal, which of the following could cause exchange rates to change from1e=$1.50 to 1e=$1.25?(a) interest rates are higher in Europe.(b) interest rates are higher in the United States.(c) interest rates in the United States and Europe are equal.(d) inflation is higher in Europe.

33. A Nobel-Prize winner suggested the following combination:(a) Developed countries should lower tariffs and less-developed countries shouldraise tariffs(b) Developed countries should raise tariffs and less-developed countries should reduce tariffs(c) Developed countries should lower tariffs and less-developed countries should reduce tariffs(d) Developed countries should raise tariffs and less-developed countries should raise tariffs

34. Which of the following is true of the 2006 international balance of payments of the U.S.?(a) Current account surplus; private financial inflows > official financial inflows(b) Current account surplus; official financial inflows > private financial inflows(c) Current account deficit; private financial inflows > official financial inflows

(d) Current account deficit; official financial inflows > private financial inflows

35. Suppose exchange rates between the U.S. and Europe changed from 1e=$1.50 to 1e=$1.25.This would cause Americans to purchase goods and services from Europe.(a) the same amount of(b) fewer(c) more(d) none of the above

36. Expansionary monetary policy in the United States causes U.S. interest rates toand the dollar to .(a) increase; appreciate (b) increase; depreciate

(c) decrease; appreciate (d) decrease; depreciate

37. The U.S. rates lower on indices of well-being than on real per capita GDP because(a) The U.S. ranks lower on life expectancy(b) The U.S. ranks lower on health care expenditures as a share of GDP(c) The U.S. ranks lower in science and math test scores(d) The U.S. ranks lower on energy spending as a share of GDP


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38. A reason for the low U.S. household saving rate is(a) Americans do not care about saving for their children(b) Americans respond to rising imports by spending now(c) Americans respond to capital gains on housing

(d) High American investment crowds out saving39. Suppose the reserve requirement is 20%, and you deposit a $1,000 check received as a gift for

acing this exam in your checking account. The bank does NOT want to hold excess reserves.By how much does the monetary base change?(a) $0 (b) $800 (c) $1000 (d) $4000 (e) $5000

40. The order of magnitude increase in prices between 1929 and 2007 was by a factor of(a) 2 (b) 5 (c) 10 (d) 20 (e) 40

41. A myth about the Great Depression is that(a) The New Deal ended the Great Depression(b) The New Deal raised the price level

(c) The New Deal raised the wage level(d) The New Deal raised interest rates

42. Consider the following table which shows the maximum amounts of machinery and petroleumthat the United States and Mexico can produce if they only produce one good. Both nationsface constant costs of production.

Countries Machinery (units) Petroleum (units)

United States 80 40

Mexico 60 180

The United States has a comparative advantage in , and Mexico has a com-

parative advantage in .(a) both goods; neither good(b) neither good; both goods(c) machinery; petroleum(d) petroleum; machinery

43. The table shows the maximum amounts of autos and clothing that the United States andCanada can produce if they only produce one good. Both nations face constant costs ofproduction.

Countries Autos (units) Clothing (units)

United States 80 40

Canada 60 30

Given the opportunity costs of production:(a) there is no basis for trade.(b) Canada should specialize in clothing.(c) the United States should specialize in autos.(d) the United States should specialize in both goods, and Canada should not produce either good.


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44. Suppose actual output is below potential output. In the long run:(a) nominal wages will decrease, and the short-run supply curve will shift to theright.(b) nominal wages will increase, and the short-run supply curve will shift to the left.

(c) the aggregate demand curve will shift to the right.(d) the long-run aggregate supply curve will shift to the right.

45. Suppose M P C = 0.6 and t = 0.25. Holding all else constant, if capital inflows goes up by100, how much does equilibrium Y change?(a) Y goes up by about 182(b) Y goes down by about 182(c) Y goes up by about 333(d) Y goes down by about 333

46. The circle to the left of George Washingtons picture on the $1 bill represents:(a) The Presidential Seal

(b) The importance of the number 13 in the design of the bill(c) The regional Federal reserve bank that issued the bill(d) The roman numeral for 1776 at the base of the pyramid

47. In the twentieth century, the years with the largest inflationary gap were:(a) 1932-35 (b) 1942-45 (c) 1952-55 (d) 1962-65

48. Suppose that annual inflation is 2% and the annual growth rate of real GDP is 3%. What isthe annual growth rate of nominal GDP?(a) 1%(b) 2%(c) 3%

(d) 4%(e) 5%(f) 6%

49. The course packet delivers a condemnation of Alan Greenspans reign at the Federal Reservebetween 1987 and 2006. Which of these comes closest to the condemnation?(a) Keeping interest rates too low in 1987-91(b) Keeping interest rates too low in 1992-96(c) Keeping interest rates too low in 1997-2001(d) Keeping interest rates too low in 2001-2005

50. An aggregate production function typically exhibits returns to scale with

respect to capital per worker.(a) Increasing(b) Decreasing(c) Constant(d) Zero


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2 Short Answer - 70 points

PLEASE NOTE: In order to receive full credit, in calculating growth rates you mustuse the logarithmic or exponential formulas from the classroom handout.

1. (14 pts.) Consider the economy of the country Microvilleshire. Its short-run aggregate supplyand aggregate demand equations are described as follows:

SRAS: CPI = 20 + 6YAD: CPI = 60 4Y

(a) Suppose Microvilleshire is in long-run equilibrium.

(2 pts.) What is output in the long-run?SOLUTION: We are told Microvilleshire is in long-run equilibrium, so we can justfind the short-run equilibrium, and we know thats the same as the long-run one.20 + 6Y = 60 4Y Y = 4

(2 pts.) What is CPI in the long-run?SOLUTION: CPI = 20 + 6 4 = 44

(3 pts.) Draw a graph of aggregate supply and aggregate demand that illustratesAD, SRAS, and LRAS.SOLUTION: The graph should have CPI on the y-axis and Y on the x-axis, and itshould include SRAS, which has intercept 20 and slope 6, AD, which has intercept60 and slope -4, as well as LRAS, which is vertical. All three lines should cross atY = 4 and CPI = 44.

(b) Now suppose that Microvilleshires main trade partner, Macrovilleshire, changes theirtrade policy in a way that decreases their demand for Microvilleshire products. Thisshifts AD such that for every level of output, the CPI is decreased by 30.

(1 pt.) Does this result in a inflationary gap, a recessionary gap, or no output gapof any sort?SOLUTION: AD falls Y falls recessionary gap.

(2 pts.) If you think there is an inflationary or recessionary gap, what is the mag-nitude? If you think there is no output gap, explain why.SOLUTION: The new AD curve is CPI = 30 4Y. Setting SRAS=AD, we get30 4Y = 20 + 6Y Y = 1. So, the recessionary gap is 4 1 = 3.

(1 pt.) Change your graph above in (a) to include the new AD and the inflationaryor recessionary gap you found.SOLUTION: There should be a forth line added to the graph: the new AD curve,which has intercept 30 and slope -4. It should cross the old SRAS line at Y = 1 and

CPI = 26.(c) (3 pts.) What is the new long-run equilibrium output and long-run equilibrium CPI?

SOLUTION: Long-run output is still Y = 4. The new long-run prices will be CPI= 30 4 4 = 14.


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2. (14 pts.) Consider a closed economy with three types of goods: consumption goods, in-vestment goods, and government-purchased goods. In 2000, data on these goods is givenby:

2000 Average Price QuantityConsumption goods: $100 1400

Investment goods: $700 900

Government goods: $500 700

After 2000, the Federal Reserve decreases the money supply, and the government engages inexpansionary fiscal policy. This leads to the following data for 2001:

2001 Average Price Quantity

Consumption goods: $90 1300

Investment goods: $650 750

Government goods: $600 850

(a) (2 pts.) What is nominal GDP in 2000 and 2001?SOLUTION: GDP in 2000 = 100 1400+700 900+500 700 = 1120000 GDP in 2001= 90 1300 + 650 750 + 600 850 = 1114500

(b) (1 pt.) Using base year 2000, what is real GDP in 2001?SOLUTION: Real GDP in 2001 using 2000 as base year = 100 1300 + 700 750+500 850 = 1080000

(1 pt.) Using base year 2001, what is real GDP in 2000?SOLUTION: Real GDP in 2000 using 2001 as base year = 90 1400 + 650 900 +600 700 = 1131000

(c) (6 pts.) Using the GDP deflator as your price index, what is the chain-weighted inflationrate between 2000 and 2001?SOLUTION: Using 2000 as base year, GDP deflator in 2000 = 11200001120000 100 = 100Using 2000 as base year, GDP deflator in 2001 = 11145001080000 100 = 103.194 Using 2000 asbase year, inflation = ln

103.194100

= 3.1445%. Using 2001 as base year, GDP deflator

in 2000 = 11200001131000 100 = 99.0274. Using 2001 as base year, GDP deflator in 2001= 11145001114500 100 = 100. Using 2001 as base year, inflation = ln

100

99.0274

= 0.9774%. So,

chain-weighted inflation = 0.031445+0.0097742 = 2.0609%.

(d) (1 pt.) Write the equation that relates the velocity of money (call it V) to the moneysupply and nominal GDP.

SOLUTION: M V = P Y V = PYM

= nominal GDP

money supply (3 pts.) Suppose that in 2000, the money supply was $224,000. Assume that the

velocity of money is the same in 2000 and 2001. Use the values of nominal GDPyou found in part (a) for 2000 and 2001 to calculate the money supply in 2001.

SOLUTION: V = nominal GDPmoney supply =1120000224000 = 5. Since V is the same in 2001, we

have M 5 = nominal GDP M = 11145005 = 222900.


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3. (17 pts.) Consider an economy in equilibrium with the following initial structure:Equilibrium GDP = Y = 10, 000M P C = 34Income tax rate = t = 19

Reserve ratio = rr = 0.10The desired currency to deposit ratio is 15%, so c = 0.15Interest rate = i = 0.04 (= 4%)Money demand is characterized by MD = 550 1000i (in millions of dollars, where i iswritten as a decimal. For example, if i = 0.07, then MD = 550 1000 0.07 = 480).Assume consumption takes the standard form C = A + M P C (Y T), and taxes take theform T = Ta + t Y.A, Ta, t, G, X, Im, and M P C do not change when the interest rate changes. However,investment does change based on the interest rate. Specifically, I = 1000 5000i.(Again, i is written as a decimal. For example, if i = 0.07, then I = 10005000 0.07 = 650.)

(a) Given that the economy is in equilibrium:

(2 pts.) What is the money supply? (Hint: consider the market for money and theequilibrium condition that relates MD to MS)SOLUTION: MS = MD = 550 1000 0.04 = 510

(2 pts.) What is the monetary base?

SOLUTION: B = MS

1+c

c+rr

= 5501.150.25

= 110.87

(b) (2 pts.) Now suppose that the central bank sells 5 million dollars worth of bonds on theopen market. What is the change in money supply?SOLUTION: MS = 1+c

c+rrB =1.150.25 (5) = 23

(c) (2 pts.) What is the new interest rate?SOLUTION: MS = MD 510 487 = 550 1000 i i = 0.063

(d) (4 pts.) What is the new equilibrium Y that results from the open market operationdescribed in parts (b) and (c)? (Hint: first, find how I changes.)SOLUTION: I = (1000 5000 0.04) (1000 5000 0.063) = 115Y = I1MPC(1t) =

11510.75 8

9

= 345 Y = 9655

(e) (5 pts.) Going back to the initial equilibrium (i.e., before the open market operations in(b) happened), suppose that net exports decreases by 100 and G increases by 20. Thecentral bank wants to keep output unchanged (i.e., wants to keep Y = 10, 000). Howmany million dollars of bonds should they buy or sell?SOLUTION: We want the change in I to offset the change in N X and G. If the Feddoes nothing, we will have AAE = 20 100 = 80. So, we want I = 80 to offset the

changes. This means we want a new level of investment of I = (10005000 0.04)+ 80 =880. If I = 880, we need an interest rate of 880 = 1000 5000 i i = 0.024. Inorder to have i = 0.024, we need MS = 550 1000 0.024 = 526. Thus, we need achange in MS of MS = 526 510 = 16. This means we needs a change in B ofB = M

S

1+c

c+rr

= 161.150.25

= 3.47826. Thus, the Fed needs to buy 3.47826 million dollars worth

of bonds.


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4. (25 pts.) Suppose an economy has the following data:

Year Y YD C I G X Im T N S

2004 700 200 150 200 150 100

2005 800 220 200 300 170 1502006 250 200 300

The consumption function and the tax function are the same in every year.

Additionally, imports are a function of disposable income. In particular, the import functionis Im = a + b YD where a and b are some numbers. This function also stays the sameevery year.

(a) (2 pts.) What is Y (GDP or output) and YD (disposable income) in 2004 and 2005?SOLUTION: Y = C + I + G + X Im. In 2004, Y = 700 + 200 + 150 + 200 150 =1100. In 2005, Y = 800 + 220 + 200 + 300 170 = 1350. YD = Y T. In 2004,YD = 1100 100 = 1000. In 2005, YD = 1350 150 = 1200.

(b) (2 pts.) What are national savings in 2004 and 2005?SOLUTION: N S = P S + GS = Y T C + T G = Y C G. In 2004,N S = 1100 700 150 = 250. In 2005, N S = 1350 800 200 = 350.

(c) (Hint: for the three sections in part (c), use the data for 2004 and 2005.)

(3 pts.) What is the consumption function? (Hint: your answer should be of theform C = A + M P C YD.)SOLUTION: The two equations to solve are: 700 = A + M P C 1000 and 800 =A + M P C 1200. These give M P C = 0.5 and A = 200. Thus, the consumptionfunction is C = 200 + 0.5 YD.

(3 pts.) What is the tax function? (Hint: your answer should be of the form

T = Ta + t Y.)SOLUTION: The two equations to solve are: 100 = Ta + t 1100 and 150 =Ta + t 1350. These give t = 0.20 and Ta = 120. Thus, the tax function isT = 120 + 0.20 Y.

(3 pts.) What is the import function? (Hint: as above, your answer should be ofthe form Im = a + b YD.)SOLUTION: The two equations to solve are: 150 = a+b1000 and 170 = a+b1200.These give b = 0.10 and a = 50. Thus, the import function is Im = 50 + 0.10 YD.

(d) (Hint: you should be using the three functions you found in part (c), along with thedata from the table for 2006, to help solve for Y.)SOLUTION: Y = C + I + G + X Im Y = A + M P C (Y (Ta + t Y)) + I +

G + X (a + b (Y (Ta + t Y))) Y = A

MPC

Ta+I+G+X

a+b

Ta1MPC(1t)+b(1t)

(2 pts.) What is the multiplier for 2006?SOLUTION: From above, the multiplier is 11MPC(1t)+b(1t) =

110.5(10.2)+0.10(10.2) =

1.4706

(2 pts.) What is AAE for 2006?SOLUTION: From above, AAE= A M P C Ta + I + G + X a + b Ta =200 0.5(120) + 250 + 200 + 300 50 + 0.10(120) = 948


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(1 pt.) What is equilibrium GDP for 2006?SOLUTION: Y = 948 1.4706 = 1394.12

(e) (2 pts.) What is the trade balance in equilibrium in 2006?SOLUTION: Trade balance= XIm = 300(50+0.10(1394.12 (120 + 0.2 1394.12))) =

126.47(f) (3 pts.) Now suppose that the government changes the tax policy by decreasing Ta by

80. By how much does equilibrium GDP change? (Hint: use the formula you found forY in part (d).)

SOLUTION: Y = AAE1MPC(1t)+b(1t) =MPCTa+bTa

1MPC(1t)+b(1t) =0.5(80)+0.1(80)

10.5(10.2)+0.10(10.2) =47.0588

(g) Return to part (d) (i.e., ignore the change in part (f)). Suppose between 2006 and 2007,M P C changes to 0.70, and t changes to 0 (no income tax).

(1 pt.) What is the new multiplier in 2007?SOLUTION: Multiplier = 11MPC(1t)+b(1t) =

110.7(10)+0.10(10) = 2.5

(1 pt.) Assume AAE is the same in 2007 as it was in 2006 (from part (d)). What isequilibrium GDP in 2007?SOLUTION: Y = 948 2.5 = 2370NOTE: AAE does change. Its new value is AAE = AM P CTa+I+G+Xa+bTa = 2000.7(120)+250+200+30050+0.1(120) = 972 Y = 9722.5 = 2430

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