Principles of Macroeconomics
Spring 2011
Midterm Exam 1
Statement of Academic Honesty:
This exam entirely reflects my own work. I have not given assistance to anyone, nor have I received assistance from anyone. I am not aware that any other students have done so.
Signature: __________________________________________________
Name: __________________________________________________
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Questions 3-5 refer to the following scenario: An individual takes $1 out of his savings account and puts it in his checking account.
3. What happens to M1?
a. M1 rises b. M1 falls c. No change
4. What happens to M2?
a. M2 rises b. M2 falls c. No change
5. What happens to M3?
a. M3 rises b. M3 falls c. No change
Question 6 refers to the scenario below.
A firm is considering five capital investment projects. The table below gives the return on each project.
Project Return
Project A 11%
Project B 9%
Project C 7%
Project D 5%
Project E 3%
6. If the market interest rate is 10%, which project or projects will the firm undertake?
a. No project b. Project A only
Question the secon
ns 7 and 8 ref nd diagram.
7. The first diagram shows a country’s CPI from 1981 to 1990. What can you say about inflation in this country?
a. There was inflation over the whole period.
b. There was inflation from 1981 to 1983 and then from 1987 to 1990 and deflation in other years.
c. There was inflation from 1983 to 1987 and deflation in other years. d. There was deflation over the whole period.
8. The second diagram shows a country’s inflation rate from 1991 to 2000. What can you say about when prices were rising and falling in this country?
a. Prices were rising over the whole period.
b. Prices were rising from 1991 to 1993 and from 1997 to 2000, but prices were falling in other years.
c. Prices were rising from 1993 to 1997, but prices were falling in other years. d. Prices were falling over the whole period.
9. The money multiplier is higher when the RRR is ____. This means that open market operations enacted by the central bank are ____.
a. Higher…less effective b. Higher…more effective c. Lower…less effective
d. Lower…more effective
10. How could you express the spending multiplier in terms of the MPS?
a. 1−MPS
b. 1
MPS
c. 1
1−MPS
d. 1
1+MPS
11. If the AS curve were horizontal, then an increase in government spending would
12. Suppose that an orange costs 100 Yen in Japan and that the nominal exchange rate is 150, i.e. $1 is worth 150 Yen. If purchasing power parity holds, how much does the orange cost in the United States?
a. $0.50 b. $0.67 c. $1.00 d. $1.50
13. If short-term interest rates exceed long-term interest rates, then this implies that
a. Investors expect interest rates to rise in the future. b. Investors expect interest rates to fall in the future.
c. Investors expect interest rates to remain constant at a high level. d. Investors expect interest rates to remain constant at a low level.
14. There are several ways to calculate GDP: the factor payments approach (FP), the value added approach (VA) and the expenditure approach (E). If national income accounting is perfect, what is the relationship between the three?
a. FP > VA > E b. E > FP > VA c. E > VA > FP d. All are equal
15. Although Saeed would prefer to hold a full-time job, he can only find a part-time job. Saeed would be classified as
a. Structurally unemployed b. Cyclically unemployed c. Frictionally unemployed
d. Employed
16. Which of the following would increase both unemployment and inflation?
17. Stock prices tend to rise when investors expect that the central bank will
a. Lower the interest rate. b. Raise the interest rate. c. Raise the inflation rate.
d. Leave interest rates unchanged.
Question 18 refers to the diagram below.
18. If the interest rate is presently 6%, then firms and households
a. Are satisfied with their money holdings.
b. Will attempt to increase money holdings by selling bonds. c. Will attempt to increase money holdings by buying bonds. d. Will attempt to reduce money holdings by buying bonds.
19. A country in which a large part of domestic production takes place at factories and facilities that are owned by foreigners is a country where
a. GDP exceeds GNP.
b. GNP exceeds GDP.
c. GDP and GNP are equal.
20. If you earn an additional $100 of disposable income
a. The sum of your consumption and your savings rises by $100.
Problem 1 (10 points)
You have $1000 that you intend to leave in a bank account for 50 years. The interest rate is 5%.
a. What is the future value of your account at the end of 50 years?
b. Suppose that the bank is willing to raise the interest rate on your account to 7%, but will charge you a fee in order to do so. The fee is collected at the end of the 50 year period. What is the maximum fee you would be willing to pay?
Problem 2 (10 points)
Consider the diagram below, showing an economy in equilibrium with actual GDP equal to potential GDP.
Suppose now that the economy experiences an increase in potential GDP.
a. Give an example of something that would create an increase in potential GDP. Be specific.
Problem 3 (15 points)
Suppose that labor costs for firms rise substantially. In this problem, you will investigate the effects of this and explore potential policy alternatives.
a. Illustrate the effect on the AD/AS diagram below.
i. What happens to GDP? ______
ii. What happens to the price level? _______
iii. What happens to consumer spending? ______
iv. What happens to the unemployment rate? ______
b. Suppose that the central bank responds to the change in (a) by raising the money supply. Show the combined effects of (a) and (b) in the diagram below.
i. What happens to GDP? ______
ii. What happens to the price level? ______
iii. What happens to the unemployment rate? ______
c. Suppose that the government responds to the change in (a) by cutting government spending. Show the combined effects of (a) and (c) in the diagram below.
i. What happens to GDP? ______
ii. What happens to the price level? ______
iii. What happens to the unemployment rate? ______
Problem 4 (15 points)
Suppose that the UAE removes the Dollar-Dirham peg. Assume that the effect of this change is a gradual appreciation of the dirham.
a. Following the theory of uncovered interest parity, what would you expect to happen to the UAE interest rate? Explain. Assume no change in foreign interest rates.
b. What is the effect of the change in (a) on UAE investment?
c. What would the effect from the change in (b) be on GDP in the UAE under a Keynesian aggregate supply curve? Use a diagram to explain.
d. What would be the effect from the change in (b) be on GDP in the UAE under a classical aggregate supply curve? Use a diagram to explain.
