Honors Macroeconomics, Fall 2004, Final Exam

Read these Instructions carefully!  You must follow them exactly!
I)  On your Scantron card you must print three things:
1) Print your full name clearly; 
2) Print the day and time of your section (for example MW 12:00); 
3) Print the number I have written in ink on the upper right corner of your copy of this test.  (This number tells me which version of the test you have.  Without it your test cannot be graded properly and you get no credit for your answers.)       
II)   Answer on your Scantron card, using a #2 pencil.  Warning:  SOME QUESTIONS MUST BE ANSWERED SEVERAL TIMES!  Such questions will begin with a phrase such as this:  
(Repeat answer on Scantron lines 37, 38 and 39)
            ---Remember to do it!
III) You must turn in this printed exam along with your Scantron card, otherwise       your score on this exam is "F".
IV) Answer any “written answer” questions in your bluebook.  (Write your name on the bluebook.  Please do your best to write legibly, in ink--and do not write on the backs of pages.
V)  Any assigned takehome questions are due as directed.

Questions:

	1.	What is the major cost of slowing down an ongoing inflation?
a. | Output must rise above potential.
b. | The Fed must sell bonds at lower prices than those at which the bonds were purchased.
c. | Output must fall below potential.
d. | The Fed must purchase bonds from the public.
e. | The Fed must lend additional money to member banks at below-market interest rates.

	2.	When economists say that there is a time lag in the effect of monetary policy, what do they mean?
a. | that it takes time to observe the effects of fiscal policy on the economy
b. | that the Fed takes awhile to figure out what it wants to do
c. | that the Congress takes awhile to figure out what it wants to do
d. | that it takes time to observe the effects of monetary policy on the economy
e. | that the public needs time to decide how to respond to monetary policy changes

	3.	(Repeat this answer on lines 31 and 32.)  Refer to Figure 14-6. Suppose a supply shock shifts the aggregate supply curve from AS_1 to AS_2, and decreases output below full employment. If the Fed then decreases the money supply, it can
a. | stabilize the price level, but cause a further decline in output
b. | return output to its full-employment level, but at the expense of an increase in the price level
c. | increase both output and the price level
d. | stabilize the price level and return output to its full-employment level
e. | decrease the price level and shift the aggregate demand curve to the right until output returns to its full-employment level

	4.	(Repeat this answer on lines 33 and 34.)  Assume an economy has a natural rate of unemployment of about 5%, which means that unemployment cannot be lower than 5% without creating inflation.  Assume the economy is in macroeconomic equilibrium with 10% unemployment.  If the Federal Reserve increases the money supply by 15% then roughly the following will happen:
a. | the economy will grow to full employment and prices will rise by 15%.
b. | employment will remain stagnant and prices will rise by 15%
c. | employment will rise by 15% and prices will not rise.
d. | prices will decline and the economy will grow by 10%.
e. | the economy will grow to full employment and prices will rise by 10%.

	5.	(Repeat this answer on lines 35 and 36.)  If we assume the supply of money is held constant but the demand for money is inversely related to interest rates (interest rates up causes demand for money to fall) then:  an increase in government spending
a. | will increase interest rates and have no impact on economic activity.
b. | will increase economic activity as much as predicted by the Keynesian model given in lecture.
c. | will result in both an increase in interest rates and an increase in economic activity (the latter because of the excess supply of money).
d. | will reduce interest rates and have no impact on economic activity.
e. | will actually reduce economic activity because the rise in interest rates will reduce borrowing and therefor spending.

	6.	(Repeat this answer on lines 37 and 38.)  It is difficult to know exactly how much inflation there is in a modern economy because
a. | if the base year market basket becomes out of date, and the prices of the new goods are rising more slowly than the prices of those in the base year basket, calculated inflation will be lower than actual inflation.
b. | no other answer is correct.
c. | since people tend to buy fewer units of goods whose prices are rising, inflation hits them harder, and actual inflation is higher than the calculations show.
d. | since many goods are becoming more reliable at the same time their prices are rising, calculated inflation tends to be lower than actual inflation.
e. | more than one answer is correct.

	7.	(Repeat this answer on line 39.)  Considering "unemployment",
a. | all of these statements are true, except e.
b. | an individual is defined as "unemployed" if the person is not currently employed, not on temporary layoff, and searched for work during the past four weeks.
c. | cyclical unemployment is the only type which macroeconomics can help to explain.
d. | "full employment" occurs when cyclical unemployment is zero, even if structural, seasonal and frictional unemployment are substantial.
e. | none of the other statements are true.

	8.	(Repeat this answer on lines 40 and 41.)  Consider the following statements about inflation, expected inflation and interest rates.
a. | If actual inflation turns out lower than was expected at the time the loan was made, the lender loses and the borrower benefits.
b. | if the expected inflation rate for the coming year rises from 3 percent to 6 percent, but the Fed prevents nominal interest rates from rising, then the real interest rate must have risen.
c. | if the real interest rate is 10% for a 4 year auto loan, and expected inflation for the next four years is 5% per year, then auto loans will have an interest rate of 15%.
d. | the real interest rate plus the nominal interest rate equals the expected rate of inflation.
e. | none of the other answers is correct.

	9.	(Repeat this answer on line 42.)  Your instructor probably believes the following:
1)  As a general rule, the government not borrow money to pay for current consumption expenditures, and instead should pay for them with taxes.
2)  As a general rule the government should not borrow money to fight a war, and instead should pay for them with taxes.
a. | 1 and 2 are both true.
b. | 1 and 2 are both false
c. | Only statement 1 is true.
d. | Only statement 2 is true.

	10.	An open market purchase of bonds by the Fed
a. | drains reserves from the banking system and decreases the money supply
b. | injects reserves into the banking system and increases money demand
c. | injects reserves into the banking system and increases the money supply
d. | drains reserves from the banking system and increases the money supply
e. | injects reserves into the banking system and decreases the money supply

	11.	If there is an excess supply of money in the economy,
a. | there is also an excess demand for money
b. | there is also an excess demand for bonds and/or goods
c. | there is also an excess supply of bonds
d. | the interest rate will rise
e. | the Fed must intervene to restore equilibrium

	12.	The decline in output at the onset of the Great Depression was caused primarily by
a. | a positive demand shock
b. | a negative demand shock
c. | a positive supply shock
d. | a negative supply shock
e. | simultaneous shocks to supply and demand

	13.	In the long run, unusually high unemployment
a. | indicates that an economy is operating above potential GDP
b. | forces the wage rate down
c. | eventually causes the aggregate supply curve to shift upward
d. | pushes the price level upward
e. | causes the aggregate demand curve to shift rightward

	14.	The standard measure of the money stock, M1, refers to
a. | checking account balances, travelers' checks, and cash in the hands of the public
b. | cash in the hands of the public, demand deposits, and small time deposits
c. | cash in the hands of the public, savings-type account balances, and travelers' checks
d. | savings-type account balances, small time deposits, and checking account deposits
e. | the sum of the cash in the hands of the public

	15.	The Federal Reserve System was created in
a. | 1800
b. | 1894
c. | 1913
d. | 1930
e. | 1936

	16.	Refer to Figure 13-9. Suppose the economy is in equilibrium with real GDP of $7 trillion. A demand shock shifts the aggregate demand curve to AD_2, increasing real GDP to its full-employment level of $7.2 trillion. In the long run, following the shock, we would expect the
a. | aggregate demand curve to shift rightward, further increasing real GDP and the price level
b. | aggregate demand curve to shift leftward, returning real GDP to $7 trillion
c. | aggregate supply curve to shift downward, returning the price level to 120
d. | aggregate supply curve to shift upward, returning real GDP to $7 trillion
e. | economy to remain at the new level of output of $7.2 trillion

	17.	The group within the Federal Reserve System that determines the general course for the nation's money supply is the
a. | Federal Monetary Oversight Committee
b. | Federal Advisory Council
c. | Board of Governors
d. | Department of Commerce
e. | Federal Open Market Committee

	18.	Which of the following shocks have caused most of the recessions since 1950?
a. | both c and e
b. | increased government spending
c. | oil price increases
d. | the beginning of a war
e. | financial crises

	19.	Which of the following events triggered intense debate over the classical model of the economy?
a. | U.S. Civil War
b. | World War I
c. | the Baby Boom
d. | the Great Depression
e. | World War II

	20.	The classical model is based on the assumption that
a. | all markets clear
b. | all demand curves are horizontal
c. | all supply curves are vertical
d. | the government's budget is always balanced
e. | the quantity of loanable funds demanded is independent of the interest rate

	21.	If the price level is falling, the economy is experiencing
a. | creeping inflation
b. | stagflation
c. | disinflation
d. | inflation
e. | deflation

	22.	In which of the following situations would a worker be happiest?
a. | She receives a pay cut and her nominal wage falls by 5 percent, while the CPI falls by 20 percent.
b. | She receives a pay cut and her nominal wage falls by 5 percent, while the CPI increases by 10 percent.
c. | Her nominal wage remains the same, as does the CPI.
d. | She receives a raise and her nominal wage increases by 5 percent, while the CPI increases by 10 percent.
e. | She receives a raise and her salary increases by 5 percent, while the CPI falls by 5 percent.

	23.	The real interest rate is calculated as the
a. | expected rate of inflation divided by the nominal interest rate
b. | real GDP plus the expected rate of inflation
c. | nominal interest rate minus real GDP
d. | nominal interest rate minus the expected rate of inflation
e. | real GDP multiplied by the expected rate of inflation

	24.	An example of a frictionally unemployed individual is
a. | Sylvia, who quit her job to spend more time with her children
b. | Rod, the lifeguard, who cannot find a job because the temperature is too low in October
c. | Ileana, a college student who quits her job to return to school
d. | Steve, an individual does not have skills to keep his job as an aerospace engineer
e. | Samantha, who quits her job to look for better one

	25.	If the full-employment rate of unemployment is 5 percent, and the economy is experiencing a 7 percent unemployment rate, what is the rate of cyclical unemployment?
a. | 8 percent
b. | -3 percent
c. | -2 percent
d. | 5 percent
e. | 2 percent

	26.	In the early 1980s, the United States experienced its most severe recession since the Great Depression. The unemployment rate peaked at around
a. | 7 percent
b. | 50 percent
c. | 11 percent
d. | 15 percent
e. | 25 percent

	27.	(Repeat your answer on 43 and 44.)  In the money supply equation just above, if the "money multiplier" is .60, then if the Fed sells $3 billion of Treasury bonds, the money supply will:
a. | increase by $3 billion.
b. | increase by $1.8 billion.
c. | decrease by $3 billion
d. | decrease by $1.8 billion.
e. | decrease by $5 billion.

	28.	(Repeat your answer on lines 45 and 46.)  If the economy initially was in a full employment equilibrium, if the FED started buying Treasury bills to increase their holdings at the rate of 7% each year, year after year, the following would happen.
a. | Interest rates would fall and remain low, meanwhile prices would start to rise.
b. | The economy would slide into a recession and prices would begin to fall as interest rates rose.
c. | Wages would start to fall.
d. | Interest rates would fall at first, and prices would start to rise, but interest rates eventually would rise higher than they were initially.
e. | Both A and C.

The Keynesian Model

	29.	(Repeat your answer on lines 47 and 48.)  Using the Keynesian model as developed in recent lectures, if "the multiplier" = 2, gross investment, I_g,  increases by $15 billion, exports, X, increase by $5 billion, and government spending, G, drops by $10 billion, then economic activity, Y, will
a. | remain unchanged.
b. | decrease by $20 billion.
c. | decrease by $10 billion.
d. | increase by $20 billion.
e. | no other answer is correct.

	30.	(Repeat your answer on lines 49 and 50.)  Evaluate the following statements about real and nominal interest rates and then select the best answer from among A through E.
1)  Nominal interest rates are very low interest rates, so low they are nominal.
2)  Real interest rates plus the expected inflation rate equals the nominal interest rate. 
3)  Nominal interest rate plus the expected inflation rate equals the real interest rate.
4)  The nominal interest rate is the interest rate actually observed in a financial market.
5)  The real interest rate is the nominal interest rate adjusted for expected inflation.
a. | Statements 2, 4 and 5 are correct, statements 1 and 3 are wrong.
b. | Statements 1, 2, 4 and 5 are correct, statement 3 is wrong.
c. | Statements 2, 3 and 5 are correct, statements 1 and 4 are wrong.
d. | Statements 1, 4 and 5 are correct and all the others are wrong.
e. | Statements 1, 3, 4 and 5 are the only ones which are correct.

Honors Macroeconomics, Fall 2004, Final Exam
Answer Section

MULTIPLE CHOICE

	1.	ANS:	C	DIF:	2

	2.	ANS:	D	DIF:	2

	3.	ANS:	A	DIF:	2

	4.	ANS:	E

	5.	ANS:	C

	6.	ANS:	B

	7.	ANS:	A

	8.	ANS:	C

	9.	ANS:	C

	10.	ANS:	C	DIF:	2

	11.	ANS:	B	DIF:	2

	12.	ANS:	B	DIF:	2

	13.	ANS:	B	DIF:	1

	14.	ANS:	A	DIF:	1

	15.	ANS:	C	DIF:	1

	16.	ANS:	E	DIF:	2

	17.	ANS:	E	DIF:	2

	18.	ANS:	A	DIF:	2

	19.	ANS:	D	DIF:	1

	20.	ANS:	A	DIF:	1

	21.	ANS:	E	DIF:	1

	22.	ANS:	A	DIF:	3

	23.	ANS:	D	DIF:	2

	24.	ANS:	E	DIF:	2

	25.	ANS:	E	DIF:	2

	26.	ANS:	C	DIF:	2

	27.	ANS:	D
Refer To:  The Money Supply Equation, with Time Dep

	28.	ANS:	D

	29.	ANS:	D

	30.	ANS:	A