UBC Okanagan Department of Economics

Economics 205 February 05, 2015

Midterm Examination II

Instructions: Ensure your mobile phone is turned off. Remove all head ware. Calculators and other electronic aids are not permitted. Answer the multiple choice questions on the bubble sheets and the analytical (short answer) questions in the examination booklet provided. Ensure that both your name and student number are on the bubble sheet and examination booklet. Read through the exam before starting and allocate your time appropriately. There are two sections: I. Multiple choice and II. Analytical questions. You have 1 hour and 20 minutes to complete the exam.

I. Multiple Choice (2 Marks Each)

1. The assumption of continuous market clearing means that:A) sellers can sell all that they want at the going price.B) buyers can buy all that they want at the going price.C) in any given month, buyers can buy all that they want and sellers can sell all that

they want at the going price.D) at any given instant, buyers can buy all that they want and sellers can sell all that

they want at the going price.

2. How does the distinction between flexible and sticky prices affect the study of macroeconomics?A) The study of flexible prices is confined to microeconomics, while macroeconomics

focuses on sticky prices.B) Macroeconomists use flexible prices to explain inflation and sticky prices to

explain unemployment.C) Flexible prices are typically assumed in the study of the long run, while sticky

prices are assumed in the study of the short run.D) Endogenous variables are measured using flexible prices, while exogenous

variables are measured using sticky prices.

3. Real GDP is measured in _____ dollars ____ time.A) current; at a point inB) current; over a period ofC) constant; at a point inD) constant; over a period of

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4. In the national income accounts, net exports equal:A) exported goods minus imported goods.B) exported goods and services minus imported goods and services.C) exported goods minus imported services.D) exported goods and services plus imported goods and services.

5. GNP equals GDP ______ income earned domestically by foreigners ______ income that nationals earn abroad.A) plus; plusB) minus; minusC) minus; plusD) plus; minus

6. Okun's Law is the _______ relationship between real GDP and the _________.A) negative; unemployment rateB) negative; inflation rateC) positive; unemployment rateD) positive; inflation rate

7. A farmer grows wheat and sells it to a miller for $1; the miller turns the wheat into flour and sells it to a baker for $3; the baker uses the flour to make bread and sells the bread for $6. The value added by the miller is:A) $1.B) $2.C) $3.D) $6.

8. If output is described by the production function Y = AK 0.2L0.8, then the production function has:A) constant returns to scale.B) diminishing returns to scale.C) increasing returns to scale.D) a degree of returns to scale that cannot be determined from the information given.

9. People use money as a store of value when they:A) hold money to transfer purchasing power into the future.B) use money as a measure of economic transactions.C) use money to buy goods and services.D) hold money to gain power and esteem.

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10. If the money supply increases 12 percent, velocity decreases 4 percent, and the price level increases 5 percent, then the change in real GDP must be ______ percent.A) 3B) 4C) 9D) 11

11. If the real return on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is ______ percent.A) 1B) 3C) 4D) 7

12. In a small open economy, if exports equal $20 billion, imports equal $30 billion, and domestic national saving equals $25 billion, then net capital outflow equals:A) –$25 billion.B) –$10 billion.C) $10 billion.D) $25 billion.

13. A trade deficit can be financed in all of the following methods except by:A) borrowing from foreigners.B) selling domestic assets to foreigners.C) selling foreign assets owned by domestic residents to foreigners.D) borrowing from domestic lenders.

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Use the following to answer question 14:

Exhibit: Saving and Investment in a Small Open Economy

14. (Exhibit: Saving and Investment in a Small Open Economy) In a small open economy if the world interest rate is r1, then the economy has:A) a trade surplus.B) balanced trade.C) a trade deficit.D) negative capital outflows.

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Use the following to answer question 15:

Exhibit: Policies Influence Real Exchange Rate

15. (Exhibit: Policies Influence Real Exchange Rate) Which of the graphs illustrates the impact on the real exchange rate of contractionary fiscal at home, in the basic version of the small open economy model?A) (A)B) (B)C) (C)D) (D)

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II. Analytical Questions

16. In September 1995, Patrick Buchanan, a Republican candidate for U.S. president, proposed a 10 percent tariff on Japanese imports to the United States, a 20 percent tariff on Chinese imports to the United States, and an unspecified “social” tariff on imports from third-world countries.a. Use the long-run model of a small open economy to illustrate graphically the impact of

these trade policies on the U.S. exchange rate and the trade balance. Assume that the country starts from a position of trade balance, i.e., exports equal imports. Be sure to label:i. the axesii. the curvesiii. the initial equilibrium valuesiv. the direction the curves shiftv. the new long-run equilibrium values.

b. Based on your graphical analysis, explain the predicted impact of Mr. Buchanan's proposed policies. Specifically state what happens to the exchange rate, the trade balance, the volume of imports, and the volume of exports.

17. Assume that the demand for real money balance (M/P) is M/P = 0.6Y –100i, where Y is national income and i is the nominal interest rate. The real interest rate r is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth.

a. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P be?

b. If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, what must i and P be?

18. Suppose a government education program succeeds in getting households to save more (you may interpret this as a downward shift in the consumption function).a. Using the long-run model of the economy developed in Chapter 3,

graphically illustrate the affect of the higher saving rate by households. Be sure to label:i. the axesii. the curvesiii. the initial equilibrium valuesiv. the direction curves shiftv. the terminal equilibrium values.

b. State in words what happens to:i. the real interest rateii. national savingiii. investmentiv. consumptionv. output.

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19. Explain why the value of GDP in 2014 would or would not change as a result of each of the following transactions:a. In 2014, the Smith family purchases a new house that was built in

2014.b. In 2014, the Jones family purchases a house that was built in 2001.c. In 2014, a construction company purchases windows to put in the

Smith family home that was built in 2014.d. In 2014, Mr. Jones paints all of the rooms of the Jones family house

purchased in 2014.e. In 2014, Mr. Smith uses an online brokerage service to purchase shares

of stock in a construction company.

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Answer Key

1. D2. C3. D4. B5. C6. A7. B8. A9. A

10. A11. D12. B13. D14. A15. A16. a.

b. Under Mr. Buchanan's policy, the dollar exchange rate would appreciate but the trade balance would remain unchanged. However, the volume of imports will decrease (because of the tariffs) and the volume of exports will decrease by the same amount (because of the appreciation of the exchange rate).

17. a. i = 4 percent, P = b. i = 5 percent, P = 1

18. a.

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b. i. real interest rate decreasesii. national saving increasesiii. investment increasesiv. consumption decreasesv. output is unchanged, fixed because it is determined by the factors of production

19. a. GDP in 2014 increases by the purchase price of the house, which is a newly produced good.b. GDP in 2014 does not change because the house is not a newly produced good, since it was built in 2001. Transactions involving used goods are not included in GDP.c. GDP in 2014 does not change directly because the windows are intermediate goods, not final goods. The value of intermediate goods is not included in GDP to avoid double counting. The value of the windows is implicitly included in the price of the house.d. GDP in 2014 does not change because home production is not included in GDP.e. GDP in 2014 does not change because financial transactions do not represent the production of final goods and services and are not included in GDP.

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