Practice Final Exam

Economics 105 Practice Final Exam

Mr. Easton Spring 2002

These questions illustrate the type that will be found on the exam. There will probably be about 60 of these drawn from all the chapters we have covered. You already have plenty of questions from the earlier chapters both from the mid-term and the practice questions, so I have not added any from the first part of the course.

There are TWO Parts to this exam. Part II follows after the answer key to Part I.

Part I Multiple Choice Questions on Chapters 26-31

There should only be one answer to each question…although mistakes happen.

1. So called voluntary unemployment occurs when a a. job is available but the worker has not yet found it. b. level of national income is at or above the economy's potential output. c. person is willing to accept a job at the going wage rate but cannot find one. d. worker enters the job market for the first time. e. worker is not willing to accept an available job at the going wage rate.

2. When the number of unfilled job openings is equal to the number of persons unemployed, _____ is zero. a. cyclical unemployment b. frictional unemployment c. involuntary unemployment d. NAIRU e. structural unemployment

3. The transmission mechanism in an OPEN economy is more complicated than it is in a closed economy because the effects of domestic monetary contraction or expansion are a. weakened because domestic interest rates are clearly linked to interest rates in the rest of the world. b. strengthened because domestic interest rates are clearly linked to interest rates in the rest of the world. c. weakened because changes in autonomous expenditure cause monetary effects that influence interest rates in the rest of the world. d. strengthened because changes in autonomous expenditure cause monetary effects that influence interest rates in the rest of the world.

1 4. Following a new deposit of $10,000, a chartered bank will find itself having a. $10,000 of excess cash reserves if the desired reserve ratio is 100 percent. b. $8,000 of excess cash reserves if the desired reserve ratio is 20 percent. c. $2,000 of excess cash reserves if the desired reserve ratio is 20 percent. d. $1,000 of excess cash reserves if the desired reserve ratio is 10 percent. e. no excess reserves if there is no reserve requirement.

5. In the case of frictional unemployment, a. the only possible cure comes from shifting the aggregate demand curve to the left. b. the only possible cure comes from shifting the aggregate demand curve to the right. c. the unemployed worker and the available job vacancy have not yet found each other. d. there are no jobs for the unemployed people in the economy. e. there is a mismatch between the job vacancy and the unemployed worker.

6. An increase in the money supply will lead to the largest increase in aggregate demand if the economy has an a. elastic demand for money and an inelastic investment demand function b. inelastic demand for money and an inelastic investment demand function c. elastic demand for money and an elastic investment demand function d. inelastic demand for money and an elastic investment demand function

7. If the actual unemployment rate is one percentage point below NAIRU, then "Okun's Law" a. can not be used to estimate the relationship between real and potential GDP. b. suggests that real GDP will be 2.5 percentage above potential GDP. c. suggests that real GDP will be 0.5 percentage above potential GDP. d. suggests that real GDP will be 0.5 percentage below potential GDP. e. suggests that real GDP will be 2.5 percentage below potential GDP.

8. A central bank can create money by a. selling some of its foreign-currency reserves for domestic currency.

2 b. issuing its own Central Bank bonds. c. increasing the rate of inflation. d. selling government treasury bills to the chartered banks. e. purchasing government securities on the open market.

9. A cyclically balanced budget, consistent with fiscal policy being stabilizing, means that the budget will a. be balanced every year. b. be balanced every four years. c. have deficits during inflationary periods. d. have deficits during recessionary periods. e. never have surpluses.

10. The impact of monetary policy on aggregate expenditures will be greater the a. greater the elasticity of the liquidity preference and investment demand functions. b. less the elasticity of the liquidity preference and investment demand functions. c. greater the elasticity of the liquidity preference schedule and the less the elasticity of the investment demand function. d. less the elasticity of the liquidity preference schedule and the greater the elasticity of the investment demand function.

11. An inflationary gap will be eliminated by a sufficiently large a. rise in the price level provided the real money supply remains constant. b. rise in the price level provided the nominal money supply remains constant. c. rise in the price level provided the nominal money supply increases at the same rate as the price level. d. fall in the price level provided the real money supply remains constant. e. fall in the price level provided the nominal money supply remains constant.

12. Debt-service payments are a. equal to the annual budget deficit. b. equal to the annual primary budget deficit. c. the interest payments on the outstanding stock of government debt. d. not related to the government deficit. e. unnecessary unless the debt is held by foreigners.

13. If the Bank of Canada sells $100 of government bonds to the nonbank private sector, the desired reserve ratio is 10

3 percent, and the chartered banks have no excess reserves, this open-market sale will force the chartered banks to a. increase reserves by $90, deposits by $100, and make no change on loans. b. increase reserves by $100, loans by $900, and deposits by $1,000. c. reduce reserves by $90, loans by $90, and deposits by $100. d. reduce reserves by $100, loans by $900, and deposits by $1,000. e. reduce reserves by $100, loans by $1,000, and deposits by $1,000.

14. A Bank of Canada policy of maintaining a constant money supply would end up being contractionary if the demand for money a. decreased sharply and interest rates fell. b. decreased sharply and interest rates rose. c. increased sharply and interest rates fell. d. increased sharply and interest rates rose. e. remained constant and interest rates fell.

15. Involuntary unemployment in a labour market occurs at a wage _____ the equilibrium wage, creating an excess _____ labour. a. above; demand for b. above; supply of c. below; demand for d. below; supply of e. equal to; employment

Case 26-3

Suppose the Bank of Canada sells $10 million worth of government securities to an investment dealer with a cheque drawn on the dealer's account with a chartered bank. The desired reserve ratio of all banks is 10 percent but there is now a cash drain of an additional 10 percent. If we assume that the banks are still operating with no excess reserves, answer the following three questions

16. In the situation described in Case 26-3, if the Chartered Bank decreases its loans as a result of its fall of reserves with the Bank of Canada, the second generation bank will a. increase its loans by $6.4 million. b. increase its loans by $8.0 million. c. decrease its loans by $8.0 million. d. decrease its loans by $6.4 million. e. not change its loans because the change in reserves does not affect it.

4 17. To increase the level of desired investment, the Bank of Canada could a. raise the bank rate. b. reduce its spending. c. reduce the reserves of the chartered banks. d. buy securities in the open market. e. transfer government accounts from the chartered banks to the Bank of Canada.

18. In the event of a sudden loss in confidence in the ability of the chartered banks to redeem deposits, the Bank of Canada would typically a. take over the operation of any banks in severe difficulties. b. lend reserves to the chartered banks. c. offer to sell government bonds to the chartered banks. d. suspend operation of the banking system until the panic subsided. e. impose severe financial penalties on the chartered banks by charging them interest at higher than the bank rate.

19. Liquidity preference (LP) function defines the relationship between a. interest rate and bond prices. b. inflation and bond prices. c. interest rate and financial assets. d. demand for money and the price level. e. demand for money and the rate of interest.

20. Gresham's law predicts that a. good money drives out bad money. b. debased money will circulate with undebased money. c. undebased money will be driven from circulation. d. debased money will be driven from circulation. e. money is neutral.

21. Monetary gradualism means that the Bank of Canada slowly a. decreases the growth of M1. b. decreases the growth of M3. c. increases the growth of M1. d. increases the growth of M2. e. increases the growth of M3.

22. It is generally thought that during the period 1950 to 1980 the conduct of monetary policy a. augmented the economy's natural swings. b. contributed to a slowdown in growth of real GDP. c. did not have any impact on the economy. d. resulted in steady growth of real GDP. e. successfully stabilized the Canadian economy.

23. Fiscal Policy means

5 a. changing taxes to change national income. b. increasing or decreasing the money supply to change national income. c. using government spending and taxes to change national income. d. using government spending and taxes together with changing the money supply in order to achieve full employment income. e. all of the above are functions of fiscal policy.

24. If most individuals will accept paper currency in transactions and paper currency is convertible into gold, then banks can safely issue a. no more paper currency than the value of the gold they hold. b. more paper currency than the value of the gold they hold. c. as much paper currency as they please. d. paper currency equal to a fraction of the gold they hold. e. none of the above.

25. An increase in the money supply will lead to only a very small increase in aggregate demand if the economy has an a. elastic demand for money and an inelastic investment demand. b. inelastic demand for money and an inelastic investment demand. c. elastic demand for money and an elastic investment demand. d. inelastic demand for money and an elastic investment demand.

26. In a closed economy, government deficits are most likely to crowd-out private investment if a. consumers are purely "Ricardian". b. interest rates rise sharply as a result of the deficit. c. rising income increases the volume of saving and interest rates rise very little. d. there is a very large output gap. e. none of the above; deficits never crowd out investment.

27. In "real business cycle" theory, labour markets are dominated by _____ shifts, while movements in wages _____. a. demand; are too sluggish to clear markets continuously b. demand; continuously clear the labour markets c. supply; are too sluggish to clear markets continuously d. supply; continuously clear the labour markets

28. Inflation is said to be validated when the a. Bank of Canada announces that the inflation rate exceeds 8 percent per annum.

6 b. rate of inflation exceeds 6 percent per annum for three consecutive quarters. c. money supply expands at the same rate as the rate of inflation. d. money supply is reduced at the same rate as the rate of inflation. e. inflation rate has been eliminated.

29. New Classical theories of unemployment argue that a. competitive labour markets cannot be relied upon to eliminate involuntary unemployment. b. all markets will clear, including labour markets, and unemployment will be eliminated. c. all unemployment is most easily corrected by government intervention in the economy. d. all unemployment arises from firms being unwilling to demand labour services. e. labour unions are necessary elements in reducing unemployment.

30. If the LRAS curve is vertical, then in the long run, expansionary monetary policy will a. move real GDP and the price level in opposite directions. b. move real GDP and the price level in the same direction. c. only affect the level of real GDP. d. only affect the price level. e. have no effect on either the price level or real GDP.

31. A decrease in the reserves of all chartered banks could be caused by a. a decision by households to hold less currency. b. a decrease in the bank rate. c. an increase in the desired reserves. d. the purchase of government bonds by the Bank of Canada. e. the sale of government bonds by the Bank of Canada.

32. The Bank of Canada uses monetary policy to control undesirable fluctuations in real GDP, among other methods, by a. controlling business investment expenditures directly. b. controlling government spending. c. influencing the money supply which affects the interest rate and hence, the marginal propensity to consume. d. influencing the money supply which affects the interest rate and hence, consumption and investment. e. all of the above.

33. During a period of renewed inflation fears in 1988, the governor of the Bank of Canada, Mr. John Crow, announced that monetary policy would be more guided by

7 a. exchange rate targets since depreciation of the Canadian dollar tends to be inflationary. b. real GDP growth. c. the goal of long term price stability. d. the level of real income growth and price stability. e. unemployment levels and the level of prices.

34. M2 is defined as currency in circulation plus a. demand deposits and savings accounts. b. demand deposits, savings deposits and non-personal notice deposits. c. term deposits and money market funds. d. term deposits, money market funds and demand loans. e. term deposits, money market funds and personal savings accounts.

35. If interest rates rise during an expansion of real GDP, then the Bank of Canada a. cannot have changed the money supply. b. may have changed the money supply in either direction. c. must have been decreasing the money supply. d. must have been increasing the money supply. e. none of the above.

8 Suggested Answers to Part I of the Practice Final

1. e 2. a 3. a 4. b 5. c 6. d 7. a 8. e 9. d 10. d 11. b 12. c 13. d 14. d 15. b 16. d 17. d 18. b 19. e 20. c 21. a 22. a 23. c 24. b 25. a 26. b 27. d 28. c 29. b 30. d 31. e 32. d 33. c 34. b 35. b

The short answer questions are illustrated on the next page

9 Part II

These questions illustrate the kinds of questions that will be on the final. There will not be this many of this type of question on the final

Answer the following questions True, False, or Uncertain and briefly explain your answer. Each question should take about 10 minutes and is worth 10 points.

1. Discuss: For fixed real income, an increase in the rate of growth of the money supply will leave the interest rate unchanged 2. For fixed real output growth of 3 percent per year, if the rate of growth of the money supply increases from 4% per year to 15% per year, we expect that the inflation rate will be 11% per year in the long run. 3. In the long run, faster rates of monetary growth lead to higher levels of real balance holdings. 4. If people begin to worry that banks are going to fail, the stock of money will tend to increase. 5. If real income growth is constant, an increase in the rate of money growth will gradually increase the rate of inflation from its initial rate to the new long run rate. 6. According to Irving Fisher, MV=Y where Y is income, V is velocity (measured in kilometers per hour) and Y is income. 7. Even if V is interesting, (1/V) is silly if we think of T as measuring all final transactions. 8. In the long run if the rate of growth of real income increases, then the rate of inflation will increase.

10 Part II