Study Questions for the First Midterm

ECO 136 (02) SPRING 2006

STUDY QUESTIONS FOR THE FIRST MIDTERM

Part I: Essay Questions

1. How do the following events influence GDP and/or GNP? a) Each of five mothers living in a neighborhood takes care of her pre-school child in her own home. b) Mary buys a new car from a dealer for $20,000. c) Dave sells Mary a used car for $7,000. b) A Japanese company builds a factory in Konya.

2. The text lists three types of unemployment: frictional, structural and cyclical. Which type is each of the following? a) Adam quits his job in Minnesota because he is tired of the snow, drives to Arizona and looks for work. b) Chris is laid off from User Group, Inc., because demand for computers has fallen off in the current recession. c) Dan has 20 years experience as a loom operator in a textile mill, but the number of mills is declining and he cannot find one that is hiring loom operators. c) Sheri has just graduated from secretarial school with strong word-processing skills, but as she looks for work she discovers that almost every business in town is laying off clerical staff.

3. a) From the following data, find the marginal propensity to consume, compute the expenditure at each level of Y, and find the equilibrium Y: GDP C I G T 5,000 3,650 1,000 1,200 400 5,500 4,000 1,000 1,200 400 6,000 4,350 1,000 1,200 400 6,500 4,700 1,000 1,200 400 7,000 5,050 1,000 1,200 400 7,500 5,400 1,000 1,200 400 b) What will be the change in unplanned investment if Y is 7,500? c) What will be the new equilibrium if T is reduced to 0?

4. Will the multiplier effect on GDP be different when these events occur? Why or why not?

1 a) Investment rises by 100 b) Consumption rises by 100 at each level of GDP c) Government spending rises by 100

5. Consider an economy in which the marginal propensity to consume is 2/3, prices are constant, the multiplier is 3, G is initially 1300, taxes are 1300, and Y is initially 7000. a) The government wishes to increase Y to 7300, and it is considering changing government purchases, or taxes. What new levels of these fiscal policy tools would be needed? In each case, what would the new government surplus or deficit be? b) Suppose instead that the government wished to reduce Y to 6400 and, again, it was considering using only one of its two available fiscal policy tools. What level of these tools would be needed? In each case, what would the government surplus or deficit be? c) Suppose instead that the government wished to raise Y to 7100, but it was unwilling to run a surplus or deficit. Therefore the change in government purchases would have to be matched by an equal change in taxes. What change in government purchases and taxes would be needed?

6. Draw a 45-degree diagram with a consumption function and an expenditure schedule, but no government spending or taxes. Show how this diagram is altered by the addition of: a) government spending b) fixed taxes.

2 Part II: Multiple Choice Questions

1. A macroeconomist would concentrate on which of the following issues? a. the price of pizzas b. the profits of the IBM Corporation c. the unemployment rate in Germany d. the market for hot dogs

2. Gross Domestic Product is best described as the a. measure of a nation’s total economic welfare. b. national income, including nonmarket income. c. sum of money values of all final output produced in the domestic economy within the year. d. national output minus environmental damage. 3. Nominal GDP is a. also called real GDP. b. a more accurate measure than real GDP. c. real GDP adjusted for changes in the price level. d. GDP measured in current prices.

4. An example of an intermediate good would be a(n) a. new car. b. used car. c. new tire for a used car. d. tire for a new car. e. All of the above.

3 5. Figure 4-1 plots potential and real output for a hypothetical economy. Based on this graph, the recession occurred a. between years 1 and 2. b. between years 2 and 3. c. between years 3 and 4. d. after year 4.

6. Before the Great Depression of the 1930s, most economists believed that a. only active government policy could prevent recessions or inflation. b. a capitalist economy had a natural tendency to cure recessions or inflation. c. a capitalist economy had a natural tendency to inflation. d. recessions and depressions were inevitable until the economy broke down completely.

7. Economists generally assume that ______economic growth is better for society. a. slower b. faster c. stable d. declining

4 8. The Peoples Republic of China has a much larger GDP than the Republic of Austria. This does not mean that the typical Chinese lives better than the typical Austrian because a. real GDP is not a good measure of living standards. b. we don’t know the price level in each country. c. the exchange rate of the Chinese Yuan is less than the Austrian Schilling. d. Chinese per capita GDP is less than Austrian per capita GDP.

9. Someone who is out of work because they are between jobs is experiencing a. frictional unemployment. b. structural unemployment. c. seasonal unemployment. d. cyclical unemployment.

10. Technological change or the effects of automation cause a. structural unemployment. b. frictional unemployment. c. seasonal unemployment. d. cyclical unemployment.

11. If wages rise by 12 percent at the same time prices rise by 3 percent, then the increase in real wages is equal to a. 12 percent. b. 9 percent. c. 6 percent. d. 3 percent.

12. If ten years ago the price of a movie ticket was $5 and the average hourly wage was $10, and today the price of a movie ticket is $8 and the average hourly wage is $20, then a. movies are now relatively cheaper in terms of work hours. b. movies are now relatively more expensive in terms of work hours. c. the relative price of movies has remained constant. d. workers now need to work longer hours to earn one movie ticket.

13. Saving is a leakage in the sense that a. saving is lost to the economy and ultimately leads to stagnation. b. the financial system often makes negative profits. c. it often accompanies a trade deficit. d. consumers spend less than their total income.

5 14. Government spending is an injection in the sense that it a. increases the amount of total spending. b. increases the size of the government deficit. c. decreases the amount of household saving. d. decreases the amount of taxes paid.

15. The relationship between consumption and disposable income is such that as a. consumption rises, disposable income falls. b. disposable income rises, consumption rises. c. disposable income rises, consumption falls. d. disposable income rises, saving falls.

16. On a graph with consumption on the vertical axis and disposable income on the horizontal axis, the slope of the line is a. greater than one. b. equal to one. c. less than one. d. undefined.

17. The difference between disposable income and consumption spending is a. transfer payments. b. personal taxes. c. net exports. d. personal investment. e. saving.

18. The nation’s disposable income increases by $400 billion and, as a result, consumer spending increases by $320 billion. Therefore, the MPC equals a. 16. b. 20. c. 60. d. 80. e. 96.

19. In Macronesia, the MPC is approximately 0.8. If disposable income changes from 1,000 billion pukas to 1,500 billion pukas, then consumption will change by a(n) a. decrease of 500 billion pukas. b. increase of 500 billion pukas. c. increase of 400 billion pukas. d. increase of 800 billion pukas.

6 20. Pat Robertson, a TV evangelist and former Republican Party candidate for president, said recently on his television program that “debt is an affront to God,” so good Christians should not spend beyond their incomes. Indeed, Robertson wants Christians to save more (as well as donate more to his ministry). If more Americans, Christians as well as others, took his message seriously, how would we represent the result using a Keynesian macroeconomic model? a. a downward movement along the consumption function b. an upward movement along the consumption function c. a downward shift of the consumption function d. an upward shift of the consumption function

21. Which of the following would lead you to predict an upward shift in the consumption function? a. a decrease in the value of real wealth b. a decrease in disposable income c. an increase in the value of real wealth d. an increase in the price level

22. The system of measurement for expressing macroeconomic data is called a. national income accounting. b. balance of payment accounting. c. generally accepted accounting principles. d. double entry bookkeeping.

23. Among the following, which would not be considered part of the investment component of GDP? a. manufacturers’ equipment b. buying corporate stock c. new houses d. business structures

24. At the equilibrium level of income it must be true that total a. income equals total spending. b. product equals total output. c. output equals total inventory. d. income equals total saving. 25. Total output equals total income a. only at equilibrium. b. always. c. only at non-equilibrium levels of income. d. never.

7 26. If total spending exceeds total output, then a. inventory levels will rise. b. inventory levels will remain constant. c. inventory levels will fall. d. output will eventually decrease.

27. If inventory levels are decreasing, then we should expect business firms to a. decrease prices. b. decrease output. c. lay off workers. d. increase output.

28. Using the standard 45-degree line diagram, how does an increase in investment spending effect the expenditure schedule? a. It shifts the expenditure schedule downward. b. It shifts the expenditure schedule upward. c. It increases the slope of the expenditure schedule. d. It decreases the slope of the expenditure schedule.

29. The concept that increases in spending cause larger increases in equilibrium Y is known as the a. profiler. b. mystifier. c. multiplier. d. depreciator.

30. The reason for the multiplier effect is that a. businesses make decisions about investment projects based on anticipated profits. b. one person’s additional expenditure creates a new source of income for another person, and this additional income leads to still more spending. c. changes in government spending typically deepen recessions and exacerbate inflationary conditions in the economy. d. additional spending lowers the rate of interest and leads to further borrowing and spending.

31. If businesses spend an additional $150 billion for investment projects in 2001, what will be the impact on national income (Y) if the multiplier is 2? a. Y will increase by $50 billion. b. Y will increase by $150 billion. c. Y will increase by $300 billion. d. Y will increase by $350 billion.

8 32. Assume that the MPC is 0.9 and investment falls by $30 billion. What is the change in Y? a. –$300 billion b. –$270 billion c. –$93 billion d. –$39 billion

33. In comparison to the oversimplified formula for the multiplier, the real-world multiplier is a. lower. b. higher. c. almost equal to it. d. higher if taxes are included.

Table 8-1 Y C I G T 1000 800 500 100 0 1500 1200 500 100 0 2000 1600 500 100 0 2500 2000 500 100 0 3000 2400 500 100 0 3500 2800 500 100 0 4000 3200 500 100 0 34. In Table 8-1, the equilibrium level of output is a. 2,500. b. 3,000. c. 3,500. d. 4,000. 35. In Table 8-1, at output of 4,000, inventories are a. decreasing by 200. b. increasing by 200. c. increasing by 300. d. decreasing by 300.

36. In Table 8-1, inventories are being depleted as long as output is below a. 2,000. b. 2,500. c. 3,000. d. 3,500.

9 37. In Table 8-1, inventories will be increasing as long as output is above a. 1,000. b. 1,500. c. 2,000. d. 3,000.

38. A decrease in autonomous consumption would have the same effect on the expenditures schedule as a(n) a. decrease in investment. b. increase in investment. c. decrease in net exports. d. increase in taxes

39. “Fiscal Policy” is the federal government’s plan for a. international trade, designed to balance exports and imports. b. spending and taxes, designed to influence the level of aggregate demand. c. manipulating the money supply and the control of interest rates. d. All of the above are correct.

40. In contrast to changes in government spending, tax changes affect spending a. directly. b. in the same proportion. c. by a greater amount. d. indirectly.

41. When you compare the effects of government spending on aggregate demand with the effects of taxes on aggregate demand, the effects of government spending are a. smaller. b. larger. c. the same. d. impossible to predict.

42. When income taxes are included in the basic macroeconomic model, the value of the a. inflationary effect is increased. b. multiplier is increased. c. multiplier is decreased. d. expenditure function is increased.

10 43. When government spending is added to the basic macroeconomic model, the multiplier for G would a. be higher than the multiplier for autonomous spending. b. be lower than the multiplier for autonomous spending. c. be equal to the multiplier for autonomous spending. d. have no relationship to the autonomous spending multiplier.

44. In order to maintain a balanced budget, government has decided to cut taxes and government spending both by $25 billion. What will happen to Y? a. It will increase. b. It will remain the same. c. It will decrease. d. It’s impossible to know without the multiplier.

45. How does the multiplier for a change in government spending compare to the multiplier for a change in taxes? a. It is smaller. b. It is the same. c. It is larger. d. It cannot be calculated.