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2006 First Prelim (Questions Plus Solutions 2 March Version)
2006 First Prelim (Questions Plus Solutions 2 March Version)
Section Number:
Part 1: Multiple Choice Questions
This exam counts 7 pages: 20 multiple choice questions, 5 short answer questions
and 3 essay questions (Total points: 40)
1. Due to a demand curve which ____ , the prices of roses could be expected to go ____
the day before Valentine s Day
a) shifts in and becomes more steep, down
b) shifts in and becomes more steep, up
c) shifts out and becomes more steep, up
d) shifts out and becomes more flat, up
Answer: c
2. In the short-run supply for agriculture products can be expected to be rather ____ , in
the long run however, the supply curve can be expected to ____ .
a) inelastic, become more steep
b) inelastic, become more flat
c) elastic, become more flat
d) elastic, become more steep
Answer: b
5. The production output of Coca-Colas company in China is part of ____. The profits
of the company which are repatriated to the US on the other hand are part of US ____
but not US ____
a) Chinas GDP; GNP; GDP
b) Chinas GDP; GDP; GNP
c) US GDP; GNP; GDP
d) US GNP; GNP; GDP
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Name: First Prelim ECON 102 2 March 2006
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Answer: a
6. The vegetables grown and eaten by farmers on their farms in Kenya are included in:
a) Kenyan GDP
b) Kenyan GNP
c) Nominal GDP
d) None of the above
Answer: d
8. John, a car mechanic from Detroit is out of a job since he his company has been
transplanted to China. Since then he has been frantically looking for a job, going to
the agencies every single day. John is part of the ____ .
a) cyclical unemployment figures
b) frictional unemployment figures
c) structural unemployment figures
d) discouraged workers figures
Answer: c
10. Uncertainty about the future is likely to ____ spending and increasing wealth is likely
to ____ spending.
a) increase, decrease
b) decrease, increase
c) increase, increase
d) decrease, decrease
Answer: b
11. When economists talk about investment, this would not include:
a) buying AOL stocks at the New York Stack Exchange
b) the creation of capital stock by firms
c) expenditures for new houses and apartments
d) the change in business inventories
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Answer: a
12. In a closed economy with no government, which of the following will occur when the
economy is in equilibrium?
a) S = I
b) C = Y
c) S = C
d) AE = C + I + S
Answer: a
15. When the Federal Reserve wants to increase the money supply in the economy it can
a) decrease the required reserve ratio or increase the discount rate
b) decrease the required reserve ratio or decrease the discount rate
c) increase the required reserve ratio or decrease the discount rate
d) increase the required reserve ratio or increase the discount rate
Answer: b
16. Which of the following determines among others the quantity demanded for money?
a) the required reserve ratio
b) the price level
c) the money multiplier
d) the policies of the Treasury
Answer: b
18. When planned investment increases by I then the change in equilibrium income Y
is ________
I
Answer: or delta I over 1 minus MPC
MPS
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Name: First Prelim ECON 102 2 March 2006
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19. The equilibrium equation of an open economy (an economy which trades with the rest
of the world) with a government is the following: _________
Answer: S + T + Im = I +G + Exp
Answer: the multiple by which deposits can increase for every dollar increase in reserves
1
or required reserve ratio
2. Consider a closed economy with no government and where investors make a decision
to increase spending on capital goods. Illustrate graphically how equilibrium changes
and explain how inventories play a role in restoring equilibrium. Consider for this
question only the goods market. (3 points)
Answer: See Figure 8.8 in the book page 149. The red line is the planned aggregate
expenditure, in this case I + C. The 45 degree line represents where AE equals Y
(equilibrium 1). So the intersection of the red line with the 45 degree line is the
equilibrium point (Y = I + C). This is a stable equilibrium, which means that if one is
outside of equilibrium, one will automatically move back to equilibrium. The unplanned
inventory reductions occur on the left. This happens when planned aggregate expenditure
exceeds aggregate output. Firms will response by increasing output, increasing output
implies increasing income, increasing consumption and the new equilibrium will have a
Y higher than before (equilibrium 2).
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Name: First Prelim ECON 102 2 March 2006
Section Number:
C+I
I+C
new
Equilibrium 2
I+C
Equilibrium 1
Unplanned inventory Y
reduction
3. Define the budget deficit. Explain briefly how a government can finance its deficit.(2
points)
Answer: Budget deficit is defined as G T. When this is positive we speak of a budget
surplus (thus it is measured on a national budget and in a certain time period, one year).
When the government runs a deficit it must borrow to finance it. To borrow the
government sells securities to the public. They can sell both to individuals as institutions,
foreign and national.
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Name: First Prelim ECON 102 2 March 2006
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r
r Ms
AE
AE
AE
Md
Md
Y M I I
Russia's real GDP calculated with 2003 annual average prices totaled RUR15.101 trillion
(approx. USD537bn) in 2005, up 6.4 percent from 2004, according to a preliminary
estimate made by the Federal Statistics Service. Nominal GDP in current prices amounted
to RUR21.665 trillion (approx. USD770.45bn), up 27.38 percent from 2004.
Explain (briefly) the difference between nominal and real GDP in a few sentences. (2
points)
Answer: nominal GDP is GDP measured in current dollars all components of the GDP
valued at their current prices. Nominal GDP adjusted for price changes is called real
GDP. The procedure to obtain the real GDP is as follows: pick a base year and use the
prices in that base year as weights to calculate the real GDP. See Table 6.6 page 111. The
difference between nominal and real GDP becomes important in countries experiencing
high inflation.
2. Read the following abstract of an article which appeared in BBC News 15 December
2005
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Name: First Prelim ECON 102 2 March 2006
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month. Fuel oil costs fell by 6.1%, while natural gas prices fell by 0.5%, the Labor
Department said. The larger decline will come as some relief to the US Federal Reserve,
which has been raising interest rates in a bid to dampen inflationary pressures.
2.2. Give an example of an event which could make energy costs decline. (1 point)
Answer: Any event which shifts the supply of oil to the right (such as the discovery of a
new oil track) and any event which shifts the demand of energy inwards.
2.3. Why does the Fed target a low inflation rate? Illustrate your answer with two
examples. (2 points)
Answer: The Federal Reserve does not like inflation because high inflation has a
negative impact on the economy. Negative impacts include: uncertainty for investors who
will stay away, people allocation large amounts of their time in trying to avoid the
impacts of inflation (economy operates under the production efficient level)
Explain how the interest rates could boost or hinder economic growth. More specifically,
illustrate with two graphs, considering both money market and goods market, how an
expansionary monetary policy of the Federal Reserve impacts the good market. (3 points)
Answer: The Federal Reserve can increase the money supply in the economy in three
different ways (open market operations, decrease required reserve ratio for banks, and
decrease the discount rate). The money supply curve will shift to the right, and the
equilibrium rate of interest falls (S2). Planned investment spending increases from I to I
(which is a component of planned aggregate expenditure), the planned aggregate
expenditure curve shifts ups and raises output. This in its turn increases the demand for
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Name: First Prelim ECON 102 2 March 2006
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money which prevents the interest rates from falling too deep (D2). Note that we could
continue a few more rounds like this.
S1 S2
r
Money market
D2
D
AE
I + C
Goods
I+C
market