Third In-Class Exam -- Spring 1996

raainbow bar Part A. Multiple Choice (3 points each). In the space provided, indicate the best answer for each question.
1. A main function of money is to avoid the double coincidence of wants required in a barter system. This is the:
A. store of value function.
B. the standard of deferred payment function.
C. unit of account function.
D. medium of exchange function.
2. If the current interest rate is unusually low and people expect it to increase in the future, then:
A. they hold more bonds and less money now because they expect bond prices to increase in the future and they want to earn a capital gain.
B. they hold less money and more bonds because the opportunity cost of holding money is too high.
C. they hold more money and less bonds now because they expect bond prices to decrease in the future and they want to avoid a capital loss.
D. they hold more money and less bonds now because they expect bond prices to increase in the future and they want to earn a capital gain.
3. According to the Keynesian theory of money demand and supply, if the quantity of money demanded exceeds the quantity of money supplied, people would:
A. buy bonds which causes bond prices to increase and the interest rate to fall.
B. sell bonds which causes bond prices to fall and the interest rate to increase.
C. buy bonds which causes bond prices to decrease and the interest rate to rise.
D. sell bonds which causes bond prices to increase and the interest rate to fall.
4. The type of unemployment associated with a recession is called:
A. frictional unemployment.
B. seasonal unemployment.
C. structural unemployment.
D. cyclical unemployment.
5. Unanticipated inflation tends to penalize:
A. governments which have a progressive personal income tax.
B. businesses which borrow money from financial institutions.
C. households who borrow money from financial institutions.
D. people who save money in financial institutions.
6. In calculating GDP, transfer payments, such as social security or unemployment compensation, are:
A. not counted.
B. counted as government spending.
C. counted as investment spending.
D. counted as consumption spending.
7. In the simple Keynesian macroeconomic model, an increase in lump sum taxes will:
A. increase the level of output.
B. reduce the size of the multiplier.
C. reduce net exports.
D. reduce government spending (G0).
E. reduce consumption.
8. If the money supply decreases, then:
A. the AD will shift to the right, and P and Y will both increase.
B. the AS will shift to the right, and P will fall while Y increases.
C. the AS will shift to the left, and P will increase while Y falls.
D. the AD will shift to the left, and P and Y will both decrease.
9. Which of the following will tend to shift the consumption schedule upward?
A. A current high level of consumer indebtedness.
B. A current low level of wealth or assets held by the consumers.
C. Expectations of future shortages of essential consumer goods.
D. Expectations of future declines in the consumer price index.
10. The Keynesian investment function will shift to the left as a result of:
A. a decrease in business taxes.
B. business pessimism about future economic conditions.
C. an increase in the interest rate.
D. an increase in businesses expected profits.
E. Both B and C.
11. In the simple Keynesian macroeconomic model, if aggregate expenditures (AE) exceed current output (Y), inventories will:
A. decrease, and businesses will increase output.
B. decrease, and businesses will decrease output.
C. increase, and businesses will decrease output.
D. increase, and businesses will increase output.
12. According to the simple Keynesian model, if the mpc equals 0.8 and government spending and lump sum taxes both fall by $100, then:
A. equilibrium GDP will not be affected.
B. equilibrium GDP will fall by more than $100.
C. equilibrium GDP will fall by $100.
D. the government budget deficit will increase.
E. Both A and D.
rainbow bar Part B. Short Answer (64 points). Answer the following questions. When appropriate, use math, graphs, or equations to help explain your answers.
1. Briefly explain why unemployment and inflation are important policy issues that we should be concerned about. (10 points)
2. Assume that the current, equilibrium GDP is below the full-employment level of GDP. Using a simple aggregate demand (AD) and aggregate supply (AS) curve, describe how demand-side policies can be used to return the economy to full employment. What tradeoffs does society have to make using demand-side policies in this case? (10 points)
3. Using a simple Keynesian 45 model, show a country that is experiencing an inflationary gap (it is also called an expansionary gap). Explain how fiscal policy can be used to return the economy to full-employment equilibrium. What would happen over time if an inflationary gap was allowed to continue? (10 points)
4. Using a simple Keynesian 45 model, compare and contrast the effect of a (i) $100 increase in government spending or (ii) a $100 decrease in lump sum taxes. Specifically mention any differences (if any) in the size of the shift in aggregate expenditures and the change in equilibrium GDP. (10 points)
5. Using the Keynesian investment function and a money demand and money supply model, explain how a decrease in the money supply affects the equilibrium level of the interest rate and the level of investment. (10 points)
6. Using the following Keynesian 45 diagram, answer the following questions. Assume lump sum taxes are equal to $2 billion (i.e., T0 = 2). (14 points).
a. What does autonomous consumption (C0) equal (in billions of dollars)?
b. What does the marginal propensity to consume (mpc) equal?
c. What does autonomous government spending (G0) equal (in billions of dollars)?
d. What do net exports (NX0) equal (in billions of dollars)?
e. What is the equilibrium level of GDP (in billions of dollars)?
f. By how much (in billions of dollars) does the equilibrium level of GDP change for every $1 billion increase in autonomous investment ( I0 )? Explain.
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