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ECON5002

Practice Mid-Semester Test

Practice Mid-semester Test Questions:

PART A:

1. Assume that between 2012 and 2020, the nominal GDP of an economy increased from ✩3 trillion to ✩5 trillion and that the GDP deﬂator increased from 100 to 125. Which of the following expresses GDP in 2020 in terms of 2012 prices?

(a) ✩3 trillion

(b) ✩3.2 trillion

(d) ✩4.5 trillion

(e) ✩5 trillion

2. Which of the following individuals would be considered unemployed?

(a) an individual who works full-time in a family business, but is not paid (b) an individual who is not working and is not looking for work

(d) an individual who is not working and is looking for work

(e) an individual who works only part-time

3. Suppose that autonomous consumption is ✩300 and the marginal propensity to consume out of disposable income is 0.75. How much of a decrease in government spending must occur for equilibrium output to decrease by ✩1,000?

(a) ✩100

(b) ✩200

(d) ✩500

(e) ✩1,000

4. Which of the following policy actions would simultaneously increase interest rates and decrease output?

(a) the government increases its defence purchases

(b) the central bank sells bonds through open market operations

(d) the government increases the tax rate

(e) the government increases defence purchases and the central bank expands the money supply

5. Assume product markets become more competitive in Australia. Given this information, we would expect the —– curve to shift —– and the natural rate of unemployment to ——.

(a) PS; downward, increase

(b) WS; right; increase

(d) PS; upward; increase

(e) PS; upward; decrease

6. The aggregate demand has its particular shape because of which of the following explanations?

(a) a decrease in the aggregate price level will cause an increase in the real wage, a decrease in employment, and a decrease in output

(b) a decrease in the aggregate price level will cause a decrease in the interest rate and an increase in output

(c) as the aggregate price level increases, goods and services become relatively more expen- sive and individuals respond by decreasing the quantity demanded of goods and services

(d) an increase in the aggregate price level prompts the government to decrease its spending in the hope of bringing down prices

(e) an increase in the money supply will cause an increase in the interest rate, a decrease in investment, and a decrease in output

7. The neutrality of money is consistent with which of the following statements?

(a) changes in the money supply will not aﬀect the price level in the medium run (b) changes in the money supply will not aﬀect employment in the medium run (c) changes in the money supply will not aﬀect wages in the medium run. (d) changes in the money supply will not aﬀect employment in the short run. (e) changes in the money supply will not aﬀect the price level in the short run.

8. Which of the following economies have the largest money multiplier?

(a) an economy in which individuals do not hold deposits and the reserve ratio is 12%

(b) an economy in which individuals hold both currency and deposits and the reserve ratio is 10%

(d) an economy in which individuals do not hold deposits and the reserve ratio is 8% (e) an economy in which individuals do not hold currency and the reserve ratio is 10%

9. At the current level of output, suppose the actual price level is less than the price level individuals expect. We know that:

(a) any subsequent decrease in the aggregate price level will cause an increase in the real money supply and a rightward shift in the aggregate demand curve

(b) the interest rate will tend to rise as the economy adjusts to this situation

(d) output is currently less than the natural level of output (e) the AS curve will tend to shift up over time

PART B:

1. Consider an IS-LM model with consumption and investment functions:

C = 120 + 0.2(Y − T)

I = 300 + 0.3Y − 2000i

and suppose G = 200 and T = 100.

Let the real money supply be Ms /P=2000, and let the real money demand be given by: Md /P = 5Y − 5000i

(a) Derive the IS relation. (2 points)

(b) Derive the LM relation. (2 points)

Due to a drop in consumer conﬁdence, consumers reduce their consumption level, so that the consumption function now becomes:

C = 20 + 0.2(Y − T)

(d) Compute the new equilibrium output Y and interest rate i if the central bank holds the real money supply ﬁxed. (1.5 points)

(e) To give a quick boost to the economy and bring the equilibrium output back to the original level identiﬁed in part (c), the central bank decides to launch an expansionary monetary policy by increasing the real money supply. Solve for the required interest rate that can achieve such a recovery. (2 points)

(f) Draw an IS-LM diagram to represent the drop in consumer conﬁdence and the expan- sionary monetary policy response. Label all axes and curves and mark all the values and equilibrium points appropriately. (2 points)

2. Consider the following model of the economy:

AS Relation: P = Pe + 2 (Y − 80)

AD Relation: Y = 90 − 200in − 0.1(P − PT)

Suppose that the price level target is PT = 1.

(a) Compute the medium-run equilibrium values of output, price level and interest rate. (2 points)

Assume that the economy starts at the natural level of output. Now suppose that there is a decrease in autonomous consumption so that consumption falls for any interest rate. The central bank maintains the price level target at PT = 1.

(b) Would the medium-run equilibrium value of output change due to the fall in autonomous consumption? Why or why not? (2 points)

(c) Explain the transition of output and the price level in the short run and the medium run following the decrease in autonomous consumption. (3 points)

(d) In an AS-AD diagram, show what happens to output and the price level in the short run and the medium run. Label all axes and curves and mark all the values and equilibrium points appropriately. (3 points)