ECON 001 - Principles of Macroeconomics
Drake University, Fall 2013
William M. Boal

www.cbpa.drake.edu/econ/boal/001

william.boal@drake.edu

FINAL EXAMINATION
Answer Key

Version A

I. Multiple choice [1 pt each: 17 pts total]

(1)a. (2)a. (3)b. (4)b. (5)c. (6)d. (7)c. (8)e. (9)d. (10)c.
(11)b. (12)b. (13)b. (14)a. (15)d. (16)a. (17)b.

II. Problems

(1) [Comparative advantage, gains from trade: 17 pts]

  1. 3/2 units of manufactured goods.
  2. 3/4 units of manufactured goods.
  3. 2/3 units of agricultural goods.
  4. 4/3 units of agricultural goods.
  5. Country Y (because it has the lower opportunity cost of producing a unit of agricultural goods).
  6. Country X (because it has the lower opportunity cost of producing a unit of manufactured goods).
  7. ... if Country X produces and exports three million units of manufactured goods to Country Y, which produces and exports 3 million units of agricultural goods in return.
  8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(2) [Economic capital: 6 pts]

  1. yes.
  2. no.
  3. yes.
  4. yes.
  5. no.
  6. yes.

(3) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

  1. Demand shifts right, supply unchanged, equilibrium price increases, equilibrium quantity increases.
  2. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
  3. Demand shifts right, supply shifts left, equilibrium price increases, equilibrium quantity cannot be determined.

(4) [Spending approach to GDP: 12 pts]

  1. $10.0 trillion, because consumption includes consumption of durable goods, nondurable goods, and services
  2. $2.3 trillion, because gross investment includes business fixed investment, residential investment and change in inventories.
  3. $0.8 trillion, because net investment equals gross investment minus depreciation.
  4. $3.0 trillion, because government purchases include defense purchases, nondefense purchase, and state and local purchases.
  5. deficit.
  6. -0.8 trillion (negative).

(5) [GDP and real GDP: 8 pts]

  1. 65 percent.
  2. 12 percent.
  3. 10 percent.
  4. 11 percent.

(6) [GDP and real GDP: 7 pts]

  1. 2004.
  2. GDP price index = 93.5, 100.0, 103.2 .
  3. Rate of inflation = 7.0 percent, 3.2 percent.

(7) [Aggregate production function: 6 pts]

  1. true.
  2. false.
  3. false.
  4. true.
  5. true.
  6. false.

(8) [Measuring the labor force: 8 pts]

  1. 13.9 million = labor force - employed.
  2. 9.0 percent = unemployed / labor force.
  3. 59.8 percent = employed / working-age population.
  4. 65.7 percent = labor force / working-age population.

(9) [Interest rate and GDP shares: 16 pts]

  1. unchanged.
  2. right.
  3. unchanged.
  4. right.
  5. unchanged.
  6. increase.
  7. increase.
  8. Justification: As shown in the graph, investment's share of GDP (I/Y) increases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending increases, the capital stock grows faster and the long-run growth rate of real GDP increases.

(10) [Technical change: 4 pts]

  1. 3.0 percent.
  2. 3.9 percent.

(11) [GDP and real GDP: 4 pts]

  1. medium of exchange.
  2. medium of exchange.
  3. unit of account.
  4. store of value.

(12) [Measuring the money supply: 10 pts]

  1. $1.6 trillion, because M1 = currency + checking deposits.
  2. $8.4 trillion, because M2 = M1 + savings deposits
  3. 1.7 , because velocity = GDP / M2.
  4. $1.7 trillion, because MB = currency + bank reserves.
  5. 4.9 , because money multiplier = M2/MB.

(13) [Quantity equation: 2 pts]

  1. 4.2 percent.

(14) [Keynesian cross, Keynesian multipliers: 12 pts]

  1. $16.5 trillion.
  2. up.
  3. $0.5 trillion.
  4. increase.
  5. $1 trillion. (Find this by drawing the new expenditure line carefully.)
  6. 2.0 = ΔY/ΔG.

(15) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 10.

  1. up, right, boom.
  2. down, left, recession.
  3. up, right, boom.
  4. up, right, boom.

(16) [Inflation adjustment: 16 pts]

  1. $15.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
  2. equal to natural rate of unemployment because GDP = potential GDP.
  3. $14.5 trillion (a decrease).
  4. 7 percent, because inflation rate has momentum in short run.
  5. greater than the natural rate because GDP is less than potential GDP.
  6. $15.5 trillion, because eventually the inflation rate will fall until GDP once more equals potential GDP.
  7. 3 percent, where aggregate demand curve 2 intersects potential GDP.
  8. equal to natural rate of unemployment because GDP = potential GDP.

(17) [Monetary policy: 6 pts]

  1. increase, because the Fed pays for bonds with reserves.
  2. decrease, because demand for money slopes down, so an increase in the money supply causes interest rates to decrease.
  3. 0.24 percentage points. Find this by solving 0.03/$100 billion = x/$800 billion.
  4. sell.
  5. $2500 billion. Find this by solving 0.03/$100 billion = 0.75/x.
  6. decrease, because banks pay the Fed for bonds with reserves.

(18) [International acounts: 6 pts]

  1. $ - 699 billion = exports of goods + exports of services - imports of goods - imports of services.
  2. $ + 101 billion = income receipts from rest of world - income payments to rest of world.
  3. $ - 672 billion (a deficit) = trade balance + net income from rest of world + net transfers from abroad (a negative number in this case).

(19) [Economic growth and globablization: 5 pts]

  1. Barbados: NO.
  2. El Salvador: YES.
  3. Honduras: YES.
  4. Mexico: YES.
  5. Panama: YES.

III. Critical thinking [3 pts]

(1) If the U.S. raises its interest rate, the the Hong Kong authorities must also raise their interest rate in order to maintain a fixed exchange rate between the U.S. dollar and the Hong Kong dollar. If they do not, then the difference in interest rates will cause the Hong Kong dollar to depreciate against the U.S. dollar.

(2) If the federal budget were required to be exactly balanced every year, it would be more difficult to prevent recessions and booms because countercyclical fiscal policy could not be used to dampen business cycles. Normally tax receipts rise during booms and fall during recessions, acting as an

automatic stabilizer

for the economy. Other automatic stabilizers include unemployment benefits, social security benefits, and welfare benefits, which rise during recessions and fall during booms. If the budget were required to be exactly balanced every year, either recessions and booms would be larger and longer, or monetary policy would have to be much more vigorous. A more practical amendment would allow the government to run deficits during recessions and surpluses during booms, so that fiscal policy could help control booms and recessions.

Version B

I. Multiple choice [1 pt each: 17 pts total]

(1)b. (2)c. (3)c. (4)a. (5)b. (6)a. (7)b. (8)b. (9)a. (10)d.
(11)b. (12)c. (13)c. (14)b. (15)b. (16)b. (17)c.

II. Problems

(1) [Comparative advantage, gains from trade: 17 pts]

  1. 1/2 units of manufactured goods.
  2. 1/3 units of manufactured goods.
  3. 2 units of agricultural goods.
  4. 3 units of agricultural goods.
  5. Country Y (because it has the lower opportunity cost of producing a unit of agricultural goods).
  6. Country X (because it has the lower opportunity cost of producing a unit of manufactured goods).
  7. ... if Country X produces and exports three million units of manufactured goods to Country Y, which produces and exports 5 million units of agricultural goods in return.
  8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(2) [Economic capital: 6 pts]

  1. yes.
  2. yes.
  3. no.
  4. no.
  5. yes.
  6. no.

(3) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

  1. Demand unchanged, supply shifts right, equilibrium price decreases, equilibrium quantity increases.
  2. Demand shifts left, supply unchanged, equilibrium price decreases, equilibrium quantity decreases.
  3. Demand shifts left, supply shifts right, equilibrium price decreases, equilibrium quantity cannot be determined.

(4) [Spending approach to GDP: 12 pts]

  1. $10.2 trillion, because consumption includes consumption of durable goods, nondurable goods, and services
  2. $2.2 trillion, because gross investment includes business fixed investment, residential investment and change in inventories.
  3. $0.7 trillion, because net investment equals gross investment minus depreciation.
  4. $3.2 trillion, because government purchases include defense purchases, nondefense purchase, and state and local purchases.
  5. deficit.
  6. -0.6 trillion (negative).

(5) [GDP and real GDP: 8 pts]

  1. 38 percent.
  2. 17 percent.
  3. 15 percent.
  4. 16 percent.

(6) [GDP and real GDP: 7 pts]

  1. 2005.
  2. GDP price index = 89.1, 94.8, 100.0 .
  3. Rate of inflation = 6.4 percent, 5.5 percent.

(7) [Aggregate production function: 6 pts]

  1. true.
  2. false.
  3. true.
  4. false.
  5. false.
  6. true.

(8) [Measuring the labor force: 8 pts]

  1. 7.7 million = labor force - employed.
  2. 5.2 percent = unemployed / labor force.
  3. 62.6 percent = employed / working-age population.
  4. 66.1 percent = labor force / working-age population.

(9) [Interest rate and GDP shares: 16 pts]

  1. unchanged.
  2. unchanged.
  3. unchanged.
  4. unchanged.
  5. left.
  6. increase.
  7. decrease.
  8. Justification: As shown in the graph, investment's share of GDP (I/Y) decreases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending decreases, the capital stock grows slower and the long-run growth rate of real GDP decreases.

(10) [Technical change: 4 pts]

  1. 0.6 percent.
  2. 0.2 percent.

(11) [GDP and real GDP: 4 pts]

  1. unit of account.
  2. store of value.
  3. medium of exchange.
  4. medium of exchange.

(12) [Measuring the money supply: 10 pts]

  1. $1.8 trillion, because M1 = currency + checking deposits.
  2. $8.8 trillion, because M2 = M1 + savings deposits
  3. 8.4 , because velocity = GDP / M1.
  4. $2.0 trillion, because MB = currency + bank reserves.
  5. 0.9 , because money multiplier = M1/MB.

(13) [Quantity equation: 2 pts]

  1. 0.7 percent.

(14) [Keynesian cross, Keynesian multipliers: 12 pts]

  1. $16.0 trillion.
  2. up.
  3. $1.5 trillion.
  4. increase.
  5. $2 trillion. (Find this by drawing the new expenditure line carefully.)
  6. 4/3 = 1.333 = ΔY/ΔG.

(15) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 10.

  1. down, left, recession.
  2. down, left, recession.
  3. down, left, recession.
  4. up, right, boom.

(16) [Inflation adjustment: 16 pts]

  1. $15.0 trillion, where aggregate demand curve 1 intersects current inflation rate.
  2. equal to natural rate of unemployment because GDP = potential GDP.
  3. $16.5 trillion (an increase).
  4. 2 percent, because inflation rate has momentum in short run.
  5. less than the natural rate because GDP is greater than potential GDP.
  6. $15.0 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
  7. 8 percent, where aggregate demand curve 2 intersects potential GDP.
  8. equal to natural rate of unemployment because GDP = potential GDP.

(17) [Monetary policy: 6 pts]

  1. increase, because the Fed pays for bonds with reserves.
  2. decrease, because demand for money slopes down, so an increase in the money supply causes interest rates to decrease.
  3. 0.15 percentage points. Find this by solving 0.03/$100 billion = x/$500 billion.
  4. sell.
  5. $1500 billion. Find this by solving 0.03/$100 billion = 0.45/x.
  6. decrease, because banks pay the Fed for bonds with reserves.

(18) [International acounts: 6 pts]

  1. $ - 384 billion = exports of goods + exports of services - imports of goods - imports of services.
  2. $ + 124 billion = income receipts from rest of world - income payments to rest of world.
  3. $ - 382 billion (a deficit) = trade balance + net income from rest of world + net transfers from abroad (a negative number in this case).

(19) [Economic growth and globablization: 5 pts]

  1. Egypt: NO.
  2. Jordan: YES.
  3. Saudi Arabia: YES.
  4. Tunisia: YES.
  5. Yemen: YES.

III. Critical thinking [3 pts]

Same as Version A.

Version C

I. Multiple choice [1 pt each: 17 pts total]

(1)a. (2)b. (3)a. (4)c. (5)b. (6)c. (7)a. (8)d. (9)b. (10)b.
(11)a. (12)c. (13)a. (14)c. (15)a. (16)c. (17)d.

II. Problems

(1) [Comparative advantage, gains from trade: 17 pts]

  1. 3 units of manufactured goods.
  2. 2 units of manufactured goods.
  3. 1/3 units of agricultural goods.
  4. 1/2 units of agricultural goods.
  5. Country Y (because it has the lower opportunity cost of producing a unit of agricultural goods).
  6. Country X (because it has the lower opportunity cost of producing a unit of manufactured goods).
  7. ... if Country X produces and exports five million units of manufactured goods to Country Y, which produces and exports 2 million units of agricultural goods in return.
  8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(2) [Economic capital: 6 pts]

  1. no.
  2. yes.
  3. no.
  4. no.
  5. yes.
  6. yes.

(3) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

  1. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
  2. Demand shifts right, supply unchanged, equilibrium price increases, equilibrium quantity increases.
  3. Demand shifts left, supply shifts left, equilibrium price cannot be determined, equilibrium quantity decreases.

(4) [Spending approach to GDP: 12 pts]

  1. $11.2 trillion, because consumption includes consumption of durable goods, nondurable goods, and services
  2. $2.5 trillion, because gross investment includes business fixed investment, residential investment and change in inventories.
  3. $0.9 trillion, because net investment equals gross investment minus depreciation.
  4. $3.2 trillion, because government purchases include defense purchases, nondefense purchase, and state and local purchases.
  5. deficit.
  6. -0.5 trillion (negative).

(5) [GDP and real GDP: 8 pts]

  1. 56 percent.
  2. 6 percent.
  3. 4 percent.
  4. 5 percent.

(6) [GDP and real GDP: 7 pts]

  1. 1995.
  2. GDP price index = 100.0, 117.2, 126.0 .
  3. Rate of inflation = 17.1 percent, 7.6 percent.

(7) [Aggregate production function: 6 pts]

  1. false.
  2. true.
  3. true.
  4. false.
  5. true.
  6. false.

(8) [Measuring the labor force: 8 pts]

  1. 6.8 million = labor force - employed.
  2. 4.5 percent = unemployed / labor force.
  3. 62.9 percent = employed / working-age population.
  4. 65.9 percent = labor force / working-age population.

(9) [Interest rate and GDP shares: 16 pts]

  1. left.
  2. unchanged.
  3. unchanged.
  4. left.
  5. unchanged.
  6. decrease.
  7. increase.
  8. Justification: As shown in the graph, investment's share of GDP (I/Y) increases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending increases, the capital stock grows faster and the long-run growth rate of real GDP will increase.

(10) [Technical change: 4 pts]

  1. 1.1 percent.
  2. 0.6 percent.

(11) [GDP and real GDP: 4 pts]

  1. medium of exchange.
  2. unit of account.
  3. store of value.
  4. medium of exchange.

(12) [Measuring the money supply: 10 pts]

  1. $1.4 trillion, because M1 = currency + checking deposits.
  2. $7.1 trillion, because M2 = M1 + savings deposits
  3. 10.1 , because velocity = GDP / M1.
  4. $0.84 trillion, because MB = currency + bank reserves.
  5. 1.7 , because money multiplier = M1/MB.

(13) [Quantity equation: 2 pts]

  1. 4.5 percent.

(14) [Keynesian cross, Keynesian multipliers: 12 pts]

  1. $17.5 trillion.
  2. down.
  3. $1.0 trillion.
  4. decrease.
  5. $1.5 trillion. (Find this by drawing the new expenditure line carefully.)
  6. 1.5 = ΔY/ΔG.

(15) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 10.

  1. up, right, boom.
  2. up, right, boom.
  3. down, left, recession.
  4. down, left, recession.

(16) [Inflation adjustment: 16 pts]

  1. $16 trillion, where aggregate demand curve 1 intersects current inflation rate.
  2. equal to natural rate of unemployment because GDP = potential GDP.
  3. $15.5 trillion (a decrease).
  4. 4 percent, because inflation rate has momentum in short run.
  5. greater than the natural rate because GDP is less than potential GDP.
  6. $16.0 trillion, because eventually the inflation rate will fall until GDP once more equals potential GDP.
  7. 2 percent, where aggregate demand curve 2 intersects potential GDP.
  8. equal to natural rate of unemployment because GDP = potential GDP.

(17) [Monetary policy: 6 pts]

  1. decrease, because banks pay the Fed for bonds with reserves.
  2. increase, because demand for money slopes down, so a decrease in the money supply causes interest rates to increase.
  3. 0.06 percentage points. Find this by solving 0.03/$100 billion = x/$200 billion.
  4. buy.
  5. $500 billion. Find this by solving 0.03/$100 billion = 0.15/x.
  6. increase, because the Fed pays for bonds with reserves.

(18) [International acounts: 6 pts]

  1. $ - 557 billion = exports of goods + exports of services - imports of goods - imports of services.
  2. $ + 233 billion = income receipts from rest of world - income payments to rest of world.
  3. $ - 458 billion (a deficit) = trade balance + net income from rest of world + net transfers from abroad (a negative number in this case).

(19) [Economic growth and globablization: 5 pts]

  1. China: YES.
  2. Comoros: NO.
  3. India: YES.
  4. Korea: YES.
  5. Malaysia: YES.

III. Critical thinking [3 pts]

Same as Version A.

[end of answer key]