ECS1601 EXAM PACK 2024

ECS1601Test bank with answers Economics, past exam papers Exam-Pack-Index From , assignment 1, assignment 2, .. ..complete solutions 1 ECS1601 TEST BANK Question 1 In the goods market of the circular flow model, …. 1) firms buy factors of production from consumers 2) firms buy finished products from households 3) consumers buy factors of production from firms 4) firms sell factors of production to the government 5) consumers buy finished products from firms The correct alternative is [5]. Explanation In the goods market of the circular flow model, consumers receive income in the form of salaries and wages, interest, rent and profit and use this income to purchase finished consumer goods and services. Question 2 In the factor market, … . 1) a student buys lunch at a local university cafeteria. 2) the South African Defence Force buys machine guns from a weapons manufacturer 3) a retirement fund buys shares in a major company 4) a farmer buys farmland from a retiring farmer The correct alternative is [4]. 5) a welder buys a personal computer from an electronics store Explanation A factor market is a market where factors of production such as labour, land and capital are traded. Therefore, in this case only the sale of land (i.e. farmland) will occur in a factor market. Question 3 In the circular flow of income and spending, … . 1) investment results in a decrease in the volume of the income flow 2) taxes result in an increase in the volume of the income flow 3) imports result in an increase in the volume of the income flow 4) savings result in a decrease in the volume of the income flow The correct alternative is [4]. Explanation In the circular flow of income and spending, savings, taxes and imports are called leakages or withdrawals since they result in a decrease in the volume of the income flow, whereas investment spending and government expenditure and exports are all injections into the circular flow since they result to an increase in the volume of the income flow. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 2 Question 4 Which one of the following statements is correct? 1) Flows (2) and (3) represent income. 2) Flows (2) and (4) represent spending. 3) Flows (1) and (2) represent spending. 4) Flows (1) and (3) represent spending. The correct alternative is [4]. Explanation In the circular flow of income and spending, households supply factors of production to firms and in turn receive income which they spend on goods and services offered by firms (Flow 3). Their spending represents the income to firms. Firms spend some of their income to pay wages to households for their services, interest for the use of capital and rent for the use of their land (Flow 1). Question 5 1) capital, wealth and income are stock variables, whereas investment and profit are flow variables 2) capital, wealth and gold reserves are stock variables, whereas investment, profit and loss are flow variables The correct alternative is [2]. 3) investment, income and profit are stock variables, whereas capital, wealth and natural resources are flow variables 4) capital, wealth and population size are stock variables, as are investment, profit and savings Explanation Capital, wealth and gold reserves are stock variables since they have no time dimension and can only be measured at a specific moment. Whereas investment, profit and loss are flows since they have a time dimension and can only be measured over a period. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 3 Question 6 In the circular flow of income and spending, the main leakages are: a) the foreign sector, the financial sector and taxes b) imports, investments, bank withdrawals, off-shore shares and securities c) imports, savings and taxes 1) a 2) c The correct alternative is [2]. 3) a and b 4) b and c 5) None of the above. Explanation Savings, taxes and imports are leakages in the circular flow of income. Question 7 In a mixed economy, the economic decisions of what to produce, how to produce it, and who will receive it are made by … . 1) the government 2) consumers and firms 3) banks and stock markets 4) household, firms, government and the foreign sector The correct alternative is [4]. 5) banks and the government Explanation In a mixed economy the households, firms, government and the foreign sector all participate in the production process. They all partake in production, income and spending since they contribute towards production, earn an income and spend their income. Question 8 An example of a double coincidence of wants is … . 1) a car dealer who wants a TV finding an electronics store owner who wants money 2) a car mechanic who wants a TV finding an electronics store owner who wants a car repaired The correct alternative is [2]. 3) an electronics store owner who wants car repairs finding a car mechanic who wants money 4) All of the above. Explanation A double coincidence of wants is present where two individuals have exactly the same products available for exchange that the other person wants. In this case a car mechanic who needs a TV finds an electronic store owner who needs a car repaired. Question 9 Money overcomes the problem of a double coincidence of wants through its function as a … 1) medium of exchange The correct alternative is [1]. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 4 2) unit of account 3) standard of deferred payment 4) store of value Explanation Money overcomes the problem of double coincidence of wants through its function as a medium of exchange – it lubricates the process of exchange. Question 10 The demand for money curve is … because a lower interest rate ... . 1) upward-sloping; increases the opportunity cost of holding money 2) downward-sloping; increases the opportunity cost of holding money 3) upward-sloping; decreases the opportunity cost of holding money 4) downward-sloping; decreases the opportunity cost of holding money The correct alternative is [4]. Explanation Demand for money curve is downward-sloping since individual households and firms earn little interest on their money holdings when interest rates fall. At lower interest rates the opportunity cost of holding money is lower. Question 11 A car-guard deposits his cash tips into his savings account. As a result of only this transaction, … . 1) M2 increases 2) M2 decreases 3) M3 remains constant The correct alternative is [3]. 4) None of the above. Explanation Overall M3 will remain unchanged since a reduction in coins and notes in circulation is offset by an increase in deposits with monetary institutions. Question 12 Assuming the economy is in equilibrium, the central bank sells bonds by means of open-market transactions. How would this affect the equilibrium quantity of money and interest rates in the short run? 1) Quantity of money will go up and interest rates will go up. 2) Quantity of money will go up and interest rates will go down. 3) Quantity of money will go down and interest rates will go up. The correct alternative is [3]. 4) Quantity of money will go down and interest rates will go down. Explanation When the central bank undertakes open market operations, selling bonds to banks, households and firms, the interest rate will go up and the quantity of money will decrease. Question 13 Suppose that Sandton Bank has excess reserves of R800 and the reserve ratio is 20%. If Tshepo deposits R1 000 into his cheque account with Sandton Bank, and in Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 5 turn Sandton Bank lends R600 to Mary, what is the maximum that the bank can lend to Karabo? 1) R200 2) R800 3) R1 000 The correct alternative is [3]. 4) R2 400 Explanation Original excess reserves R 800 plus new reserves R 800 (New deposit less the reserve ratio of 20%: Total excess reserves R 1 600 R1 000 – 200 = 800) less loan to Mary R 600 New excess reserves R 1 000 Question 14 Suppose the bank receives a cheque deposit of R300 and its excess reserves increase by R255, the required reserve ratio must be … . 1) 5% 2) 15% The correct alternative is [2]. 3) 25% 4) 65% 5) 38% Explanation The reserve ratio (rr) can be calculated as follows: rr = (300−25) 300 x 100 = 0, 15 x 100 = 15% Question 16 The …demand for money arises from the need to hold money as a medium of exchange. This demand for money is a function of … . 1) precautionary; interest rates 2) transaction; national income The correct alternative is [2]. 3) speculative; interest rates 4) precautionary; national income 5) transaction; interest rates Explanation Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 6 The transactions motive of holding money arises out of its function as a medium of exchange and since the amount of money an individual must hold depends on the value of transactions concerned, the demand for money depends on the individual’s level of income. At an aggregate level, the transactions demand for money is a function of national income. Question 17 If the economy is suffering from a recession, the SARB should apply … monetary policy by … interest rates. 1) expansionary; decreasing The correct alternative is [1]. 2) expansionary; increasing 3) contractionary; decreasing 4) contractionary; increasing Explanation When the central bank wishes to lift the economy from a recession, it will conduct an expansionary monetary policy by lowering interest rates. In South Africa the SARB make changes to the market interest rates through changes in the repo rate. Question 20 If the SARB institutes a policy to reduce inflation, which of the following is most likely to increase? 1) Taxes 2) Investments 3) government expenditure 4) interest rates The correct alternative is [4]. 5) real GDP Explanation The main instrument used by the SARB to control inflation is the repo rate, which is the interest rate at which SARB accommodates the financing needs of banks. Therefore, in order to institute a policy to reduce inflation, the SARB will make adjustments to the interest rates. Question 1 An appropriate measure of government’s involvement in economic activity is 1) the volume of government subsidies. 2) total government spending. 3) government’s share of total spending in the economy. The correct alternative is [3] 4) the growth of government spending. Explanation Government’s involvement in economic activity is often measured by the share of government spending in total spending in the economy. Question 2 Which of the following statements regarding fiscal policy and the budget are correct? a) Demand management only refers to fiscal policy. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 7 b) If government spending should decrease and taxation should increase, a budget deficit is likely to occur. c) When government plans to stimulate economic activity, it can increase its spending or reduce taxes. 1) a and c 2) b and c 3) a 4) b 5) c The correct alternative is [5] Explanation When the government plans to simulate economic activity it can increase its spending or reduce taxes. Question 3 Which of the following statements regarding financing government expenditure are correct? a) The budget deficit is positively related to the interest on public debt. b) Government can finance its deficit by buying bonds from the public. c) Inflationary financing occurs when government borrows from the central bank. 1) All the statements are correct. 2) a and b 3) a and c 4) a 5) c The correct alternative is [5] Explanation Inflationary financing occurs when government borrows from the central bank. Question 4 Which of the following statements regarding taxes are correct? a) A tax is neutral if it has the minimum distortion effect on prices. b) Tax avoidance occurs when people do not pay the taxes they are supposed to pay. c) A gate fee at a private park is an example of user charges. 1) a The correct alternative is [1] 2) b 3) c 4) a and b 5) All the statements are correct. Explanation A tax is neutral if it has minimum distortion effects on prices. Question 5 Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 8 … takes a smaller proportion of income from high-income groups than from lowincome groups. 1) Company tax 2) Value-added tax The correct alternative is [2] 3) Personal income tax 4) Capital gains tax Explanation Value-added tax takes a smaller proportion of income from the high-income groups than from the low-income groups. Question 6 Which one of the following statements regarding tax incidence is correct? 1) The burden of a specific excise tax is smaller for consumers than for suppliers. 2) The statutory incidence determines who ultimately bears the burden of the tax. 3) The imposition of a specific excise tax increases the income of suppliers. 4) The tax burden depends on the relative price elasticities of the demand curve and the supply curve. The correct alternative is [4] Explanation The tax burden depends on the relative price elasticities of the demand curve and the supply curve. Question 7 According to Adam Smith, international trade mainly arises because of 1) differences in foreign currencies. 2) differences in factor endowment. The correct alternative is [2] 3) trade barriers. 4) trade agreements. Explanation According to Adam Smith, international trade mainly arises because of differences in factor endowment. Consider the following table, which shows the production possibilities of two countries, and answer questions 8 and 9. Cocoa production (output of 50 people in tons) Tea production (output of 50 people in tons) Country A 90 60 Country B 20 40 Question 8 Which one of the following statements is correct? 1) Country A has an absolute advantage in the production of both tea and cocoa, and a comparative advantage in the production of tea. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 9 2) Country A has an absolute advantage in the production of both tea and cocoa, and a comparative advantage in the production of cocoa. The correct alternative is [2] 3) Country B has an absolute advantage in the production of tea, and a comparative advantage in the production of cocoa. 4) Country B has an absolute advantage in the production of cocoa, and a comparative advantage in the production of tea. Explanation Country A has an absolute advantage in the production of both products. It produces 90 tons of cocoa compared to the 20 tons in Country B or 60 tons of tea compared to 40 tons. Remember, with absolute advantage the question is simply "who can produce more?” With comparative (or relative) advantage one wants to establish what is the opportunity cost of specialising in the production of a particular product. To produce 1 ton of cocoa, Country A has to sacrifice 2/3 tons of tea, whereas Country B sacrifices 2 tons of tea. Country A can produce cocoa "cheaper". Country A has a comparative advantage in the production of cocoa. To produce 1 ton of tea Country A must sacrifice 1½ tons of cocoa, while country B must sacrifice ½ ton. Country B can produce tea "cheaper"; it has a comparative advantage in the production of tea. Question 9 It would be more efficient for country A to export 1) both cocoa and tea. 2) cocoa. The correct alternative is [2] 3) tea. Explanation Since Country A has a comparative advantage in the production of cocoa, it would be more efficient for them to export cocoa. Question 10 Which of the following statements regarding the balance of payments are correct? a) When South Africans export their financial and insurance services, this transaction is entered into the financial account. b) A current account surplus implies that exports exceed imports. c) An appreciation of the rand would worsen the deficit on the current account of the balance of payments. 1) a and b 2) a and c 3) b and c The correct alternative is [3] 4) b 5) All the statements are correct. Explanation Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 10 b) A current account surplus implies that the exports exceed the imports. c) An appreciation of the rand will worsen the deficit on the current account of the balance of payments since exports become expensive and decline, while import prices will decrease increasing imports. Question 11 Which one of the following would occur in the South African economy if the SARB reduced interest rates relative to the rates in the USA? 1) More capital inflow → an increase in the supply of dollars → depreciation of the rand. 2) More capital inflow → increase in the demand for dollars → appreciation of the rand. 3) More capital outflow → decrease in the supply of dollars→ depreciation of the rand. The correct alternative is [3] 4) More capital outflow → decrease in the demand for dollars → depreciation of the rand. Explanation If the SARB reduces the interest rates relative to the rates in the USA, capital will flow out of the country. In addition, as the interest rates are relatively lower, the supply of dollar will decrease; the rand will depreciate. Question 12 is based on the diagram below, which shows the foreign exchange market. Question 12 Which of the following statements are correct? a) If South Africans should stop purchasing assets from the USA, the demand curve could shift from D to D1. b) If more South Africans should import goods from the USA, the demand curve could shift from D1 to D. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 11 c) If the SARB should intervene in the foreign exchange market and buy US dollars, the demand curve will shift from D to D1. 1) a 2) b 3) c The correct alternative is [3] 4) a and b 5) All the statements are correct. Explanation If the SARB intervenes in the foreign exchange market and buys the US dollars, the demand for dollar increases. The demand curve shifts to the right. Question 13 Which of the following statements regarding exchange rates are correct? a) Fluctuations in exchange rate only affects export prices, not import prices. b) When the prices of South African exports fall relative to the prices of imports, the country's terms of trade improve. c) When the rand appreciates against the dollar, it does not necessarily appreciate against other currencies. 1) All the statements are correct. 2) a and c 3) b and c 4) b 5) c The correct alternative is [5] Explanation When the rand appreciates against the dollar, it does not necessarily appreciate against other currencies as those currencies could have appreciated more against the dollar, i.e. the rand is relative worse off against those currencies. Question 14 Which of the following are macroeconomic objectives? a) unemployment, economic growth and inflation b) external stability, full employment and economic growth c) an equitable distribution of income and price stability 1) All the statements are correct. 2) a and b 3) b and c The correct alternative is [3] 4) a and c 5) None of the above statements. Explanation The macroeconomic objectives are economic growth, price stability, full employment, equitable distribution of income, and balance of payments (external) stability. Question 15 GDP is defined as Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 12 1) the total value of goods and services produced in an economy in a particular year. 2) the production of goods and services in an economy in one year. 3) the total value of all final goods and services produced within the boundaries of a country in a particular year. The correct alternative is [3] 4) the value of goods and services produced in a year. Explanation The correct definition of GDP should have all of the following aspects: total value, final, within the boundaries, time period (a year). Only statement [3] has all the aspects of the definition of GDP. Question 16 The three ways of calculating GDP are: 1) production, prices and income methods 2) income, product and services methods 3) expenditure, spending and production methods 4) income, expenditure and production methods The correct alternative is [4] Explanation The statement has all the three methods of calculating GDP. Question 17 Which one of the following is correct about the measurement of GDP? 1) If subsidies on production were lower than taxes on production, GDP at factor costs would be higher than GDP at basic prices. 2) If subsidies on products were higher than taxes on products, GDP at basic prices would be lower than GDP at market prices. 3) If taxes on products were lower than subsidies on products, GDP at market prices would be lower than GDP at basic prices. The correct alternative is [3] 4) If taxes on products were higher than subsidies on products, GDP at basic prices would be lower than GDP at factor costs. Explanation If subsidies on products are higher than taxes on products, then GDP at basic prices will be higher than GDP at market prices. Given the table below, answer question 18 Year GDP at current prices (Rmillions) GDP at constant (2003) prices (R millions) Question 18 Why are GDP at current prices and GDP at constant prices the same for the year 2003? Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 13 a) 2003 is the base year. b) The same prices are used in both instances. c) There was no inflation in the year 2003. 1) All the statements are correct. 2) a 3) b 4) c 5) a and b The correct alternative is [5] Explanation To convert GDP at current price into GDP at constant prices, all the goods and services produced in each year are valued at the prices ruling in the base year. In the base year, the GDP at current prices equals the GDP at constant prices since the same prices are used. Question 19 is based on the table below, which shows the GDP of country A at current prices for years 1 and 2. Year GDP at current prices 1 100 2 110 Question 19 Which of the following statements are correct? a) The increase in GDP from year 1 to year 2 can be the result of an increase in the general price level. b) The increase in GDP from year 1 to year 2 can be the result of an increase in production. c) It is impossible to tell from the given information whether the 10% increase in GDP from year 1 to year 2 represents economic growth. 1) All the statements are correct. The correct alternative is [1] 2) a and b 3) a and c 4) b and c 5) a Question 20 Which of the following are measurements of inequality? a) the Lorenz curve and the Gini coefficient b) the income ratio c) the quantile ratio 1) a and b 2) a and c The correct alternative is [2] 3) b and c 4) a 5) All the statements are correct. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 14 Explanation The measurements of income inequality are the Lorenz curve, the Gini coefficient and the Quantile ratio. Question 1 The consumption function is based on the premise that as income increases, consumption expenditure will: 1) Increase by the same amount. 2) Increase by a smaller amount. The correct alternative is [2]. 3) Increase by a larger amount. 4) Remains constant since the consumption function does not shift. Explanation As income increases, so does spending, but the increase in spending (or consumption) is less than the increase in income. Make sure you understand this basic assumption as it is the foundation of the Keynesian model. Question 2 Which of the following is likely to shift the consumption schedule upwards? 1) Expectations of a fall in interest rates. 2) Consumer prices are expected to fall. 3) A currently large stock of durable goods in the possession of consumers. 4) The expectation of a future rise in the consumer price index. The correct alternative is [4]. Explanation Before you attempt to pick the answer to a question out of the list of alternatives, try to work out what you expect to find amongst the alternatives. In this question, you would ask yourself: “What causes the consumption function to shift upwards?” The function is C = Co + cY and anything that increases Co will cause the curve to shift upwards. To finalise your answer, you need to look at the options and ask which one causes Co to increase. Expectations of lower prices will cause consumers to delay spending, as will decreases in interest rates. Question 3 In the Keynesian consumption function, current consumption: 1) depends upon current income. 2) does not change from one period to another. 3) fluctuates with the business cycle. 4) Both [1] and [3] above are correct. The correct alternative is [4]. Explanation In the model, consumption depends on current consumption plus changes in income which may reflect the business cycle. Question 4 In the aggregate expenditures model, the size of the MPC is assumed to be: 1) less than zero. 2) greater than one. 3) greater than zero, but less than one. The correct alternative is [3]. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 15 4) eater than one, less than two. Explanation Consumption increases as income increases, but slower than the increase in income. The marginal propensity to consume is the ratio between the change in consumption and the change in income. By definition this is greater than zero, but less than one. Question 5 The equation C = 35 + 0,75Y, where C is consumption and Y is disposable income, tells us that: 1) households will consume three-fourths of whatever level of disposable income they receive. 2) households will consume R35 if their disposable income is zero and will consume three fourths of any increase in disposable income they receive. The correct alternative is [2]. 3) households will save R35 if their disposable income is zero and will consume three-fourths of any increase in disposable income they receive. 4) households earn R35 and spend three quarters of their income. Explanation The equation C = 35 + 0,75Y tells us that if income were zero (Y=0), households would consume R35’s worth of goods and services regardless. It also tells us that for every increase of R1, households will spend 75 cents (or ¾, three quarters). With this information, you can work out that option [2] must therefore be the correct alternative. The equation defines consumption, not savings, and in effect, at the income level of zero the household dissaves by R35. Question 6 If aggregate desired expenditure is less than current output, it is likely that national income will ______________ and inventories will ________________ 1) fall; rise The correct alternative is [1]. 2) fall; fall 3) rise; rise 4) fall; remain unchanged Explanation If desired expenditure is less than current output, it means output is relatively “too high”. Firms will be accumulating inventories as more is produced than consumed. This is not a sustainable situation as there is no equilibrium. Incomes will fall and inventories will rise in order to reach equilibrium. Question 7 With respect to the aggregate expenditure function, it is true that: 1) at any point above the 45-degree line, it is likely that inventories must fall to reach equilibrium. 2) at any point on the 45-degree line, the economy is in equilibrium. 3) at any point below the 45-degree line, inventories must rise to reach equilibrium. 4) at any point on the 45-degree line, inventories are zero. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 16 Explanation Alternatives [1], [2] and [3] are correct – all students were credited with the marks for this question. Question 8 As the marginal propensity to spend increases, the aggregate expenditure curve becomes ___________ and the multiplier _____________. 1) Flatter; decreases 2) Flatter; remains the same 3) Steeper; remains the same 4) Steeper; increases The correct alternative is [4]. Explanation As the marginal propensity to spend (MPC) increases, the aggregate expenditure curve becomes steeper as a larger and larger proportion of each extra unit of income is spent. The multiplier is 1-c (1-MPC) in the denominator and therefore as c (the MPC) rises, so the multiplier will decrease. Question 9 Consider the following diagram, which depicts the Keynesian model of an open economy with government A Y=A A=C+I+G A1 =C + I + G +(X –M) A1 Y 0 Y1 Y0 Y0 represents 1) the equilibrium level of income if the economy were closed. The correct alternative is [1]. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 17 2) the equilibrium level of income if exports equal imports. 3) a level of income less than aggregate expenditure. 4) the level of income where exports equal imports. Explanation Y0 is where the aggregate expenditure curve without international trade intersects the 45 degree line and it is therefore where equilibrium in a closed economy exists. You can read that directly off the graph without any calculation. The equation includes C+I+G and does not include X and M and hence there is no international trade. All options referring to trade are therefore incorrect. Question 10 Consider the following information: Marginal propensity to consume = 0.9 Investment = R 200m Autonomous consumption = R 70m The equilibrium level of income is 1) R 300m. 2) R 2 000m. 3) R 2 700m. The correct alternative is [3]. 4) impossible to determine from the information provided. Explanation If marginal propensity to consume is 0.9, investment is R200m and autonomous consumption is R70m, then the equation will be Y0 = 70 + 0.9Y + 200. Solving the equation in Y gives an answer of R2 700. All that is required is to place the values provided in the standard equation for the Keynesian model. Question 11 In the Keynesian model, unemployment can be reduced by 1) decreasing the level of saving or decreasing consumption. 2) decreasing the level of saving. The correct alternative is [2]. 3) persuading households to reduce their consumption. 4) raising the interest rate. Explanation In the Keynesian model, unemployment results from too little spending. The saying goes in the Keynesian model that demand creates its own supply. In order to increase job opportunities, demand has to increase so goods can be produced to service the demand. Any increase in savings will necessarily cause unemployment to increase. Households must be encouraged to consume (not save) and investment must be encouraged. Higher interest rates inhibit investment. Question 12 An increase in taxes of a specific amount will have a smaller impact on the equilibrium GDP than will a decline in government spending of the same amount because: Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 18 1) the MPC is smaller in the private sector than it is in the public sector. 2) disposable income will fall by some amount smaller than the tax increase. 3) some of the tax increase will be paid out of income which would otherwise have been saved. The correct alternative is [3]. 4) Government spending may be used to buy motor vehicles. Explanation An increase in taxes of a specific amount will have a smaller impact on the equilibrium GDP than will a decline in government spending of the same amount, because each unit of income removed through taxation has a smaller effect on output, as only a proportion of the unit would have been spent (MPC is less than 1). Government spending, on the other hand, has a direct and unadulterated effect on GDP. There is no leakage from the system as is the case with income which may have been spent or saved. Question 13 Which one of the following will cause a movement down along an economy's consumption schedule? 1) an increase in stock prices. 2) a decrease in stock prices. 3) an increase in consumer indebtedness. 4) a decrease in disposable income. The correct alternative is [4]. Explanation The first three options ([1], [2] and [3]) will all cause the consumption function to shift. Only option [4] refers to a change that brings about a movement along a single consumption curve. As disposable income changes, there will be movement along the consumption curve. Question 14 The multiplier effect means that: 1) consumption is typically several times as large as saving. 2) a small change in consumption can cause a much larger increase in investment. 3) a small increase in investment can cause GDP to change by a larger amount. The correct alternative is [3]. 4) a small decline in the MPC can cause equilibrium GDP to rise by several times that amount. Explanation The multiplier effect refers to the ratio between the eventual change in income and the initial change which brought about such change. A change in consumption does not necessarily impact on investment; they are two specific variables in the equation. Following from the definition of the multiplier, it is possible that a small increase in investment may have a greater impact on GDP as the multiplier effect works its way through the economy. Question 15 Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 19 If net exports decline from zero to some negative amount, the aggregate expenditures schedule would: 1) shift upward. 2) shift downward. The correct alternative is [2]. 3) not move (net exports do not affect aggregate expenditures). 4) become steeper. Explanation What does it mean if net exports decrease? Either exports (X) fall or imports (Z) increase. Either way, X-Z in the question becomes more negative. This will cause the aggregate expenditure curve to shift downwards as imports exceed exports. Imports are a leakage or withdrawal from the circular flow of income and as they increase, so does the negative effect on the economy grow and the aggregate expenditure curve shift downwards. Question 16 The MPC for an economy is: 1) the slope of the consumption schedule or line. The correct alternative is [1]. 2) the slope of the savings schedule or line. 3) 1 divided by the slope of the consumption schedule or line. 4) 1 divided by the slope of the savings schedule or line. Explanation Since the marginal propensity to consume is one of the most important ratios in macroeconomics it is vital that you understand its impact. In graphical terms, it is the slope of the consumption function. It is c in the Keynesian model equation. Question 17 The multiplier is useful in determining the: 1) full-employment unemployment rate. 2) level of business inventories. 3) rate of inflation. 4) change in equilibrium GDP resulting from a change in spending. The correct alternative is [4]. Explanation Make sure you understand the process of multiple effects which work their way through an economy when aggregate demand changes. The multiplier does not determine the full-employment unemployment rate, the inflation rate or the level of business inventories. The multiplier effect may impact on all these variables, but the multiplier itself does not determine them. Question 18 If the MPC is 0,70 and gross investment increases by R3 billion, the equilibrium GDP will: 1) increase by R10 billion. The correct alternative is [1]. 2) increase by R2.10 billion. 3) decrease by R4.29 billion. 4) increase by R4.29 billion. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 20 Explanation To calculate the impact of the R3 billion increase in investment on equilibrium GDP, you first need to calculate the multiplier. If MPC = 0.7, then the multiplier is 1/(1-0.7) which equals 3.33. Then you multiply the result by the increase in investment to get an answer of R10 billion. Since investment increased, the resultant change in GDP must be an increase. Question 19 If the multiplier in an economy is 5, a R20 billion increase in net exports will: 1) increase GDP by R100 billion. The correct alternative is [1]. 2) reduce GDP by R20 billion. 3) decrease GDP by R100 billion. 4) increase GDP by R20 billion. Explanation In this question you are provided with the value of the multiplier, you do not have to work it out. The process is the same as for question 3.18 once you have the value of the multiplier. If net exports increase by R20 billion, equilibrium income will increase by 5 x 20, which is 100. Question 20 The above diagram shows consumption schedules for economies A and B with Ca the consumption line for economy A and Cb that for economy B. We can say that the: 1) MPC is greater in B than in A. 2) Investment at any given income level is greater in B than in A. 3) MPC is greater in A than in B. The correct alternative is [3]. 4) MPS is smaller in B than in A. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 21 Explanation The slope of A is steeper thus the MPC is greater. Question 1 Which one of the following statements is correct? 1) The aggregate demand curve (AD curve) can be shifted by monetary as well as fiscal policy measures. The correct alternative is [1]. 2) A restrictive fiscal policy will result in a rightward shift of the aggregate demand curve (AD curve). 3) A general increase in wages in the economy will shift the aggregate supply curve downward (to the right). 4) None of the above statements is correct. Explanation Statement [1] is correct, as the aggregate demand curve (AD curve) can be shifted by monetary as well as fiscal policy measures. Statement [2] is incorrect, as restrictive fiscal policy will result in a leftward shift of the aggregate demand curve. Statement [3] is also incorrect, as a general increase in wages in the economy will shift the aggregate supply curve upward (to the left). Question 2 Which one of the following statements is incorrect? 1) The aggregate AD-AS model seeks to explain the general price level and the aggregate production of goods and services. 2) The aggregate demand curve shows the aggregate quantities that are demanded at different price levels. 3) If aggregate supply falls, there will be an upward pressure on prices. 4) In terms of the AD-AS model, if aggregate demand falls, with no change in aggregate supply, the money supply will increase. The correct alternative is [4]. Explanation Statement [4] is incorrect. In terms of the AD-AS model, if aggregate demand falls, with no change in aggregate supply, no noticeable money supply change will follow as a consequence. The other statements are correct. Consider the diagram below for questions 3 and 4. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 22 Question 3 The immediate effect of a decrease in government expenditure will be to 1) move the AD curve to the left. The correct alternative is [1]. 2) move the AD curve to the right. 3) move the AS curve to the left. 4) move the AS curve to the right. Explanation Statement [1] is correct, as the immediate effect of a decrease in government expenditure will be to move the AD curve to the left. Question 4 If South Africa were to discover a plentiful supply of cheap oil, this would 1) move the AD curve to the left. 2) move the AD curve to the right. 3) move the AS curve to the left. 4) move the AS curve to the right. The correct alternative is [4]. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 23 Explanation If South Africa were to discover a plentiful supply of cheap oil, this would move the AS curve to the right. Statement [4] is therefore correct. Question 5 Which one of the following will give rise to an increase in aggregate demand? 1) a deterioration in business confidence as a result of increased political violence 2) a decrease in the repo rate. The correct alternative is [2]. 3) an increase in the company tax rate 4) a decrease in the international prices of the commodities that we export (e.g. gold, platinum, coal) Explanation Statement [2] is correct, as a decrease in the repo rate (a lower level of the repo rate) will give rise to an increase in aggregate demand, illustrated by a rightward shift of the AD curve. This is not the case with any of the other statements. Question 6 Which one of the following is an example of an expansionary fiscal policy? 1) a decrease in interest rates 2) a decrease in government spending 3) an increase in government spending The correct alternative is [3]. 4) None of these statements is an example of expansionary fiscal policy. Explanation Statement [3] is correct, as an increase in government spending is an example of an expansionary fiscal policy. Statement [1] pertains to monetary policy and statement [2] is an example of contractionary fiscal policy. Question 7 The monetary transmission mechanism: 1) explains how banks create money. 2) explains how the central bank transmits messages to other banks. 3) describes the ways in which changes in the monetary sector are transmitted to the rest of the economy. The correct alternative is [3]. 4) explains how developments in the economy affect the monetary sector, especially the banks. Explanation The monetary transmission mechanism describes ways in which changes in the monetary sector are transmitted to the rest of the economy. Statement [3] is therefore correct. Question 8 Inflation refers to: 1) a sudden increase in prices 2) a small increase in prices 3) “too much money chasing too few goods” Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 24 4) a sustained increase in the general price level The correct alternative is [4]. Explanation Inflation refers to a sustained increase in the general price level. Statement [4] is therefore correct. Question 9 If the consumer price index at the end of 2011 was 100 and at the end of 2012 was 120, then the rate of inflation for 2012 was: 1) 25% 2) 20% The correct alternative is [2]. 3) 16,66% 4) 1,5% Explanation If the consumer price index at the end of 2011 was 100 and at the end of 2012 was 120, then the rate of inflation for 2012 was 20%. Statement [2] is therefore correct. Use the data in the table below to answer question 10 (all amounts in rand) Year GDP at current prices GDP at constant 2012 prices GDP deflator 000 A B C Question 10 In the table above, A, B and C are respectively equal to: 1) 66,67, R500 000 and 100 The correct alternative is [1]. 2) 133,33, R600 000 and 66,67 3) 66,67, R600 000 and 1 4) 133,33, R500 000 and 100 Explanation In the table, A, B and C are equal to 66,67, R500 000 and 100, respectively. This implies that statement [1] is correct. Please consult pages 478 and 479 for the calculations. Please note that 2012 values are given, therefore implying that GDP values in 2012 should be the same in nominal and real terms, and the index should accordingly be 100. Question 11 If the real interest rate is negative, then 1) the inflation rate is larger (higher) than the nominal interest rate. The correct alternative is [1]. 2) the inflation rate is smaller than the nominal interest rate. 3) lenders will gain. 4) the real value of a loan will increase. Explanation If the real interest rate is negative, then the inflation rate is larger (higher) than the nominal interest rate. Statement [1] is therefore correct and statement [2] is incorrect. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 25 Statement [3] is incorrect, as borrowers will gain. Statement [4] is incorrect, as the real value of a loan will decrease. Question 12 If a country’s rate of unemployment increases then we can conclude that 1) the country is experiencing jobless growth. 2) no new jobs are being created. 3) GDP growth must be falling. 4) the proportion of people of working age who want employment but cannot find employment is increasing. The correct alternative is [4]. Explanation If a country’s rate of unemployment increases, then we can conclude that the proportion of people of working age who want employment and who cannot find employment is increasing. Statement [4] is therefore correct. On face value, statements [1] and [2] might seem correct. However, in the case of statement [1] (the country is experiencing jobless growth), it is incorrect to assume that the economy is growing, as this was not stated in the question. In the case of statement [2] (no new jobs are being created), new jobs might be created, but only to replace jobs that are no longer available, for example because businesses downscale or close. Question 13 Which of the following situations describe structural unemployment? a) John is qualified as an economist, but cannot find employment because employers prefer to hire female economists. b) Jacob used to work in a gold mine and lost his job after the price of gold fell and the mine closed. c) Johanna is a typist and cannot find employment because she does not know how to use a computer. d) Jim can only find work as a tourist guide on the Cape Wine Route during the summer months. 1) a, b and c The correct alternative is [1]. 2) a, b, c and d 3) b, c and d 4) a and d Explanation The first three statements describe structural unemployment, in other words a situation where people cannot find employment owing to the structure of the economy. This includes employment practices, businesses closing and technological advances. Alternative [1] is therefore correct. The last statement is an example of seasonal unemployment. Question 14 Reasons on the demand side of the labour market for increasing unemployment in South Africa could include a) an increase in population growth. b) an increase in the capital intensity of production. c) an increase in immigration. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 26 d) a decrease in the production of goods and services. e) an increase in the cost of employing labour. 1) a, b and d 2) a, c and e 3) b, d and e The correct alternative is [3]. 4) b and d Explanation Alternative [3] is correct. The reasons on the demand side of the labour market for increasing unemployment in South Africa could include an increase in the capital intensity of production, a decrease in the production of goods and services and an increase in the cost of employing labour. The other two statements (an increase in population growth and an increase in immigration) pertain to the supply side of labour, not the demand side. Question 15 A rightward shift of the Phillips curve 1) indicates that the trade-off between inflation and unemployment has become less severe. 2) indicates that every level of inflation is associated with more unemployment than before. The correct alternative is [2]. 3) is associated with deflation. 4) indicates an expansion in economic output. Explanation A rightward shift of the Phillips curve indicates that every level of inflation is associated with more unemployment than before. Statement [2] is therefore correct. Question 16 Which one of the following should not form part of a strategy to combat unemployment in South Africa? 1) steps to increase the capital intensity of production The correct alternative is [1]. 2) steps to limit the supply of labour 3) steps to stimulate the demand for labour 4) steps to increase the labour intensity of production Explanation A strategy to combat unemployment in South Africa should not focus on any increase in the capital intensity of production. Increased capital intensity of production will result in increased unemployment, in other words capital will replace labour. Option [1] is therefore the appropriate choice. Question 17 During a recession, cyclical unemployment will ________ and inflation will ________. 1) increase; decrease The correct alternative is [1]. 2) decrease; decrease 3) decrease; increase Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 27 4) increase; increase Explanation Option [1] is correct, as cyclical unemployment will increase and cyclical inflation will decrease during a recession. Question 18 Import substitution involves 1) the reduction of import tariffs so that an economy can export goods that were previously imported. 2) the use of import tariffs to encourage the local production of goods that were previously imported. The correct alternative is [2]. 3) the protection of industries in which an economy would traditionally have enjoyed comparative advantage. 4) the substitution of local labour with imported capital to reduce the costs of production and ensure the competitiveness of strategic industries. Explanation Import substitution involves the use of import tariffs so as to encourage the local production of goods that were previously imported. Option [2] is therefore correct. Question 19 Which one of the following statements is incorrect? Economic growth: 1) may be measured as the annual rate of increase in GDP. 2) may be measured as the annual rate of increase in GDP at constant prices. 3) may be measured as the annual rate of increase in GDP at current prices. The correct alternative is [3]. 4) should preferably be measured on a per capita basis. Explanation The correct alternative is [3], as this is the incorrect alternative. Economic growth may be measured as the annual rate of increase in GDP at constant prices, and not as the annual rate of increase in GDP at current prices, as is stated in alternative [3]. The other statements describe economic growth. Question 20 The phase of the business cycle at which almost all available resources in the economy are in use is referred to as 1) the recovery phase. 2) the peak phase. The correct alternative is [2]. 3) the expansion phase. 4) the trough phase. Explanation The phase of the business cycle at which almost all available resources in the economy are in use is referred to as the peak phase. Statement [2] is therefore correct. Question 1 Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 28 Which of the following statements are correct? a) A flow variable is measured over a specific period. b) Wealth, assets, liabilities and profit are all stock variables. c) Stocks can change as a result of flows. 1) All the statements are correct. 2) a and b 3) a and c The correct alternative is (3). 4) b and c 5) a Explanation A flow variable is measured over a specific period. The level of water in a dam changes as a result of the inflow of water. The diagram below shows the circular flow of income and spending between households and firms. Question 2 Which one of the following statements is correct? 1) Flows (2) and (3) represent income. 2) Flows (2) and (4) represent spending. 3) Flows (1) and (2) represent spending. 4) Flows (1) and (3) represent spending. The correct alternative is (4) Explanation Firms spend on the factor market (Flow 1), while households spend on the goods market (flow 3). Question 3 In the circular flow of income and spending 1) investment results in a decrease in the volume of the income flow. 2) taxes result in an increase in the volume of the income flow. 3) imports result in an increase in the volume of the income flow. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 29 4) savings result in a decrease in the volume of the income flow. The correct alternative is (4) Explanation Savings, taxes and imports are leakages from the circular flow of income and spending and therefore result in a decrease in the volume of the income. Investment is an injection into the circular flow and results in an increase in the volume of the income flow. Question 4 is based on the following diagram. Question 4 Which flows represent taxes? 1) C and D 2) E and F 3) D and E The correct alternative is (3) 4) A and B Explanation Taxes flow from households and firms to government, that is, flows D and E. Question 5 Which of the following statements are correct? a) Investment is the most important form of saving in the economy. b) Financial institution acts as intermediary between those who save and those who wish to invest. c) Financial sector is the funnel through which investment is withdrawn from the circular flow of income and spending. 1) All the statements are correct. 2) a and b 3) b The correct alternative is (3) 4) a and c Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 30 5) None of the statements is correct. Question 6 Which of the following constitute the government? 1) national government 2) local government 3) provincial government 4) All of the above The correct alternative is (4) Explanation The government includes the national government, regional (or provincial) government and the local government. Question 7 Which of the following could be considered as examples of financial institutions in South Africa? 1) Nedbank and Old Mutual Insurance Company. The correct alternative is (1) 2) South African Revenue Service (SARS) and the Iscor Pension Fund. 3) National Lottery and Coca Cola Mega Millions. 4) National Treasury and JSE Securities Exchange. Explanation Financial institutions act as links between households and firms with surplus funds and other participants (eg firms) that required funds. Question 8 Which one of the following is NOT a function of money? 1) Money serves as a medium of exchange. 2) Money serves as unit of account. 3) Money serves as a store of value. 4) Money serves as a stock and flow. The correct alternative is (4) Explanation Money is not a stock but a flow variable. Money serves as a medium of exchange, a unit of account and a store of value. Question 9 The modern bank note’s value of exchange 1) is equal to its intrinsic value. 2) is undermined by its use as a store of value. 3) is supported by gold that the SARB vaults. 4) is based on confidence. The correct alternative is (4) Explanation The value of the modern banknote is solely based on the public’s confidence in the government or monetary authorities to control the supply of money in such a way that its purchasing power does not fall substantially. If too much money is created, the public will lose confidence in its purchasing power and the perceived value of the money may collapse. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 31 Question 10 The positive balance on your cheque account is 1) an asset for you and a liability for your bank. The correct alternative is (1) 2) a liability for you and an asset for your bank. 3) an asset for both you and your bank. 4) a liability for both you and your bank. Explanation When a deposit is made at the bank it becomes an asset for a person who deposited it and a liability for a bank, because they now owe the funds to the depositor. Question 11 The South African Reserve Bank 1) is responsible for the implementation of fiscal policy. 2) is lender of last resort for those consumers who are unable to secure a loan from commercial banks. 3) is co-responsible for tax collection. 4) is responsible for the formulation of monetary policy. The correct alternative is (4) Explanation The South African Reserve Bank is responsible for, amongst others, the formulation and implementation of monetary policy. Question 12 Which of the following statements are correct? a) Banks can create demand deposits by granting credit to their clients in the form of overdraft facilities. b) When a person deposits cash in a cheque account there is no immediate change in the quantity of money. c) When the cash reserve requirement increase, the credit multiplier increases. 1) All the statements are correct. 2) a and b The correct alternative is (2) 3) a and c 4) b and c 5) c Question 13 The quantity of money available will increase when 1) a person deposits his or her money with a bank. 2) banks keep their reserves with the reserve bank. 3) banks make loans that result in additional deposits. The correct alternative is (3) 4) the government keeps its funds with the reserve bank. Question 14 If the required reserve ratio is increased, the money multiplier 1) decreases. The correct alternative is (1) 2) remains the same, as long as banks hold no excess reserves. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 32 3) could either increase or decrease. 4) increases. Explanation An increase in the cash reserve requirement of banks will reduce the credit multiplier. Question 15 The demand for money 1) for transaction purposes is determined by income and the interest rate. 2) for precautionary purposes is determined by income and the interest rate. 3) for speculation purposes is determined by the interest rate. The correct alternative is (3) Explanation The demand for money for transaction purposes and for precautionary purposes is determined by income, while the demand for speculation purposes is determined by the interest rate. Question 16 The quantity of money demanded for precautionary purposes decreases if 1) total output decreases. The correct alternative is [1] 2) consumer incomes increase. 3) the interest rate increases. 4) the inflation rate increases. Explanation If production decreases it implies a decrease in income and therefore a decrease in the demand for precautionary balances. Question 17 Which of the following statements are correct? a) The demand for money is a function of income and the interest rate. b) In general terms the liquidity preference may be expressed as L = f (Y, i). c) The supply of money is determined by demand for money and the interest rate. 1) All the statements are correct. The correct alternative is (1) 2) a 3) b and c 4) a and c 5) None of the statements is correct. Explanation a) The demand for money is a function of income and interest rate. b) The Keynes liquidity preference of money demand can be expressed as L = f (Y,i)  Where: L = demand for money  Y = level of income  i = interest rate. Downloaded by Abdra Sree () lOMoARcPSD| RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR 33 c) The supply of money is determined by the interaction of the interest rate (ie the cost of credit) and the money demand. Question 18 is based on the diagram below, which shows the money market. Question 18 Which of the following statements are correct? a) A change in equilibrium from E1 to E0 could be as a result of an increase in interest rate. b) A change in equilibrium from E0 to E1 could be as a result of a decrease in income. c) A change in equilibrium from E0 to E2 could be as a result of an increase in income. 1) All the statements are correct. 2) a 3) a and b 4) a and c The correct alternative is (4) 5) b and c Explanation An increase in the interest rate causes a movement along the money demand curve. In Economics 1A we made a distinction between a movement along the demand curve, as a result of a change in price, and a shift of the demand curve (as a result of a change in any of the other determinants of demand). The interest rate is the price of money, thus the movement along the demand curve. An increase in income leads to an increase in the demand for money. This can be illustrated by a rightward shift of the money demand curve. Question 19 The reserve banks can use the open market operations to 1) issue new currency notes.