MACRO ECON 101 PRACTICE QUIZ ANSWERS AVAILABLE

MACRO ECON 101 PRACTICE QUIZ ANSWERS AVAILABLE 1. If real GNP has doubled and nominal GNP has quadrupled we can say that: a) prices have quadrupled b) prices have doubled c) prices are unchanged d) prices have fallen by 50% 2. If you purchase $10 million worth of stock in IBM, GNP would: a) be unchanged b) rise by $10 million c) rise by $10 million plus a share of the profits earned by Digital d) rise, the exact amount of this increase would depend on whether the stock price increased during the year 3. An example of a transfer payment is: a) the salaries of public school teachers b) government spending on the military c) unemployment insurance d) private firms' payments of dividends to households 4. Disposable income: a) is unaffected by changes in taxes b) equals consumption minus taxes c) equals personal income minus taxes d) equals consumption minus saving 5. Which of the following is excluded from current calculations of GNP? a) computers exported to Europe b) the salary of the president c) a family sells an existing house d) business inventories 6. Which of the following is considered part of investment as it was defined in class? a) purchase of a company's stock b) buying government securities c) purchase of land from a real estate company d) the purchase of a new house 7. Assume that the marginal tax rate is equal to 0. If the marginal propensity to save is equal to 0.2, an increase in spending of $5 billion will raise income by: a) $5 billion b) $10 billion c) $25 billion d) $40 billion 8. Suppose that government spending and taxes both rise by $10 million. It follows that: a) income will fall b) income will rise by $10 million c) income may rise or fall because the former policy is expansionary, whereas the latter is contractionary d) income may rise or fall, but consumption will fall due to lower disposable income 9. Which of the following is a form of contractionary fiscal policy? a) an increase in taxes b) an increase in government spending c) a decrease in the money supply d) a decrease in transfers 10. In the circular flow model developed in class, government spending and investment are: a) leakages b) withdrawals c) injections d) automatic stabilizers 11. In the Keynesian income-expenditure model developed in class, which of the following is true? a) output will contract if the budget is not balanced b) output cannot be affected by policy c) the economy is on the production possibility frontier d) tax cuts and government spending can expand the level of employment and output 12. In the income-expenditure model the economy is in equilibrium if: a) exports equal imports b) aggregate expenditure is equal to output c) the budget is balanced d) consumption is equal to investment 13. The government spending multiplier: a) is greater than the tax multiplier b) is smaller than the balanced budget multiplier c) is between 0 and 1 d) is always greater than or equal to the money multiplier 14. Suppose that the government finds that temporary tax cuts are less expansionary than permanent tax cuts. This suggests that: a) consumption depends only on current income b) taxes are automatic stabilizers c) the public behaves in a manner consistent with the life cycle model d) the tax multiplier is greater than the government spending multiplier 15. Suppose that it is found that fiscal policy is fairly effective at raising output but monetary policy is ineffective at raising output. This evidence is consistent with which of the following? a) investment is relatively insensitive to interest rates b) the marginal propensity to consume is small c) the government spending multiplier is small d) the life cycle hypothesis is correct 16. Expansionary monetary policy is being pursued if there is: a) an increase in the discount rate b) a decrease in taxes c) an increase in taxes d) an open market purchase of government debt 17. As the interest rate rises: a) the present value of investment projects rises, leading to an increase in investment b) the present value of investment projects falls, leading to an increase in investment c) the present value of investment projects rises, leading to a decrease in investment d) the present value of investment projects falls, leading to a decrease in investment 18. Suppose that automatic stabilizers are built into the system. This implies that: a) tax revenue and transfers will both be raised when output is high b) during a recession both tax revenue and transfers will be low c) during a recession both tax revenue and transfers will be high d) during a recession tax revenue will be low and transfers will be high 19. If automatic stabilizers are built into the tax system: a) disposable income will fluctuate less than otherwise b) the money multiplier will be smaller than otherwise c) the life cycle hypothesis will describe consumer behavior d) monetary policy will be more effective than fiscal policy in raising output 20. Suppose that you were given two options: 1) receive a $100,000 check during each of the next two years or 2) receive a $70,000 check during each of the next three years. Suppose further that at the current interest rate you are indifferent between the two options. Which of the following is true? a) an increase the interest rate will lower the present value of both options, but 2) will be chosen b) an increase in the interest rate will lower the present value of both options, but 1) will be chosen c) an increase in the interest rate will raise the present value of both options, but 2) will be chosen d) an increase in the interest rate will raise the present value of both options, but 1) will be chosen 21. Let b = the marginal propensity to consume. The government spending multiplier is equal to: a) b/(1-b) b) 1/b c) 1/(1-b)) d) 1 22. Let b = the marginal propensity to consume. The tax multiplier is equal to: a) -b/(1-b) b) 1/b c) 1/(1-b) d) 1 23. Which of the following is true? a) the government spending multiplier without taxes (i.e. where the marginal tax rate is equal to 0) is greater than the government spending multiplier with taxes (i.e. where the marginal tax rate is positive) b) the tax multiplier is greater than the government spending multiplier with taxes c) the government spending multiplier without taxes is smaller than the government spending multiplier with taxes d) the sum of the government spending multiplier with taxes and the government spending multiplier without taxes is equal to 1 24. Which of the following will be the most expansionary? a) government spending and taxes rise by $50 billion b) government spending rises by $50 billion but taxes are unchanged c) government spending rises by $50 billion, taxes are unchanged, and the Federal Reserve buys $50 billion worth of government debt d) government spending and taxes rise by $50 billion, and the Federal Reserve buys $50 billion worth of government debt 25. Suppose that the money supply is decreased. In the new equilibrium, we can say that: a) C, I and Y will all be lower b) I will be lower, but C and Y will be higher c) I will be lower, but C and Y will be unchanged d) I will be higher, but C and Y will be lower 26. The salary of a Japanese citizen working for General Motors in the U.S. is considered part of: a) Japanese GNP b) U.S. GNP c) it depends on where the cars he (she) produces are sold d) both U.S. and Japanese GNP 27. Transfer payments: (Hint: look carefully at this one) a) are included in the government expenditure (G) category in GNP b) refer to all payments made to households by the government c) refer only to those payments made by the government that are not made in return for a good or service produced d) typically rise when output is high 28. The consumption function discussed in class refers to: a) the relationship between consumption and income b) the relation between consumption and interest rates c) the relation between consumption and taxes d) the relation between consumption and investment 29. The crowding out effect refers to the fact that: a) increased government spending may increase interest rates which in turn increases investment b) increased government spending may increase interest rate which in turn lowers investment c) higher government spending causes the budget deficit to rise d) higher government spending lowers consumption 30. A decrease in government spending will: a) cause output, interest rates, and investment all to be lower b) cause output and interest rates to be lower, but consumption to be higher c) cause output to be higher, but consumption and investment will be lower d) cause output and interest rates to be lower, but investment to be higher 31. If the crowding out effect is weak this implies that: a) monetary policy is strong b) fiscal policy is strong c) the tax multiplier is small d) the government spending multiplier is small 32. As you may know, the U.S. government is currently considering steep tariffs (taxes) on European white wines. Suppose that these taxes go into effect, and wine imports are lowered. Suppose further that U.S. exports are not affected. This implies that U.S. GNP will: a) be unchanged b) rise because of lower imports c) fall because less imported wine is consumed d) it is uncertain 33. If investment is relatively sensitive to interest rates this implies that: a) both expansionary fiscal and monetary policy will be effective b) expansionary fiscal policy will be effective, but monetary policy will be ineffective c) expansionary fiscal policy will be ineffective, but monetary policy will be effective d) both expansionary fiscal and monetary policy will be ineffective ANSWERS TO SECOND SET OF PRACTICE QUESTIONS FOR THE SECOND EXAM 1. b) Let p1x1 equal nominal GNP in year 1, and let p2x2 equal nominal GNP in year 2. In this notation pt and xt are equal to the price level and quantity of goods produced, respectively, in year t. For simplicity we have assumed that only one good is produced. As x2 = 2x1 (real GNP has doubled) and p2x2 = 4p1x1 (i.e. nominal GNP has quadrupled) it follows that p2 = 2p1 (i.e. prices have doubled). 2. a) The purchase of stock is not investment because nothing has been produced. Therefore GNP does not change. 3. c) Unemployment insurance is an example of a transfer payment because no good or service is provided. 4. c) Disposable income (Yd) is defined as personal income minus taxes, i.e. Y -T. 5. c) The sale of an existing house does not affect current GNP because nothing is being produced. Rather, ownership of an asset is being exchanged. 6. d) The purchase of a new house is counted as part of investment for two reasons: 1) it was produced in the current year 2) housing is considered to be a form of investment. Note that the purchase of stock is not investment (see the preceding question), nor is the purchase of government securities. The purchase of land is not investment because the land is not produced; rather its ownership is merely being exchanged. 7. c) The multiplier is equal to 1/(1-b), where b is equal to the marginal propensity to consume and 1 - b is equal to the marginal propensity to save, i.e. the multiplier is the reciprocal of the marginal propensity to save. Therefore the multiplier in this case is equal to 1/0.2 = 5, which implies that income will rise by $25 billion. 8. b) Income will rise by $10 million because of the balanced budget multiplier. 9. a) and d) When I wrote this question I did not realize that two answers were correct. Note that b) is expansionary and c) is a form of monetary policy. An increase in taxes or a decrease in transfers will both reduce disposable income. This in turn reduces spending, which in contractionary. 10. c) Government spending and investment are injections because funds are entered into the circular flow. Savings and taxes are withdrawals. 11. d) In the Keynesian model discussed in class, the economy suffers from unemployment and is well within the production-possibility frontier. 12. b) In order for the economy to be in equilibrium there need not be trade balance (exports do not have to equal imports) nor is it necessary that the budget be balanced. 13. a) The government spending multiplier is always greater than the tax multiplier because the former is equal to 1/(1-b) and the latter is equal to -b/(1-b). Note that even if the response is interpreted as "is greater than the tax multiplier in absolute value", the answer would still be a). Note that the government spending multiplier is always greater than 1 and that there is no connection between the government spending multiplier and the money multiplier. 14. c) If permanent tax cuts are more expansionary than temporary tax cuts, this may be due to the fact that the public wishes to smooth its consumption over time. As permanent tax cuts have a larger effect on lifetime wealth than temporary tax cuts, this result is consistent with the life cycle hypothesis. 15. a) If investment is insensitive to interest rates, fiscal policy will be relatively effective because there will be little crowding out. By contrast, expansionary monetary policy works by indirectly raising investment through lower interest rates. If investment is relatively insensitive to interest rates, monetary policy will be relatively ineffective. 16. d) Note that a) is contractionary, and b) and c) are types of fiscal policy. 17. d) As the interest rate rises, the present values of investment projects fall. Therefore fewer projects are chosen, and the level of investment falls. 18. d) During a recession income falls which implies that disposable income will also fall. However, if taxes fall and transfers rise during such a contraction, disposable income will be somewhat cushioned. Therefore the multiplier effect will be weakened, and the recession will be less severe. 19. a) This question is similar to the one just above. Note that there is no relationship between the money multiplier and the government spending multiplier. 20. b) An increase in the interest rate will lower the present value of all projects. However, projects which provide a relatively short run payoff will become relatively more attractive. As 1) is the project which provides earnings in the shorter period of time, it will become more attractive. This was a somewhat difficult question, given the limited amount of time involved. Please see me if you have further questions about this one. 21. c) 22. a) 23. a) It is clear that a) is the correct answer because 1/(1-b) 1/(1 - b(1-t)) if t 0. Note that the tax multiplier is generally smaller than the government spending multiplier so b) is incorrect, and c) is incorrect because it implies that the statement in a) is false. 24. c) It is clear that b) is more expansionary than a) because in the latter taxes are raised. It is also clear that c) is more expansionary than a) because in the former expansionary monetary policy is used. The difference between c) and d) is that in the former taxes do not rise. Therefore c) is unambiguously the most expansionary of the four options listed. 25. a) Contractionary monetary policy lowers investment, which in turn lowers income and consumption through the multiplier effect. 26. a) The services provided by a Japanese citizen contribute to Japanese GNP. The services provided by an American citizen contribute to American GNP. Note that this would be true even if the Japanese citizen were working for an American company in the U.S., or if an American citizen works for a Japanese firm in Japan. Note that there is another measure of output called Gross Domestic Product (GDP). The salary of a Japanese citizen working in the U.S. would contribute to U.S. GDP. 27. c) The key point is that transfer payments refer to payments which are not made in return for a good or service, whereas G only includes payments in return for a good or service. As transfers typically fall when output is high, d) is clearly not correct. 28. a) The consumption function refers to the relation C = c0 + bY, which was discussed at length in class. 29. b) The crowding out effect occurs because expansionary fiscal policy raises income, which raises money demand. As the money supply is unchanged, interest rates rise which in turn lowers investment. 30. d) This is similar to the question above. A decrease in government spending is contractionary. The reduction in income leads to lower money demand, which in turn lowers interest rates - thereby stimulating investment. 31. b) The crowding out effect offsets the effects of expansionary fiscal policy on output. This implies that if the crowding out effect is weak, fiscal policy will be effective. 32. b) It was noted in class that Y = C + I + G + X - Im, where X = exports and Im = imports. This implies that Y (i.e. GNP) will rise if imports fall. Some students during the exam asked whether the reduction in domestic spending on imported wine is matched by an increase in purchases of domestic wine. As long as some of dollars previously spent on imported wine are now used to buy domestic goods, imports will unambiguously fall. Unless Americans shift all of the dollars spent on European wines to other imported goods, U.S. GNP will unambiguously rise. 33. c) If investment is sensitive to interest rates monetary policy will be effective, because a given reduction in interest rates will have a large effect on output. By contrast, fiscal policy will be relatively ineffective because the crowding out effect will be relatively large. See also the answer to question 15