Part I - (50%) Multiple Choice (1% each).  On a scantron form, mark the single best answer.  Put your name on the scantron, and turn it in with this exam.  You have 120 minutes to complete this exam.

1.  Gross domestic product is:
    a) The total income of all the residents of a country during a specified period, including income from abroad but not payments made to those abroad.
    b) The total money value of the goods and services produced by the residents of a country during a specified period.
    c) The total money value of goods and services produced by the residents of a country during a specified period, adjusted for changed in prices.
    d) The total money value of the goods and services the residents of a country could produce during a specified period if labor and machines were used to capacity.

2.  Real gross domestic product (real GDP):
    a) Equals nominal GDP divided by the price level.
    b) Equals nominal GDP multiplied by the price level.
    c) Divided by the price level equals nominal GDP.
    d) Divided by nominal GDP equals the price level.

3.  The total money value of the goods and services the residents of a country could produce during a specified period if labor and machines were used to capacity is known as:
    a) Real gross domestic product.
    b) Net domestic product.
    c) Gross domestic product.
    d) Potential gross domestic product.

4.  A recession is said to occur when:
    a) Nominal gross domestic product exceeds real gross domestic product.
    b) Real gross domestic product declines for two consecutive quarters.
    c) The growth rate of real gross domestic product falls for two consecutive quarters.
    d) Real gross domestic product is below potential gross domestic product.

5.  Discouraged workers:
    a) Are counted among the unemployed.
    b) Are employed workers who do not like their work.
    c) Are not counted as part of the labor force.
    d) Have left work because they were low paid.

6.  Unemployment that occurs as the result of a transition from one job to another is called:
    a) Frictional unemployment.
    b) Voluntary unemployment.
    c) Structural unemployment.
    d) Cyclical unemployment.

7.  Government policy is aimed at reducing the frequency and magnitude of:
    a) Frictional unemployment.
    b) Seasonal unemployment
    c) Cyclical unemployment
    d) Structural unemployment

8.  In 1973 the consumer price index (1983 = 100) was 44; in 1994 it was 148.  The increase in consumer prices between 1973 and 1994 was:
    a) 48 percent
    b) 148 percent
    c) 236 percent
    d) 336 percent

9.  If the substitution effect of an increase in the interest rate normally outweighs the income effect, then the increase has a:
    a) Negative effect on the rate of savings.
    b) Positive effect on current consumption.
    c) Negative effect on the nominal rate of interest.
    d) Positive effect on the rate of savings.

10.  An increase in the wage rate has an income effect and a substitution effect, which operate in opposite directions.  If the substitution effect dominates, the labor-supply curve:
    a) Is vertical.
    b) Is upward-sloping.
    c) Is downward-sloping.
    d) Is horizontal.

11.  If the nominal rate of interest is 12 percent and the rate of inflation is 8 percent, the real rate of interest is:
    a) 4 percent
    b) 20 percent
    c) 8 percent
    d) minus 4 percent

12.  An increase in the interest rate:
    a) Has no effect on the present discounted value of investment projects.
    b) Increases the present discounted value of investment projects, making more of them profitable.
    c) Reduces the present discounted value of investment projects, making more of them profitable.
    d) Reduces the present discounted value of investment projects, making fewer of them profitable.

13.  If the wage is rigid, and the labor demand curve shifts leftward:
    a) The wage is now above the market-clearing level, and labor supply exceeds labor demand, resulting in unemployment.
    b) The wage is now below the market-clearing level, and labor supply exceeds labor demand, resulting in unemployment.
    c) The wage falls to the new market-clearing level, but labor supply exceeds labor demand, resulting in unemployment.
    d) The wage is now below the market-clearing level, and labor demand exceeds labor supply, resulting in unemployment.

14.  A point of consensus among economists is their agreement on the crowding-out effects of increased government spending when a closed economy is at full employment.  They agree that higher government spending:
    a) Restricts equilibrium employment below what it would otherwise be.
    b) On one activity restricts government spending on some other activity.
    c) Restricts equilibrium consumption and investment.
    d) Increases output but by less than the amount of the increased spending.

15.  If the federal government spends more in any year than it receives in revenues, the difference is called the:
    a) The federal shortfall.
    b) The federal deficit.
    c) The federal debt.
    d) The federal surplus.

16.  When money is neutral, an increase in the money supply affects only the equilibrium:
    a) Level of output.
    b) Level of investment.
    c) Real wage.
    d) Price level.

17.  All of the following, except one, would be expected to give rise to a leftward shift in the aggregate demand curve in the United States.  Which is the odd one out?
    a) An economic downturn in Europe.
    b) An increase in government spending.
    c) A decline in new business investment.
    d) A reduction in exports.

18.  Changes in government expenditures and taxes, aimed at improving macroeconomic performance, are referred to as:
    a) Demand shocks
    b) Corrections of market failure
    c) Fiscal policy
    d) Monetary policy

19.  The future-oriented theories of consumption proposed by Milton Friedman and Franco Modigliani share the common feature that individuals:
    a) Save during their workings years to provide for consumption during their retirement.
    b) Save in bad years to provide for consumption in goods years.
    c) Base consumption decisions on their current income.
    d) Alter their consumption less in response to a temporary change in income than to a permanent change.

20.  One of the reasons aggregate consumption expenditures fluctuate with current income is that:
    a) When current income is low, households buy durable goods sooner than they otherwise might.
    b) Durable goods are purchased regardless of the level of current income
    c) When current income is high, households buy only nondurable goods.
    d) When current income is low, households postpone purchases of durable goods.

21.  Which of the following should not be counted as part of the investment component of aggregate expenditures?
    a) The purchase of a share of stock
    b) Additions to an existing factory
    c) Increases to the level of inventories
    d) Construction of a new apartment complex

22.  Economists consider checks to be money because:
    a) They are guaranteed by the banks on which they are drawn.
    b) They are completely backed by banks’ reserves
    c) Individuals are willing to accept them in exchange for goods.
    d) The government has declared them as legal tender

23.  The measure of the money supply referred to as M1 consists of:
    a) Currency and coin
    b) Currency, coin, traveler’s checks, and demand deposits
    c) Currency, coin, traveler’s checks, demand deposits, and savings deposits of less than $100,000
    d) Currency, coin, traveler’s checks, demand deposits, and savings deposits of less than $100,000, certificates of deposit, money market mutual funds, and Euro dollars.

24.  The Federal Reserve System does all of the following except one.  Which is the odd one out?
    a) Set tax rates
    b) Lend money to member banks
    c) Control the money supply
    d) Regulate the banking system

25.  Open market operations, the most important means by which the Fed controls the money supply, involve:
    a) Changing the discount rate.
    b) Setting interest rates.
    c) Changing the reserve requirement.
    d) Buying and selling government bonds.

26.  Assume that the price level is fixes and there is excess capacity in the economy.  When an increase in the money supply lowers the interest rate and increases investment and national income, the increase in national income is larger:
    a) The more elastic is the demand for money.
    b) The more inelastic is the investment schedule.
    c) The more inelastic is the demand for money.
    d) The smaller is the multiplier.

27.  Many economists believe, as did Keynes, that in a recession:
    a) Investment spending is not very responsive to changes in the interest rate.
    b) Monetary policy is at its most effective.
    c) Investment spending is very responsive to changes in the interest rate.
    d) Fiscal policy is completely ineffective.

28.  Altering monetary policy to keep the interest rate constant when fiscal policy increases aggregate expenditures, national income, and money demand, which would otherwise increase the interest rate, is termed:
    a) The multiplier.
    b) Accommodative monetary policy.
    c) The money multiplier.
    d) A fiscal stimulus.

29.  Automatic stabilizers are:
    a) Programs, such as unemployment insurance or progressive taxation, that increase the deficit during recessions and reduce it during economic booms.
    b) Policy rules that restrain the use of discretionary fiscal and monetary policy.
    c) The adjustments that individuals with rational expectations make to offset fiscal and monetary policy.
    d) Market responses, such as increased interest rates, that limit the ability of government to stimulate the economy.

30.  All of the following, except one, are reasons advanced for why wages do not fall enough to eliminate unemployment when labor demand decline.  Which is the odd one out?
    a) Union contracts
    b) Implicit contracts
    c) Minimum wage law
    d) Firms do not maximize profits

31.  Efficiency wage theory argues that firms may not lower wages in the face of persistent unemployment because the firms:
    a) Believe that higher wages may lead to higher productivity.
    b) Believe that the labor supply curve is perfectly elastic.
    c) Have signed a union contract that fixes the wage.
    d) Have entered into an implicit contract with the workers.

32.  Efficiency wage theory argues that a higher unemployment rate:
    a) Can lead to the efficiency wage falling below the market wage.
    b) Will encourage greater effort even without an increase in the wage.
    c) Would be eliminated if wages were increased.
    d) Could be easily eliminated with work-sharing schemes.

33.  Which of the following schools of macroeconomics thought is least likely to argue that monetary growth should be pegged to the growth of real output?
    a) Real Business Cycle theorists
    b) Monetarists
    c) New Keynesians
    d) New Classical economists

34.  The idea that actions of rational individuals offset the impact of government actions is associated with:
    a) Real Business Cycle theory.
    b) Monetarism.
    c) New Keynesianism.
    d) New Classical theory.

35.  Which policy likely promotes labor mobility?
    a) Moral suasion
    b) Regulations requiring notification in anticipation of layoffs
    c) Training programs for displaced workers
    d) Automatic stabilizers

36.  Lower savings leads to:
    a) A lower interest rate, which leads to lower investment.
    b) A higher interest rate, which leads to lower investment.
    c) A lower interest rate, which leads to higher investment.
    d) A higher interest rate, which leads to higher investment

37.  Human capital refers to:
    a) Education and skills that increase the productivity of individuals.
    b) Fertility.
    c) Output per hour worked.
    d) The capital goods that workers use on the job.

38.  During the 1980s, the United States ran:
    a) Typical peacetime federal budget surpluses.
    b) Typical peacetime federal budget deficits.
    c) Very high federal budget deficits.
    d) Very high federal budget surpluses.

39.  Because of the increase in life expectancy:
    a) The number of workers per retired person will decrease.
    b) Medicare payments will increase.
    c) Social Security payments will increase.
    d) All of the above

40.  The fraction of the Social Security Trust Fund currently invested in equities is about:
    a) Zero.
    b) One-fourth.
    c) One-half.
    d) One.

41.  When a tariff is introduced:
    a) Domestic producers lose because they sell fewer goods at a lower price.
    b) Domestic producers gain because they sell more goods at a higher price.
    c) Domestic producers gain because they sell the same quantity but at a higher price.
    d) Domestic consumers gain because they pay lower prices for a greater quantity.

42.  Voluntary export restrictions and quotas are examples of:
    a) Fair trade laws.
    b) Non-tariff barriers.
    c) Tariffs.
    d) Anti-dumping laws.

43.  In an open economy, the trade surplus equals:
    a) Private savings – government savings + investment.
    b) Investment -private savings – government savings.
    c) Private savings + government savings – investment.
    d) Government savings – private savings + investment.

44.  Specialization based upon comparative advantage:
    a) Promotes self-sufficiency.
    b) Allows strong countries to exploit their comparative advantage at the expense of weak countries.
    c) Reduces relative costs of production.
    d) Increases total world production.

45.  The infant industry argument advocates:
    a) Temporary protection while firms gain experience needed to compete with foreign rivals.
    b) Lowering prices to drive foreign rivals out of business.
    c) Subsidizing firms that face competition from foreign firms subsidized by their governments.
    d) Quotas rather than tariffs.

46.  In the former Soviet Union, the question of which goods were produced, and in what quantities, was determined largely by:
    a) Markets
    b) Government ministries
    c) Unions
    d) Consumers and firms

47.  In the former Soviet Union, Joseph Stalin focused investment in:
    a) Agriculture.
    b) Services.
    c) Heavy industry.
    d) Export industries.

48.  In China in the late 1970s and early 1980s, agricultural products grew more quickly than it had hitherto.  The faster growth followed:
    a) The overthrow of a totalitarian government and its replacement by a democratically elected one.
    b) A decision by the state to invest more heavily in agriculture.
    c) A rejection of market-based methods in favor of a greater emphasis on central planning.
    d) Reforms that allowed farmers to sell most of what they produced and keep the proceeds.

49.  Several countries that were less developed countries have more recently become middle-income countries.  These countries are sometimes called:
    a) Newly industrialized countries.
    b) Newly developed countries.
    c) Emerging countries.
    d) Formerly less developed countries.

50.  All the following, except one, are characteristics of a less developed country, relative to a developed one.  Which is the odd one out?
    a) Lack of capital
    b) High population growth
    c) High rate of return on capital
    d) Low levels of education

Part II - (50%) Problems and Short Essays.  Use the back of the page if necessary, noting where your answer continues.

1.  (10%) Suppose the country of Ricardinia has 1 million rural workers and 1 million urban workers.  Each rural worker can produce 100 units of agricultural goods because they have more land, while each urban worker can only produce 10 units of agriculture because the building give too much shade and the empty lots are cramped.  However, rural workers can only produce 25 units each of industrial goods due to difficulties getting parts; urban workers have better transportation and access to suppliers, so each of them can produce 200 units of industrial goods.

    a) Suppose each worker spends ¼ of his or her time producing agricultural goods, and the other ¾ producing industrial goods, regardless of where they live.  Putting agriculture (A) on the horizontal axis and industry (I) on the vertical axis, show on a graph how much they would produce of each good (remember to multiply by the number of workers).  Then show how much they would produce if they each spent all their time producing industry, or all their time producing agriculture.

    b) What is the opportunity cost of farming for each group of workers?  Who has the comparative advantage in which good?

    c) How much of each good would this country produce if its workers fully specialized according to comparative advantage?  Show this on your graph above, and also show there the country’s Production Possibility Frontier.

2. (5%)  What is money?  What are its characteristics?  Why is money necessary in a modern economy?

3.   (10%) Suppose all members of the public deposit any and all additions to their holdings of money into a bank, while banks hold 12.5% of all deposits in reserve and lend the rest.

    a) If the Federal Reserve buys $10 million in Treasury Bonds on the open market, how does this affect the overall money supply?

    b) How does this change in the money supply affect the interest rate, the inflation rate, the exchange rate, the growth rate, and the unemployment rate?  Give a brief explanation for each answer.

4. (10%)  Suppose you have estimated the following functional relationships for the U.S. economy in 1996:  consumption expenditures C =7/8?×(Y-T), where Y equals GDP and T equals net taxes, where T=0.20×Y, net exports NX= X-Imp, where X=500 and Imp = 1/8×(Y-T), gross private investment I=900, and government purchases G=1600.  Assume the marginal propensities to consume and import are fixed, and prices, interest rates, and exchange rates do not change.

    a) Solve for Aggregate Expenditures as a function of GDP, in the form AE = a + bY.

    b) Solve for (i) equilibrium GDP in 1996, (ii) the government budget surplus or deficit, and (iii) the trade surplus or deficit.

    c) You just heard the news that Al Gore has signed a trade deal with China, and you predict that exports will rise from 500 to 600.  How will this affect equilibrium GDP?  How will this affect the government budget surplus/deficit and the trade surplus/deficit?  Give amounts.

    d) Show your solutions for equilibrium GDP, for both (a) and (b), on an aggregate expenditures graph (Keynesian cross).


5.  (10%)  Using the AD/AS model with an SRAS curve for an large open economy with sticky prices operating near full employment:

    a) Describe the macroeconomic effects of combining an increase in taxes with an increased money supply.

    b) Describe (and show) how this would affect the capital market and the foreign exchange market.

    c) How would your answer change if both taxpayers and investors were currently worried about the long-run effects of the federal budget deficit?

6.  (5%) Suppose that welfare reform reduces the benefits available to the jobless.  How would you predict that this would affect both the efficiency wage and the unemployment rate?  Use the appropriate graphs in explaining both effects.

Bonus:  Back in the 1970's, news of high growth, low inflation, and low unemployment rates generally led to increasing prices in the stock market.  Now, news of low inflation still improves stock prices, but reports of high growth and low unemployment often lead to declines in the stock market.  Newspaper headlines have labeled this phenomenon as “Wall Street versus Main Street.”  Using what you have learned in class, explain this phenomenon.  Can you explain why it was different in the 1970's?  Does it mean that the Fed is currently doing a bad job, or a good job?  Explain.