ECON 305 PRACTICE QUESTIONS: (April 7, 2003) A. Multiple choices: 1. The monetary approach to balance of payments problems, often used by the IMF, relies on A) restricting monetary policy B) imposing domestic credit controls C) creating a recession D) letting interest rates increase E) all of the above 2. Under a system of fixed exchange rates, the process of correcting current account deficits by price and money supply adjustments is called the A) Keynesian adjustment process B) Bretton Woods adjustment process C) classical adjustment process D) J-curve effect E) sterilization 3. Under a flexible exchange rate and perfect capital mobility, an expansionary monetary policy will A) increase income in both the short run and the long run B) decrease the interest rate in the long run C) increase the price level in the short run but not in the long run D) cause an increase in the price level and a depreciation so that the real exchange rate is unchanged in the long run 4. Assume that domestic nominal interest rates decrease while domestic real interest rates increase. We can A) expect a capital inflow from countries abroad B) expect a loss in competitiveness C) assume that the domestic inflation rate has probably declined D) expect an appreciation of the domestic currency E) all of the above 5. The ______ differ(s) between monetary and fiscal policy. A) recognition lag B) action lag C) decision lag D) decision lag and the action lag E) recognition lag and the action lag 6. Which of the following is considered to be an automatic stabilizer? A) unemployment compensation B) chartered banks' reserve holding C) a discretionary increase in welfare spending in response to worsening economic conditions D) a policy rule that ties the growth rate of money supply to the unemployment rate E) an expansionary fiscal/restrictive monetary policy mix 7. Automatic stabilizers A) prolong the inside lag but reduce the outside lag B) reduce the multiplier effect of disturbances on aggregate demand C) make active fiscal policy unnecessary D) work when there is a demand disturbance but not when there is a supply shock E) always combine fiscal policy with monetary policy 8. It is always good to practice "diversification" in the use of fiscal and monetary policy to stabilize the economy since A) the size of both the fiscal and monetary multipliers are uncertain B) neither fiscal nor monetary policy works well when used by itself C) one has only a short-run effect and the other only a long-run effect D) this way full-employment can always be maintained E) none of the above 9. Assume a model with no government and where consumption is the only component of aggregate demand. If consumption is C = 400 + (0.9)Y, what is the equilibrium level of consumption? A) 400 B) 1,600 C) 2,000 D) 3,600 E) 4,000 10. In a simple model with no government and no foreign sector, a decline in investment of $10 will lead to a $50 decline in income if A) the mps is 0.2 B) the mpc is 0.5 C) the ratio of total consumption to total income is 0.8 D) changes in consumption divided by changes in income equal 0.2 E) changes in saving divided by changes in income equal 0.8 11. Assume an economy with no foreign sector, a marginal propensity to save of mps = 1/10 and a marginal income tax rate of t = 1/3. Assume that government transfer payments decrease by 200. Which of the following is true? A) national income will decrease by 450 B) tax revenues will decrease by 150 C) the budget deficit will decrease by 50 D) consumption will decrease by 450 E) all of the above 12. Assume the savings function is defined as S = – 200 + (0.25)YD and the marginal income tax rate is t = 0.5. If autonomous investment increased by 50, then the full- employment budget surplus would A) remain unaffected B) increase by 10 C) increase by 40 D) increase by 80 E) increase by 100 13. If investment becomes more responsive to changes in the interest rate, then A) the size of the expenditure multiplier will increase B) income will increase more with any increase in the interest rate C) the IS-curve will become flatter D) the IS-curve will become steeper E) both A) and C) 14. If money demand becomes more income elastic, the LM-curve will A) shift to the right B) shift to the left C) become steeper D) become flatter E) remain unaffected 15. A movement along the AD-curve from left to right is equivalent to a shift of A) the LM-curve to the right due to an increase in real money balances B) the IS-curve to the right due to a decrease in interest rates C) the LM-curve to the right due to an increase in nominal money supply D) the IS-curve to the right due to a lower interest rate E) both the IS- and LM-curves to the right due to a lower price level 16. Which of the following describes a part of the transmission mechanism A) a change in real money balances causes a portfolio disequilibrium and asset holders' reaction influences interest rates B) an income tax rate cut stimulates private spending but the resulting interest rate increase dampens the income expansion C) the Bank of Canada undertakes open market purchases and the resulting interest rate increase reduces private spending D) an increase in government spending is partially offset by the crowding out of private investment E) both B) and D) 17. Policy A is a tight-money/easy-fiscal policy mix and Policy B is an easy- money/tight-fiscal policy mix. Compared to Policy B, Policy A will cause a A) lower level of investment B) higher level of investment C) higher level of consumption D) lower level of saving E) surplus in the current account of the balance of payments 18. Crowding out A) is total (100%) if the LM-curve is vertical B) is caused by a rise in interest rates resulting from expansionary fiscal policies implemented to stimulate income C) cannot happen if the LM-curve is horizontal D) cannot happen if the IS-curve is vertical E) all of the above 19. In an open economy IS-LM model with perfect capital mobility and flexible exchange rates, restrictive monetary policy causes A) the LM-curve to shift to the left with a subsequent shift of the IS-curve to the left due to a currency appreciation B) the LM-curve to shift to the right with a subsequent shift of the IS-curve to the right due to a currency appreciation C) the LM-curve to shift to the left while the IS-curve remains the same D) the LM-curve to shift first to the left and then back to the right due to a currency appreciation E) the LM-curve to shift to the left and the IS-curve to shift to the right due to a currency appreciation B. Consider the following model: Y=C+I+G+NX (equilibrium condition Y=AD) C=10+0.8(Y+TR-TA) (consumption) TR=20 (transfer payment) TA=0.25Y (tax revenue) BS=TA-TR-G (budget surplus) I=20 (investment) G=30 (government purchase of goods and services) NX=X-Q (net export) X=30 (export) Q=10+0.1Y (import) a. Solve the numerical value of Y, TA, C, BS, Q and NX. b. Calculate the value of the multiplier. c. If we increase government purchase of goods and services G by 1 dollar, what will happen to the equilibrium output? d. If increase transfer payment TR by 1 dollar, what will happen to equilibrium output? e. If we increase the tax TA by 1 dollar, what will happen to the equilibrium output? f. Solve the value of the G that would be necessary, given the values of all other exogenous variables, to balance the government budget (BS=0) g. Solve the value of the G that would be necessary, given the values of all other exogenous variables, to let the net export NX equal to zero. h. Suppose the full employment level of output is 202. At the original levels of G and TR, we want to increase X such as to achieve the output level to Y*=202. What is the new X? Also solve for BS in this new situation. C. You are the chief economic adviser in a small open economy with flexible exchange rate system. Your big boss, the prime minister of the country, wishes to increase the level of output in the short run in order to win re-election. a. Do you recommend using expansionary or contractionary, monetary or fiscal policy? b. Use the Mundell-Fleming model to illustrate graphically your proposed policy.
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