Department of Economics
Directions: You must complete the entire exam. Your answers should be your own work; you may
neither give nor receive help. This is a closed book exam. You may have 3 hours to
complete the exam.
Part I. Multiple Choice (35 points)
1. Because population grows over time, the best indicator of average living standards is:
A) the unemployment rate.
B) total output.
C) output per person.
D) the inflation rate.
2. The value of output was $1,000 billion in Northland and $2,000 billion in Southland. The
population of Northland was 50 million and the population of Southland was 120 million.
There were 30 million employed workers in Northland and 75 million employed workers
in Southland. Average labor productivity was higher in _________ and the standard of
living was _______.
A) Northland; the same in both countries
B) Northland; higher in Northland
C) Southland; higher in Northland
D) Southland; higher in Southland
E) Southland; the same in both countries
3. Gross domestic product (GDP) equals the ______ of final _______ produced within a
country during a given period of time.
A) market value; goods
B) market value; services
C) market value; goods and services
D) quantity; goods
E) quantity; goods and services
4. If an automobile manufacturer pays $200 for a car windshield, $400 for four car tires, $100
for a car CD player, and sells cars made with these parts for $20,000, then each car the
automobile manufacturer sells contributes how much to GDP?
5. Suppose that the total expenditures for a typical household in 1995 equaled $5,500 per
month, while the cost of purchasing exactly the same items in 2000 was $6,875. If 1995 is
the base year, the CPI for the year 2000 equals:
6. Vickie earns $1,000 per week and spends $850 per week on living expenses, puts $50 in a
savings account, and buys $100 worth of shares in a stock mutual fund. Vickie's saving is
____ and her saving rate is _____.
A) $50; 5%
B) $50; 5.9%
C) $100; 10%
D) $100; 11.8%
E) $150; 15%
7. A higher real rate of interest _____ the reward for saving and _____ the amount people
need to save to reach a given target.
A) increases; increases
B) increases; decreases
C) increases; does not change
D) decreases; decreases
E) decreases; increases
8. Where Y is GDP, C is consumption, I is investment, and G is government spending, if there
is no international trade, then national saving equals:
A) C + I + G
B) Y - C - G
C) Y + C + G
D) Y - C - I
E) Y - C - I - G
9. An increase in the government's budget deficit ____ the real interest rate and ____ the
equilibrium quantity of national saving.
A) increases; increases
B) increases; decreases
C) increases; does not change
D) decreases; increases
E) decreases; decreases
10. Financial intermediaries are firms that:
A) extend credit to borrowers using funds from savers.
B) match buyers and sellers of stocks.
C) match buyers and sellers of bonds.
D) conduct open market operations.
E) issue currency in exchange for government debt.
11. When the interest rate on newly issued bonds increases, the price of existing bonds:
C) increases only if the coupon rate is below the new rate.
D) may either increase or decrease.
E) does not change.
12. When a bank makes a loan by crediting the borrower's checking account balance with an
amount equal to the loan:
A) money is created.
B) the bank gains new reserves.
C) the bank immediately loses reserves.
D) money is destroyed.
E) the Fed has made an open-market purchase.
13. Unplanned inventory investment equals zero, when
A) planned investment is greater than actual investment.
B) planned investment is less than actual investment.
C) planned investment equals actual investment.
D) expected sales are greater than actual sales.
E) expected sales are less than actual sales.
14. In the Keynesian model, a $1 billion increase in autonomous consumption leads to ______
in short-run equilibrium output.
A) a $1billion increase
B) a greater than $1 billion increase
C) no change
D) a $1 billion decrease
E) more than a $1 billion decrease
15. In the short-run, if the Federal Reserve increases interest rates, then consumption and
investment ______, aggregate demand ______, and short-run equilibrium output
A) increase; increases; increases
B) increase; increases decreases
C) increase; decreases; decreases
D) decrease; decreases; increases
E) decrease; decreases; decreases
16. To close a recessionary gap, the Fed ____ interest rates which ______ aggregate demand
and _____ short-run equilibrium output.
A) raises; increases; increases
B) raises; decreases; increases
C) raises; decreases; decreases
D) lowers; increases; decreases
E) lowers; increases; increases
17. Countries can achieve the highest level of consumption if they specialize in the production
of the goods and services in which they have the _____ opportunity cost and then ____.
A) highest; trade on international markets
B) highest; consume only what they produce domestically
C) highest; save an amount equal to the amount they consume
D) lowest; trade on international markets
E) lowest; consume only what they produce domestically
18. Tighter monetary policy in the United States ____ net exports through a _____ dollar.
A) increases; stronger
B) increases; weaker
C) does not change; stronger
D) decreases; stronger
E) decreases; weaker
19. In applying the cost-benefit principle one should calculate the:
A) total cost and total benefit and choose that quantity of an activity where they are equal.
B) marginal cost and marginal benefit and choose that quantity of an activity where the
marginal benefit exceeds the marginal cost by the greatest amount.
C) total cost and total benefit and choose that quantity of an activity where the total cost
exceeds the total benefit by the greatest amount.
D) marginal cost and marginal benefit and choose that quantity of an activity where the
marginal benefit equals the marginal cost.
E) marginal cost, total cost, marginal benefit, and marginal cost and choose that quantity
of an activity where the marginal cost equals the total cost and the marginal benefit
equals the total benefit.
Use the following to answer question 20:
Sharon, a marketing major, has an economics test and a finance test to take tomorrow and she has
four hours tonight to allocate to studying the two subjects. The data below show her scores on the
two tests based on the time spend studying. (Hint: Studying economics for 0 hours means studying
finance for 4 hours.)
Hours Spent Studying Economics
0 1 2 3 4
Economics Score 65 77 86 89 91
Finance Score 80 79 77 70 50
20. To efficiently allocate her time, Sharon should study economics for __________ hours and
finance for __________ hours.
A) 2; 2
B) 1; 3
C) 3; 1
D) 0; 4
E) 4; 0
Use the following to answer question 21:
Per Hour Per Hour
Jenny 3 2
Craig 4 3
21. Based on their comparative advantages, Craig should specialize in producing __________
while Jenny should specialize in producing __________.
A) shoes; pants
B) both; neither
C) neither; both
D) pants; shoes
E) pants; pants
22. Which of the following would cause an increase in quantity supplied?
A) The price farmers receive for their crops rises.
B) The United Auto Workers negotiates a wage increase for its union members.
C) The price firms pay for liability insurance falls.
D) New, faster computer processors are introduced.
E) OPEC limits the production of crude oil.
23.In a market where government has set the price artificially low, one would expect
A) quantity demanded to equal quantity supplied.
B) excess supply.
C) a black market to develop as individuals try to take advantage of unexploited
D) quantity supplied to surpass quantity demanded.
E) suppliers and demanders are content.
24. Assume the marginal utility of the 3rd candy bar is 15, the marginal utility of the first tube
of toothpaste is 12, the price of a candy bar is $1.50/bar and the price of toothpaste is
$2.00/tube. If one buys three candy bars and a tube of toothpaste, is one applying the
rational spending rule correctly?
A) Yes, this is an optimal combination of candy and toothpaste.
B) No, spend less on candy and more on toothpaste.
C) No, spend more on candy and less on toothpaste.
D) No, spend more on both candy and toothpaste.
E) No, spend less on both candy and toothpaste.
Use the following to answer question 25:
Price of Mark’s quantity Bob’s quantity Joe’s quantity
Coffee per lb demanded demanded demanded
$3 6 10 19
$4 4 7 15
$5 2 6 11
$6 1 4 9
$7 0 3 8
25. If the price of coffee increases from $6 to $7, total revenues _________, suggesting market
demand is ________.
A) increase; elastic
B) decrease; elastic
C) increase; inelastic
D) decrease; inelastic
E) remain constant; unit elastic
26. Given the following demand curve, P = 55 - .048*Q, the absolute value of price elasticity
of demand when P = $20 is
27. The law of diminishing marginal returns
A) is a long run concept.
B) applies only to small and medium sized firms.
C) is a short and long run concept.
D) applies only to large firms.
E) is a short run concept.
28. If the firm produces an output level where price is greater than marginal costs, then the firm
A) pay more to its variable factors of production.
B) pay more to its fixed factors of production.
C) contract output to earn greater profits or smaller losses.
D) expand output to earn greater profits or smaller losses.
E) leave its output decision unchanged.
29. The shutdown condition for a firm is where
A) total revenues are less than the total cost of fixed and variable factors of production.
B) total revenues are less than the cost of variable factors of production.
C) total revenues are less than the cost of fixed factors of production.
D) profits are negative.
E) profits are zero.
30. Given the total cost function, TC=100+7*Q, fixed costs are
31. Given the total cost function, TC=531+14*Q, marginal costs are
E) impossible to calculate with information provided.
Use the following to answer questions 32-34:
32. At the point of monopoly profit maximization, consumer surplus is represented by the area
33. A perfectly competitive equilibrium would have resulted in a price equal to the distance
__________ and a quantity equal to the distance __________.
A) 0B; 0A
B) 0G; 0H
C) 0C; BK
D) 0J; CE
E) 0G; AH
34. The deadweight loss resulting from monopoly is represented by the area
Problems (45 points)
1.You have just been appointed Economics Minister of Pseudopais. It is your job to institute
policies that will bring your country to full employment. Your staff reports the following
to you about current policy and spending:
Government Spending G = 50
Investment Spending I = 40
Net Exports NX = 10
Taxes T = 12.50 + .25*Y
Consumption Spending C = 150 + .8(Y-T)
a. Calculate equilibrium national income.
b. What is the government surplus/deficit?
T=12.5+.25(600), G = 50, Surplus = 112.5
c. If full employment income/output is 850, what is the size of the GDP gap?
d. At the present equilibrium, what is the recessionary gap?
e. Compute the new equilibrium that would result if the lump sum tax of 12.50 were reduced
Done similarly to a.: Y=625
f. What fiscal policy would you recommend for getting the economy to full employment? Be
specific, include numbers.
Y=600, we want Y = 850, so we need Y=250. To get this we can set G=150, or I=140,
or NX=110. In any case the change in autonomous spending is 100. From your
answers to the earlier parts you might have noticed that the multiplier was 2.5,
otherwise you could do this part by trial and error.
2. During the summer in Elmtown, lemonade is sold at many small stands on street corners in
residential neighborhoods. All stands are independently owned and operated by school children.
They are also equally efficient and sell lemonade of the same quality.
Each stand has a U-shaped long run average cost curve that reaches a minimum value of $.25 at
q = 40 cups per day. In addition, factor prices (for lemons, sugar, etc.) and production conditions
are unaffected by the scale of the industry. To a first approximation, therefore, lemonade in
Elmtown is a constant cost competitive industry. The consequence is that the supply curve for
lemonade in Elmtown is a horizontal line at $0.25.
The daily Elmtown demand for lemonade is Q = 500 - 400P.
The lemonade market can be depicted as in the following diagram.
Lemonade in Elmtown
0 200 400 600
a. What are equilibrium price and quantity?
Price = _______.25_____ Quantity = _____400_________
b.How many stands are there and how many cups of lemonade is each selling per day?
Stands = _____10______ Cups = ______40__________
c. How much consumer surplus are lemonade buyers as a group receiving?
Consumer Surplus = ___1/2 (1.25-.25)(400) = 200__
Buffy Warren (age 11) lives in Elmtown and studied economics in fifth grade. She sees that
selling lemonade would be much more profitable if all stands were owned by a single firm and the
entry of new ones prohibited. Using money from an inheritance, she buys out all the existing
stands and bribes the Elmtown City Council to give her an exclusive franchise. She names her
new company Lemonopoly.
d. What price will Lemonopoly charge and what quantity will it produce?
P1 = ______.75__________ Q1 = ________200_________
e. How many of the original stands will it close? ______5__________
f. What profit will it earn? 1 = __(.75-.25)(200)=100____
g. How much consumer surplus will lemonade buyers receive?
C1 = _(1/2)(5/4 – ¾)(200) = 50__
h. What deadweight loss will monopolization impose? = ________50_
Essay (20 points) Please err on the side of brevity and clarity.
As president of the central bank of Pseudopais it is your job to formulate monetary policy. You
have reviewed the most recent economic figures and determined that there is an inflationary gap in
the economy. Explain the appropriate course of action for the central bank. Your answer should
include an explanation of the consequences of your policy recommendation.
Sell bonds Money supply Interest rate (r)
C AD Output
Your answer would be in essay form, but would convey the message of my flow chart. Start in the upper left
corner and read left to right, then go down to the row that begins with r.