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CITY UNIVERSITY OF HONG KONGNOT TO BE TAKEN AWAYCourse code & title : EF 2401: Economics IISession : Semester A 2012/Time allowed : Two hoursThis paper has NINE pages (including this cover page). This paper consists of two sections. Section A contains 30 multiple choice questions Section B c...

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CITY UNIVERSITY OF HONG KONG

NOT TO BE TAKEN AWAY

Course code & title

:

EF 2401: Economics II

Session

:

Semester A 2012/13

Time allowed

:

Two hours

This paper has NINE pages (including this cover page).

1.

This paper consists of two sections.

2.

Section A contains 30 multiple choice questions

3.

Section B contains 2 questions.

4.

Answer ALL questions in Section A and ALL questions in Section B.

5.

Use the multiple choice answer sheet to answer the questions in Section A.

6.

Answer the questions for Section B using the answer book provided.

This is a closed-book examination. Candidates are allowed to use the following materials/aids: 1. Approved calculator. Materials/aids other than those stated above are not permitted. Candidates will be subject to disciplinary action if any unauthorized materials or aids are found on them.

EF 2401: Economics II Semester A 2012/13 This exam has a total of 100 points. Section A: Multiple Choice (30 Questions  2 points each, 60 points total) Answer all questions in this part. Choose only one answer, the best answer. 1. In the early 2010s much of Europe and North America was in recession. We expect that in the short run, this caused Chinese net exports to

A. B. C. D. E. 2.

rise, and so Chinese GDP to decrease. rise, and so Chinese GDP to increase fall, and so Chinese GDP to decrease fall, and so Chinese GDP to increase None of the above are correct.

Which of the following will usually NOT decrease the short run aggregate demand for goods and services:

A. B. C. D. E.

real household wealth increases the interest rate rises the dollar appreciates income tax rate increases None of the above are correct answers.

3. By using the concept of purchasing-power parity, we can compare inflation rates between countries in order to determine

A. B. C. D. E.

changes in nominal exchange rates in the short run. changes in nominal exchange rates in the long run. changes in real exchange rates in the short run. changes in real exchange rates in the long run. None of the above are correct.

4. If the Japanese Yen appreciates perhaps because of speculation or government policy then Japanese

A. B. C. D. E. 5.

net exports increase and aggregate demand shifts left. net exports increase and aggregate demand shifts right. net exports decrease and aggregate demand shifts left. net exports decrease and aggregate demand shifts right. None of the above are correct.

Which of the following shifts Aggregate Supply to the left?

A. B. C. D. E.

A decrease in the money supply. Technological progress that increases the profitability of capital goods. An increase in world prices for the commodities that we import. A decrease in income taxes. An increase in foreign demand for our exports.

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6.

Suppose that there has been some kind of natural disaster, bad weather, an earthquake, or some other event that reduces the productive capacity of some companies. According to the quantity theory of money, if the growth rate of money supply remains unchanged, we would expect that:

A. B. C. D. E. 7.

both inflation and real GDP growth will rise. both inflation and real GDP growth will fall. inflation will fall, but real GDP growth will rise. inflation will rise, but real GDP growth will fall. None of the above are correct.

Today, most governments and central banks offer lender-of-last-resort facilities to commercial banks and deposit insurance to commercial bank customers. Because of this

A. bank runs are uncommon, and even when they happen, they cause less disruption to the financial system. B. bank runs are more common than before, but they cause less harm to the economy. C. bank runs are uncommon, but when they happen, the financial system will collapse causing widespread panic. D. the governments of most countries are nearly bankrupt. E. None of the above are correct. 8. Suppose that Argentina had a budget surplus last year, but due to changes in the government budget, this year they experience a deficit. This action will

A. increase national saving and shift Argentina's supply of loanable funds to the right. B. increase productive capacity and shift the Aggregate Supply curve to the right. C. decrease planned expenditures and shift the Aggregate Demand curve to the left. D. increase money supply and lower real interest rates. E. None of the above are correct. 9.

Which of the following policy alternatives would NOT be an appropriate response to a sudden decrease in investment demand, if the government wants to stabilize output and inflation?

A. B. C. D. E.

Increase the money supply Increase minimum wages Increase government expenditures Increase central bank holdings of foreign exchange None of the above are correct.

10. In the 16th century, when Europe used gold and silver as money, for more than 100 years the Spanish Empire brought in large amounts of gold and silver from the Americas. This caused a series of economic events that became known as the Price Revolution. Given your understanding of macroeconomics, which of the following likely happened?

A. Higher nominal interest rates, and higher inflation. B. Lower economic growth and higher unemployment.

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C. Lower inflation and higher investment. D. Higher inflation, and higher unemployment. E. Higher real interest rates, and lower investment. 11. Suppose the economy is experiencing an expansionary gap. Output is above long run capacity and unemployment is below the natural rate. As the economy adjusts back to the long run equilibrium, we should expect that,

A. B. C. D. E.

Both inflation and unemployment rises. Inflation falls and output stays the same. Inflation rises and unemployment falls. Inflation rises in the short run but falls in the long run. None of the above are correct.

12. Economists generally favor using monetary policy to stabilize the economy because:

A. If the exchange rate is fixed, fiscal policy cannot offset changes in the unemployment rate. B. Fiscal stabilization policy is inflexible and unreliable, because it depends on a political process, and there are long lags in the implementation of fiscal stabilization policy. C. Neither monetary policy nor fiscal policy are able to affect the unemployment rate. D. Expansionary monetary policy can shift the AS curve to the right and increase a country’s long run rate of economic growth. E. None of the above are correct. 13. In the 1970’s many countries experienced both high inflation and high unemployment. They called it ‘Stagflation’. According to the Keynesian AD-AS model, stagflation can be caused by

A. B. C. D. E.

A shift to the right of the AS curve A shift to the right of the AD curve A shift to the left of the AS curve A shift to the right of the AS curve combined with a shift to the right of the AD curve. A shift to the right of the AS curve combined with a shift to the left of the AD curve.

14. For the past several years, China has kept its exchange rate undervalued by constantly selling RMB (the local currency) and accumulating foreign reserves. Suppose the Chinese government decides to float the RMB and allow flexible exchange rates. Which of the following will likely happen?

A. B. C. D. E.

Inflation will accelerate. Chinese consumers will buy more imported goods. China’s trade surplus will increase. The Chinese currency will depreciate. Export manufacturer’s profits will increase.

15. The quantity theory of money states that MV = PY. Assume that velocity is stable. Suppose real income grows at 7 % per year. What should the growth rate of money supply be if we want 2% inflation in the long run?

A. 2% B. 3.5% C. 5%

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D. 7% E. 9%

16. When the central bank of a flexible-exchange-rate country raises it’s interest rate target,

A. Aggregate Demand rises and its currency depreciates relative to other currencies in the world. B. Aggregate Demand rises and its currency appreciates relative to other currencies in the world. C. Aggregate Demand falls and its currency depreciates relative to other currencies in the world. D. Aggregate Demand falls and its currency appreciates relative to other currencies in the world. E. None of the above are correct. 17. During long recessions or depressions, when many workers have been unemployed for a long time, some of them become discouraged and stop looking for work, this causes:

A. B. C. D. E.

A drop in both the unemployment rate and the labor force participation rate. An increase in both the unemployment rate and the labor force participation rate. A drop in the unemployment rate, but an increase in the labor force participation rate. An increase in the unemployment rate, but a drop in the labor force participation rate. None of the above are correct.

18. When constructing the CPI, the Department of Statistics tries to include

A. B. C. D. E.

all all all all all

goods goods goods goods goods

produced in the economy. and services produced in the economy. and services sold in the economy. and services that a typical consumers buy. (but not services) bought by a typical consumer.

19. In the long run, a higher real interest rate induces people to

A. B. C. D. E.

save more, so the demand for loanable funds slopes upward. save less, so the supply of loanable funds slopes downward. invest more, so the supply of loanable funds slopes upward. invest less, so the demand of loanable funds slopes downward. None of the above are correct.

20. If the government increases taxation without changing government spending, then

A. the supply for loanable funds in the financial markets shifts right B. the supply for loanable funds in the financial markets shifts left and the demand shifts right. C. the demand for loanable funds in the financial markets shifts right 5

D. neither curve shifts, but the interest rate falls to equilibrate supply and demand. E. None of the above are correct. 21. Which of the following is NOT considered part of consumption spending?

A. B. C. D. E.

buying new housing spending on foreign goods buying durable goods like cars and washing machines spending on medical services spending on intangible luxury services.

22. According to the Keynesian AD-AS model, in the short run, an increase in the growth rate of money supply will cause,

A. B. C. D. E.

lower inflation, and lower unemployment. higher investment, and higher unemployment. higher consumption and higher investment. higher real interest rates, and higher inflation. None of the above are correct.

23. Which of the following best describes the action of “automatic stabilizers” in the economy:

A. There are laws and government policies (e.g. income tax, social welfare) that automatically change the government budget balance in response to output gaps. B. The central bank will automatically increase or decrease money supply to keep interest rates stable. C. Consumers will spend more when incomes go up – the effect of any change in spending will be multiplied. D. Even without changes in government policy, the economy will automatically stabilize itself in the long run – unemployment will automatically reach the natural rate of unemployment. E. None of the above are correct. 24. According to the simple Keynesian model, if the government increases spending by $100 billion, and the marginal propensity to consume is 0.75, in short run equilibrium (prices remain constant), this increase in government spending will cause

A. B. C. D. E.

private savings to increase by about $25 billion. consumption to rise, but investment will fall by the same amount. national income to rise by about $175 billion. consumption to rise by about $300 billion. None of the above are correct.

25. During recessions and times of financial crisis, banks typically choose to lend out less and hold more excess reserves relative to their deposits. If the central bank holds money supply constant, how will this action affect the broad money supply (M2) and the money multiplier (ratio of money supply to reserves)?

A. It increases the money multiplier and increases the money supply.

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B. C. D. E.

It decreases the money multiplier and decreases the money supply. It does not change the money multiplier, but increases the money supply. It does not change the money multiplier, but decreases the money supply. None of the above are correct.

26. Between 1992 and 1996 the government budget deficit in the US fell by almost two-thirds. In the long run, this decrease should have caused

A. B. C. D. E.

real interest rates and private investment to rise. real interest rates and private investment to fall. real interest rates to rise and private investment to fall. real interest rates to fall and private investment to rise. None of the above are correct.

27. One problem that economists highlight about using per capita real Gross Domestic Product to compare the living standards of people in different countries is that:

A. B. C. D. E.

It does not take into account the real exchange rate. Per capita real GDP does not adjust for how overcrowded a country is. It does not take into account differences in income inequality. It does not adjust for differences in the Consumer Price Index. None of the above are correct.

28. If the reserve ratio is 20 percent and a bank receives a new deposit of $500. Which of the following is INCORRECT?

A. B. C. D. E.

The The The The The

bank will need to keep $100 more as required reserves. bank will initially see its total reserves increase by $500. bank will have $400 more of excess reserves. bank's liabilities will have increased by $500. bank will lend out $2500 more because of this new deposit.

29. According to the long run model of economic growth, a higher savings rate will NOT increase:

A. B. C. D. E.

The real GDP of the country in the future. Investment and capital stock in the future. Productivity (output per worker) in the future. The inflation rate in the future. None of the above are correct.

30. Which of the following may have caused the movement in the Market for Money shown in the diagram?

A. The Central Bank reduces its inflation rate target. B. Banks decide to hold more excess reserves. C. The Central Bank increases its holdings of foreign reserves. D. The government increases government spending

MS

MD M 7

and sells more government bonds. E. Increased uncertainty about the economic situation causes people to hold more cash.

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Section B: Short Questions (40 points total) Answer all of the following questions. Briefly justify your answer, but keep your answers as short and as clear as possible.

1. Suppose that a friend of yours goes to Australia for a holiday, and the day before coming back to Hong Kong, she calls you to check if you wanted a bottle of Australian Chardonnay wine. She tells you that the cost of this bottle of wine is 10 Australian dollars (A$). Right after you hang up, your sister, who studies in England, calls. She is coming home for Christmas. Knowing how much you like Chardonnay, she tells you about a deal that she came across: A bottle of the same quality Chardonnay wine for 6 British pounds (£). Both tell you that they can buy and bring you the bottle of wine (you’ll pay them back when they are in Hong Kong). Furthermore, a bottle of similar quality local Chardonnay wine is sold at a nearby Hong Kong store for HK$70. i) If one HK dollar exchanges for 0.15 Australian dollars, how many HK dollars will the Australian bottle of wine cost? (2 points) ii) If one pound exchanges for HK$12, how many HK dollars will the British bottle of wine cost? (2 points) iii) Given the exchange rates above, what is the exchange rate between Australian dollars and British pounds? (2 points) iv) Which of the bottles of wine (Australia, European or local) would represent the best value for your money? (2 points) v) Assume that wine is the only good that matters. What are the real exchange rates between HK-Britain and HK-Australia given what was described above? (4 points) vi) For Purchasing Power Parity were to hold, what should be the nominal exchange rate for the HK dollar relative to the Australian dollar? How about for the HK dollar relative to the British pound? (4 points)

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2a. Political instability (because of the Vietnam War and other issues) was a major worry in the US in the 1960s. The Federal Reserve at that time tried to support the US government by loosening monetary policy – keeping interest rates low in order to hold down unemployment rates. Inflation, from about 1% in the early 1960s, had increased to more than 5% by the early 1970s. Assume that the economy starts in long run equilibrium. i) Describe the short run effects of loosening monetary policy. What happens to inflation, GDP, unemployment, interest rates (both nominal and real), investment and consumption? Use an AD-AS diagram to illustrate your arguments. (6 points) ii) Describe the long run effects of loosening monetary policy. What will happen to inflation, GDP, unemployment, interest rates (both nominal and real), investment and consumption? Use an AD-AS diagram to illustrate your arguments. (6 points)

2b. Because of the on going economic difficulties arising from the Global Financial Crisis, the US posted a record US$1.3 trillion fiscal deficit for the financial year ended September 30, 2011. In 2011, the US Congress passed a number of laws that (if unchanged) will result in tax increases and spending cuts in 2013 that will reduce the US budget deficit by about 50%. Assume that when this drop in the deficit occurs next year, the economy will be in long run equilibrium. i) Describe the short run effects of reducing the budget deficit. What happens to inflation, GDP, unemployment, interest rates (both nominal and real), investment and consumption? Use an AD-AS diagram to illustrate your arguments. (6 points) ii) Describe the long run effects of reducing the budget deficit. What will happen to inflation, GDP, unemployment, interest rates (both nominal and real), investment and consumption? Use an AD-AS diagram to illustrate your arguments. (6 points)

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