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CITY UNIVERSITY OF HONG KONGCourse code & title : EF 2401: Economics IISession : Semester B 2011/Time allowed : Two hoursThis paper has TEN pages (including this cover page). This paper consists of two sections. Section A contains 25 multiple choice questions Section B contains 3 questions. ...

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CITY UNIVERSITY OF HONG KONG

Course code & title

:

EF 2401: Economics II

Session

:

Semester B 2011/12

Time allowed

:

Two hours

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

1.

This paper consists of two sections.

2.

Section A contains 25 multiple choice questions

3.

Section B contains 3 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. 2. One A-4 Size Self-prepared Hand-written ‘Cheat Sheet’. 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.

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EF 2401: Economics II Semester B 2011/12 This exam has a total of 100 points. Section A: Multiple Choice (25 Questions  2 points each, 50 points total) Answer all questions in this part. Choose only one answer, the best answer.

1.

If the government increases its spending during a depression in order to assist the economic recovery, the monies that it spends must come from some source. According to Keynesian theory, which of the following sources would tend to be the most expansionary, i.e. which source when chosen will cause the largest increase in Aggregate Demand?

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

Creation of new money to fund spending. Taxes on corporate profits. Taxes on individual incomes. Borrowing from the citizens. Borrowing from foreign banks.

In the long run, poorer countries (measured as GDP per capita) tend to experience faster economic growth that richer countries unless:

A. B. C. D.

The poor country has inadequate infrastructure, e.g. bad phone systems, poorly built roads, etc. The poor country has a poorly educated population, and low human capital. The poor country suffers damaging competition from globalization and international trade. The poor country suffers from widespread corruption, political violence and government instability. E. The poor country has very little physical capital (e.g. machinery, factories, buildings).

3.

When considering the long run models of unemployment (cyclical and structural unemployment), faster innovation, quicker technological progress and accelerated sectorial shifts in productive activity:

A. B. C. D.

will tend in the long run to replace workers with machinery, leading to lower overall wages. may increase GDP growth, but may also increase frictional unemployment. tends to increase structural unemployment. will increase short run cyclical unemployment, but will not affect the long run unemployment rate. E. None of the above are correct answers.

4.

Which of the following best describes the Keynesian cause-effect chain of how loose money (expansionary monetary policy) affects GDP?

A. An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand, which increases GDP. B. A decrease in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand, which increases GDP. C. A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand, which increases GDP. D. An increase in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand, which increases GDP E. None of the above are correct answers.

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5.

When we observe a fall in nominal GDP, which of the following cannot have occurred:

A. B. C. D. E. 6.

Suppose that the central bank of country ‘C’ constantly buys foreign currency in order to depreciate its currency to promote exports and economic growth. In the long run, this policy will lead to :

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

shifts to the right when AD falls during recessions. represents the stable tradeoff between economic growth and unemployment. moves up when the AS curve moves down. shifts up when inflation expectations increase. None of the above are correct answers.

A firm in Singapore sells toys to a US department store chain and keeps the revenue received in a US bank. These sales lead to:

A. B. C. D. E. 9.

a larger government budget deficit. higher money supply growth and higher inflation. lower nominal interest rates and more investment. permanently higher real economic growth. None of the above are correct answers.

The short-run Phillips curve:

A. B. C. D. E. 8.

An increase in the price level, and an increase in real production. A fall in the price level, but an increase in real production. An increase in the price level, but a fall in real production. A fall in the price level, and a fall in real production. None of the above are correct answers.

A decrease in US net exports and an increase in US capital outflow. An increase in Singapore’s net exports and no change in Singapore’s capital outflow. An increase in Singapore’s net exports and an increase in Singapore’s capital outflow. An increase in Singapore’s net exports and a decrease in Singapore’s capital outflow. None of the above are correct answers.

You suspect that there has been a large increase in the number of ‘discouraged workers’ – unemployed workers who have stopped looking for work. This can distort the labor force statistics and give a biased view of the unemployment situation. What can you do to in order to check if this has happened?

A. B. C. D. E.

Examine the unemployment rate to see if it has gone down. Examine the under-employment rate to see if it has gone down. Examine the labor force participation rate to see if it has gone down. Examine the dependency ratio to see if it has gone done. None of the above are correct answers.

10. According to the national accounting model of the economy, in the long run the primary effect of tax cuts (holding government spending constant) is to:

A. B. C. D.

decrease Consumption and increase Net Exports increase Consumption and decrease Investment increase GDP decrease unemployment

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E. None of the above are correct answers.

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11. Which of the following events cannot cause the change in the Foreign Exchange market that is illustrated in the diagram on the right?

E NCO

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A. B. C. D.

Capital flight from the country. An increase in the private savings rate. A decrease in the government budget deficit. An increase in investment opportunities, leading to an increase in private investment demand. E. None of the above are correct answers.

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12. If the economy was originally in equilibrium with unemployment at the natural rate, what action should be taken by the central bank in response to a large increase in investment spending?

A. B. C. D. E.

the central bank should decrease the amount of government bonds that it sells. the central bank should print more money in order to increase the money supply. the central bank should increase its inter-bank interest rate target. the central bank should increase the money multiplier. None of the above are correct answers.

13. Suppose that a financial innovation (e.g. stored value cards) reduces the amount of cash that the public wishes to hold. This will:

A. B. C. D. E.

take away the central bank’s ability to control the money supply. increase the money multiplier. tend to increase the interest rate. cause the exchange rate to appreciate. None of the above are correct answers.

14. Which of the following does not usually happen during the beginning of a typical recession?

A. B. C. D. E.

the inflation rate falls (disinflation). commercial rents for retail space falls. the capacity utilization rate for factories fall. the labor force participation rate falls. private investment in physical capital falls.

15. Suppose that the central bank always reacts in order to stabilize output, and it can do so perfectly, always keeping GDP at potential output and unemployment at the natural rate. A new government has been elected and changes budget policy. In this scenario, which of the following can happen?

A. The government increases government spending, in response the central bank tightens monetary policy and private investment rises. B. The government increases government spending, in response the central bank loosens monetary policy and private investment rises. C. The government increases taxation, in response the central bank loosens monetary policy and private investment rises. D. The government increases taxation, in response the central bank tightens monetary policy and private investment falls. E. The government increases taxation, in response the central bank loosens monetary policy and private investment falls.

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16. In Keynesian economics the size of the Marginal Propensity to Consume (MPC) is usually assumed to be __________, which in turn implies that the Keynesian demand multiplier is __________:

A. B. C. D. E.

greater than one ; greater than one less than zero ; less than one greater than one ; less than zero greater than zero but less than one ; greater than one None of the above are correct answers.

17. If the government cuts taxes causing the budget deficit to increase, this action cannot:

A. B. C. D. E.

Increase real interest rates. Increase GDP in the short run. Crowd out private investment. Decrease private consumption. None of the above are correct answers.

18. Which of the following is not a reason why some economists object to using economic policy to stabilize short-term fluctuations?

A. The Keynesian model concentrates on how increased government spending affects aggregate demand, but ignores possible negative effects on the long run growth of the economy. B. In the real world, government budget policies change slowly, it is not practical to use fiscal policy to fight a recession. C. If the government takes no policy action to eliminate a recession, prices will eventually adjust to bring the economy back to potential output. D. Monetary policy affects the economy only after a long lag; this makes it easy to misapply monetary policy, potentially causing even more problems. E. Automatic stabilizers affect the economy even before economists know that a recession has occurred. This means that governments are often enacting stabilization policy without knowing that it is happening. 19. Assuming the reserve requirement is 20 percent and commercial banks hold no excess reserves, the commercial banking system could increase the money supply by a maximum of $1,000,000 if the central bank:

A. B. C. D. E.

sells $1,000,000 of bonds to commercial banks lends $250,000 of cash to the commercial banks buys $1,000,000 of bonds from commercial banks buys $200,000 of bonds from commercial banks None of the above are correct answers.

20. The United States is experiencing a trade deficit that is about 10% of GDP. Which of the following government policies can reduce this trade deficit in the long run?

A. The US government provides a subsidy to companies that export more than 50% of their production. B. The US government imposes an import quota to limit the import of foreign cars, requiring all importers to apply for a limited number of import licenses. C. The US government imposes a new sales tax on all goods sold in the US. D. The US government improves roads near seaports in order to facilitate exports. E. None of the above are correct answers.

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21. High variability in the inflation rate and uncertainty about future inflation harms debtors and creditors who participate in the financial system because:

A. B. C. D. E.

it increases real interest rates and acts like a tax on financial transactions. it can causes financial bubbles to develop in asset markets. it crowds out private consumption. it increases the risk involved in either borrowing or lending money at a fixed interest rate. None of the above are correct answers.

22. Suppose the price of Thai rice increases, causing the Hong Kong consumer to have to pay more for imported rice. This price increase will be reflected in:

A. B. C. D. E.

neither the GDP deflator nor the consumer price index, as rice is not grown in Hong Kong. an increase in only the GDP deflator. an increase in only the consumer price index. an increase in both the GDP deflator and the consumer price index. None of the above are correct answers.

23. Starting from long-run equilibrium, without active policy intervention, which of the following will not happen to an economy that experiences an adverse supply shock?

A. B. C. D. E.

Real interest rates will increase. Private investment will fall. The unemployment rate will increase. The inflation rate will accelerate. Real GDP growth will slow down.

24. Which of the following is an example of frictional unemployment?

A. Lower rainfall in some parts of Australia (because of global warming) has caused many farmers to decide to give up farming and search for jobs in nearby cities. B. Some disabled people are willing to work for less than the minimum wage, but they are unemployed because employers cannot hire them for less than the minimum wage. C. There are many qualified pilots who would like to work as an airline pilot, but airlines do not find it profitable to hire them at the wage established by the airline pilot's union. D. In Spain, because of the global financial crisis, the unemployment rate is nearly 50% for workers younger than 30. E. After a long recession, some workers become discouraged and stop looking for work. 25. In the past, some countries used silver coins as money; they did not use paper money or other types of money (e.g. Mexico in the 18th century). Suppose the supply of silver in such a country is fixed, what would happen if a new technological innovation caused real GDP to grow rapidly for the next several years?

A. B. C. D. E.

Inflation will accelerate. Nominal interest rates will rise. There will be deflation (negative inflation). The exchange rate will depreciate. None of the above are correct answers.

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Section B: Short Questions (50 points total) Answer all of the following questions. Briefly justify your answer, but keep your answers as short and as clear as possible.

1. The table below shows nominal GDP data for a country for 1960 and 1964. Also shown are data for the GDP deflator (price level) and the population. Calculate nominal GDP growth and the average inflation rate, and then calculate real GDP growth and real GDP growth per-capita, annually for that period. (8 points) Year 1960 1964

Nominal GDP (in $ millions) 2708 6738

GDP deflator (1963 = 100) 71.7 126.1

Population (in millions) 22 26

a) What was the average annual percentage growth of nominal GDP between 1960 and 1964? (Hint: Take the 4th root of the increase between 1960 and 1964 to obtain average annual percentage growth for the 4 years. E.g. 41.36 = 1.0799 so 36% in four years is a 7.99% per year.) b) What was the average annual GDP deflator inflation rate between 1960 and 1964? c) i. Calculate real GDP (in 1963 prices) for both 1960 and 1964. ii. What was the average annual percentage growth of real GDP between 1960 and 1964? d) i. Calculate real GDP per capita (in 1963 prices) for both 1960 and 1964. ii. What was the average annual percentage growth of real GDP per capita between 1960 and 1964? e) i. Which statistic should you look at if you are interested in how the productive capacity of the economy has grown over time? ii. Which statistic should you look at if you are interested in how the average person’s quality of life has improved over time?

2. Use the AS-AD framework to analyze the following recent Chinese government policies. Use the ASAD graph to illustrate your answers, but also clearly explain your reasoning. a) In late 2008 (after the collapse of Lehman Brothers), the Chinese government responded to the global financial crisis with a $586 billion stimulus package. Use the AS-AD diagram to explain both the rationale and the likely impact of this fiscal policy. (6 points) b) In the year 2011, the People’s Bank of China raised the reserve requirements for commercial banks

several times. Use the AS-AD diagram to analyze the likely effects of this policy. (6 points) c) Can you explain the relationship between the monetary policy in 2011 and the stimulus package back in 2008? What do you think happened to the unemployment rate and the inflation rate in China between 2008 and 2011? (6 points)

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3. a) During the Asian Financial Crisis in 1997-1998, Thailand experienced capital flight. Investors no longer wanted to keep their investment funds in Thailand, and funds flowed out of the country. The interbank interest rates shot up, and the Thai Baht rapidly depreciated. In the months that followed, imports collapsed and exports boomed, leading to a large trade surplus. Can you explain how all these changes are connected by using the long run model of the open economy? (12 points) b) Singapore has had both a large government budget surplus and a large trade surplus for many years. Can you explain how these two surpluses are related to each other by using the long run model of the open economy? Also explain how a government budget surplus affects interest rates, domestic investment, and net capital outflows in the country. (12 points) For both part a) and part b) use a diagram, similar to the diagram below, to illustrate your argument. Use one diagram for part a) and a separate diagram on a different page for part b). Remember to label all the curves and axes.

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