Midterm 1 mock exam (with answer key) Multiple choice questions 1. During the period between 1900 and 2000, the unemployment rate in the United

States was highest in the: A) 1920s. B) 1930s. C) 1970s. D) 1980s. 2. Deflation occurs when: A) real GDP decreases. B) the unemployment rate decreases. C) prices fall. D) prices increase, but at a slower rate. 3. When studying the short-run behavior of the economy an assumption of ______ is

more plausible, in contrast to studying the long-run equilibrium behavior of an economy, when an assumption of ______ is more plausible.

A) inflation; unemployment B) unemployment; inflation C) flexible prices; sticky prices D) sticky prices; flexible prices 4. All of the following are a stock except: A) a consumer's wealth. B) the government budget deficit. C) the number of unemployed people. D) the amount of capital in the economy. 5. When bread is baked but put away for later sale, this is called: A) waste. B) saving. C) fixed investment. D) investment in inventory. 6. Assume that a tire company sells four tires to an automobile company for $400,

another company sells a compact disc player for $500, and the automobile company puts all of these items in or on a car that it sells for $20,000. In this case, the amount from these transactions that should be counted in GDP is:

A) $20,000. B) $20,000 less the automobile company's profit on the car. C) $20,900. D) $20,900 less the profits of all three companies on the items that they sold.

7. In the national income accounts, government purchases are goods and services purchased by:

A) the federal government. B) the federal and state governments. C) state and local governments. D) federal, state, and local governments. 8. An increase in the price of imported goods will show up in: A) the CPI but not in the GDP deflator. B) the GDP deflator but not in the CPI. C) both the CPI and the GDP deflator. D) neither the CPI nor the GDP deflator. 9. According to the definition used by the U.S. Bureau of Labor Statistics, people are

considered to be unemployed if they: A) are out of a job, but not looking for work. B) retired from the labor force before age sixty-five. C) do not have a job, but have looked for work in the past four weeks. D) are absent from work because of bad weather or illness. 10. If the number of employed increases while the number of unemployed does not

change, the unemployment rate: A) will increase. B) will decrease. C) will not change. D) may either increase or decrease. 11. In the long run, the level of national income in an economy is determined by its: A) factors of production and production function. B) real and nominal interest rate. C) government budget surplus or deficit. D) rate of economic and accounting profit. 12. If an increase of an equal percentage in all factors of production results in an

increase in output of the same percentage, then a production function has the property called:

A) constant marginal product of labor. B) increasing marginal product of labor. C) constant returns to scale. D) increasing returns to scale. 13. A competitive, profit-maximizing firm hires labor until the: A) marginal product of labor equals the wage. B) price of output multiplied by the marginal product of labor equals the wage. C) real wage equals the real rental price of capital. D) wage equals the rental price of capital.

14. The real rental price of capital is the price per unit of capital measured in: A) dollars. B) units of output. C) units of labor. D) units of capital. 15. According to the neoclassical theory of distribution, total output is divided between

payments to capital and payments to labor depending on their: A) supply. B) equilibrium growth rates. C) relative political power. D) marginal productivities. 16. In a closed economy, the components of GDP are: A) consumption, investment, government purchases, and exports. B) consumption, investment, government purchases, and net exports. C) consumption, investment, and government purchases. D) consumption and investment. 17. If the consumption function is given by C = 150 + 0.85Y and Y increases by 1 unit,

then C increases by: A) 0.15 unit. B) 0.5 unit. C) 0.85 unit. D) 1 unit. 18. The real interest rate is the: A) rate of interest actually paid by consumers. B) rate of interest actually paid by banks. C) rate of inflation minus the nominal interest rate. D) nominal interest rate minus the rate of inflation. 19. Consumption depends positively on ______ and investment depends negatively on

______. A) disposable income; the real interest rate B) the real interst rate; disposable income C) private saving; public saving D) public saving; private saving 20. In the classical model with fixed income, if the interest rate is too low, then

investment is too ______ and the demand for output ______ the supply. A) high; exceeds B) high; falls short of C) low; exceeds D) low; falls short of

21. Private saving is: A) income minus consumption minus government spending. B) disposable income minus consumption. C) disposable income minus government spending. D) taxes minus government spending. 22. The demand for loanable funds is equivalent to: A) national saving. B) private saving. C) public saving. D) investment. 23. The supply of loanable funds is equivalent to: A) national saving. B) private saving. C) public saving. D) investment. 24. According to the model developed in Chapter 3, when government spending

increases and taxes increase by an equal amount: A) consumption and investment both increase. B) consumption and investment both decrease. C) consumption increases and investment decreases. D) consumption decreases and investment increases. 25. A country that is on a gold standard primarily uses: A) commodity money. B) fiat money. C) credit money. D) the barter system. 26. The central bank in the United States is the: A) Bank of America. B) U.S. Treasury. C) U.S. National Bank. D) Federal Reserve. 27. If income velocity is assumed to be constant, but no other assumptions are made, the

level of ______ is determined by M. A) prices B) income C) transactions D) nominal GDP

28. The right of seigniorage is the right to: A) levy taxes on the public. B) borrow money from the public. C) draft citizens into the armed forces. D) print money. 29. The percentage of government revenue raised by printing money has usually

accounted for: A) more than 10 percent of government revenue in the United States. B) less than 3 percent of government revenue in the United States. C) less than 3 percent of government revenue in Italy. D) less than 3 percent of government revenue in Greece. 30. The real interest rate is equal to the: A) amount of interest that a lender actually receives when making a loan. B) nominal interest rate plus the inflation rate. C) nominal interest rate minus the inflation rate. D) nominal interest rate. 31. The one-to-one relation between the inflation rate and the nominal interest rate, the

Fisher effect, assumes that the: A) money supply is constant. B) velocity is constant. C) inflation rate is constant. D) real interest rate is constant. 32. When a person purchases a 90-day Treasury bill, he or she cannot know the: A) ex post real interest rate. B) ex ante real interest rate. C) nominal interest rate. D) expected rate of inflation. 33. If the real return on government bonds is 3 percent and the expected rate of inflation

is 4 percent, then the cost of holding money is ______ percent. A) 1 B) 3 C) 4 D) 7 34. The general demand function for real balances depends on the level of income and

the: A) real interest rate. B) nominal interest rate. C) rate of inflation. D) price level.

35. All of the following are costs of fully expected inflation except that expected inflation:

A) causes lower real wages. B) leads to shoeleather costs. C) increases menu costs. D) leads to taxing of nominal capital gains that are not real. 36. A rate of inflation that exceeds 50 percent per month is typically referred to as a(n): A) inflation. B) hyperinflation. C) deflation. D) disinflation. 37. The major source of government revenue in most countries that experience a

hyperinflation is: A) customs duties. B) personal taxes. C) seigniorage. D) borrowing. 38. According to the classical dichotomy, when the money supply decreases, _____ will

decrease. A) real GDP B) consumption spending C) the price level D) investment spending Short answer questions 1. Explain which expenditure category of GDP changes and the direction of the change

that results for each transaction described. a. A domestic business purchases a domestically produced computer to

use in a business office. b. A domestic business produces a computer that is sold to a foreign

company. c. The federal government purchases a domestically produced computer

to use in a court house. d. A domestic household purchases a domestically produced computer to

use in a home. e. A domestic household purchases a computer produced in a foreign

country to use in a home. 2. Consider two countries, Hitech and Lotech. In Hitech new arrangements for making

payments, such as credit cards and ATMs, have been enthusiastically adopted by the population thereby reducing the proportion of income that is held as real money

balances. Over this period no such changes occurred in Lotech. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully explain your answer.

Analytical problems 1. Assume that GDP (Y) is 5,000. Consumption (C) is given by the equation C = 1,000

+ 0.3(Y – T). Investment (I) is given by the equation I = 1,500 – 50r, where r is the real interest rate in percent. Taxes (T) are 1,000 and government spending (G) is 1,500. a. What are the equilibrium values of C, I, and r? b. What are the values of private saving, public saving, and national

saving? c. Now assume there is a technological innovation that makes business

want to invest more. It raises the investment equation to I = 2,000 – 50r. What are the new equilibrium values of C, I, and r?

d. What are the new values of private saving, public saving, and national saving?

2. a. Suppose a government education program succeeds in getting households to save

more (you may interpret this as a downward shift in the consumption function). Using the long-run model of the economy developed in Chapter 3, graphically illustrate the impact of the higher saving rate by households. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction curves shift; and v. the terminal equilibrium values.

b. State in words what happens to: i. the real interest rate; ii. national saving; iii. investment; iv. consumption; and v. output.

Answer Key Multiple choice questions 1. B 2. C 3. D 4. B 5. D 6. A 7. D 8. A 9. C 10. B 11. A

12. C 13. B 14. B 15. D 16. C 17. C 18. D 19. A 20. A 21. B 22. D 23. A 24. B 25. A 26. D 27. D 28. D 29. B 30. C 31. D 32. A 33. D 34. B 35. A 36. B 37. C 38. C Short answer questions 1. a. Investment spending increases by the price of the computer.

b. Exports (and net exports) increase by the price of the computer. c. Government spending increases by the price of the computer. d. Consumption spending increases by the price of the computer. e. Consumption spending increases by the price of the computer, but imports also increase by the price of the computer, so that net exports decrease by the price of the computer and there will be no net change in GDP.

2. The rate of inflation would be higher in Hitech. According to the quantity theory, if the rates of money growth and real GDP growth are the same, differences in rates of inflation are related to differences in velocity. The faster increase in velocity leads to a higher rate of inflation, holding other factors constant. In Hitech the reduction in the proportion of income held as real balances (smaller k) is the equivalent of a speedup in the rate of velocity and, consequently, a higher rate of inflation in Hitech than in Lotech.

Analytical problems 1. a. 2,200; 1,300; 4 percent

b. 1,800; –500; 1,300 c. 2,200; 1,300; 14 percent d. 1,800; –500; 1,300

2. a.

b. i. real interest rate decreases ii. national saving increases iii. investment increases iv. consumption decreases v. output is unchanged, fixed because it is determined by the factors

of production