Principles of Macroeconomics, Deskins

Sample Exam Questions

These questions are taken from exams I gave at Creighton from 2005 through 2007. They will aid in preparation for the written half of the exams. Multiple choice questions comprise the second half of the exams; our quizzes will aid in preparation for that half.

Chapter 5 1. Assume the following depicts the U.S. economy: Year 2003 2004 Quantity-Boats 20 30 Quantity-CDs 50 60 Price-Boats $1,000 $1,500 Price-CDs $10 $12

Calculate nominal GDP for both years. What was the growth rate of real GDP between 2003 and 2004?

2. List the five individual components of GDP. Give an example of an expenditure that would fall into each category. Which category is the biggest?

3. Discuss two imperfections with real GDP as a measure of economic well-being?

4.

In class we discussed how real GDP fluctuates over time. Please draw a diagram that illustrates the business cycle (time on one axis and economic activity on the other). Now point out the peaks and troughs of the business cycle. How are these points typically characterized in terms of unemployment and inflation?

5. Which of the following are likely to increase measured GDP and which are likely to reduce it? a) The fraction of women working outside the home increases. b) Higher tax rates cause people to hide more of their income.

6.

If the Bureau of Economic Analysis added up the value of every good and service sold during the year, would the total be larger or smaller than GDP? Why?

Deskins, Sample Exam Questions

Chapter 6 1. Discuss two imperfections with the CPI as a measure of the cost of living. 2. Joe, who quit smoking in 1995, provided the following answer to why he quit: I quit because it was just getting too expensive. I started smoking in 1965 when cigarettes were only 45 cents/pack. The last pack I bought was $2 and I just couldnt justify spending more than four times on cigarettes as I used to Assume that the CPI was 31.5 in 1965 and was 152.4 in 1995. What is wrong with Joes reasoning? Explain fully (using numbers as well as a written description).

Chapter 10 1. Assume the following depicts the U.S. economy: 2003 168 7 105 2004 171 9 109

Adult Population Number Unemployed Number Employed

What is the labor force participation rate for 2003? What is the growth rate in the unemployment rate from 2003 to 2004?

2. Please explain why every economy experiences unemployment, even in the long-run. In other words, why does unemployment exist even when economies experience strong growth? Your answer should center on the different types of unemployment and you should discuss the natural rate of unemployment.

3. Please define the natural rate of unemployment. Please list and briefly describe the three types of unemployment that form the natural rate? What is cyclical unemployment?

4. Please explain what economists mean when they say that a relatively more generous unemployment insurance program enhances equity in society at the cost of efficiency, i.e., it represents a tradeoff for equity over efficiency. 5. When the U.S. economy is at full-employment, why isnt the unemployment rate (as measured by the BLS) equal to zero? Explain fully

Deskins, Sample Exam Questions

6. How are each of the following likely to impact the unemployment rate? a) The length of time workers are eligible to receive unemployment insurance payments doubles. b) The minimum wage is increased. c) More companies make information on job openings easily available on Internet job sites.

7. Fill in the missing values in the table of data collected in the household survey for the year 2000: Working age population: Employment: Unemployment: Unemployment rate: Labor force: Labor force participation rate: a)___________ 136,897,000 b)___________ 4% c)___________ 67.1%

Chapter 7 1. Please provide the fundamental reason why we observe such an enormous disparity in the level of economic output across nations and across time. Describe three of the four factors that determine the fundamental reason for the income disparity you listed above. Discuss three ways in which governments can enhance economic growth and prosperity in the long-run. Also address some tradeoffs associated with these policies.

2. Haiti is one of the poorest countries in the world. Suppose you were asked to be an advisor to Haitian policymakers. Please briefly discuss two policies that you would recommend to them to promote economic development in their country.

Deskins, Sample Exam Questions

Chapter 8 1. Suppose President Bush proposes decreasing the tax rate on interest income. Please provide a graphical illustration of how this policy would affect interest rates and the quantity of loanable funds (i.e., provide a supply and demand graph applied to loanable funds). Also include a short written description of what is happening.

2. Suppose Congress reduces the tax rate on income from savings accounts and enhances the Investment Tax Credit (that is, they provide greater tax relief to firms when they purchase new physical capital). How would these policy changes affect the quantity of savings and investment and the interest rate? Provide a short written answer as well as a graphical illustration. 3. Suppose that President Bushs new economic policy includes providing an investment tax credit but will also increase the federal government budget deficit. How would these changes affect the quantity of savings and investment and interest rates? Provide a short written answer as well as a graphical illustration.

4. Suppose that you are asked to advise President Bush on economic policy and that he is considering either a) an Investment Tax Credit or b) a cut in the tax rate on interest income to stimulate savings and investment in the country. However, assume that economic research has found that the supply of loanable funds is not very responsive to changes in the interest rate. Which of the two policies above would you recommend he adopt? Provide a short written answer and a graphical illustration.

Chapter 11 1. Assume Fed researchers determine that the money supply needs to be increased by $18,000 to achieve their monetary policy goals. Describe what action the Fed would normally take to achieve this goal. Assume for simplicity that banks hold no excess reserves, individuals hold no currency, and the reserve requirement is 5 percent. Please provide a brief written explanation as well as numerical answer. Describe two alternative polices the Fed could use to achieve this goal. (Do not provide a numerical answer this time.) Graphically illustrate what effect this action would have on interest rates. More specifically, provide a supply and demand graph applied to the money market to show the effect of increasing the money supply on interest rates.

Deskins, Sample Exam Questions

Chapter 12 1. Assume the Fed doubles the money supply. What effect would this have on real variables (i.e., real GDP and the unemployment rate) in the long-run? Describe what would happen to the price level once prices have had time to fully adjust.

2. Please discuss how unexpected changes in the rate of inflation affect borrowers and lenders. What is the implication of a redistribution of wealth that is associated with volatile rates of inflation for savings/investment and real GDP in the long-run? Now discuss the Feds role in light of this concern. What is the Feds ultimate objective in the long-run? Explain.

Chapter 15 1. Please provide two explanations why the short-run aggregate supply curve is upward sloping. Why is the long-run aggregate supply curve vertical?

2. Please use an aggregate demand/aggregate supply diagram to make sense of the OPEC Oil Embargo of the 1970s. That is, use this analytical tool to illustrate what effect higher oil prices following from the embargo had on the U.S. macroeconomy. Explain why the aggregate supply and/or the aggregate curve shifted as it did. Provide a written description in addition to the graph.

3. Please use the Aggregate Demand/Aggregate Supply analytical system to describe the Great Depression of the 1930s. That is, explain why the U.S. economy experienced a large and persistent deviation from the full-employment level of output. Name at least one factor that contributed to the Depression, describe how this affected the aggregate demand and/or aggregate supply curve, and illustrate the effects on real GDP and the price level. Provide a written description in addition to the graph.

4. Assume the economy is originally at the full-employment level of output. Now assume the Fed uses monetary policy to stimulate aggregate demand. What will happen to real GDP in the short-run and in the long-run? Explain and provide a graphical illustration.

Deskins, Sample Exam Questions

Chapter 16 1. Assume the economy experiences a wave of pessimism following a news report that a major firm has engaged in corrupt accounting practices. Use the aggregate demand/aggregate supply framework to depict what effect this shock would have on the price level and on real GDP. Now assume that this decline in aggregate demand is measured to be $10 million. What could Congress do to return the economy to full-employment? Assume that people typically spend 90 percent of their income. Quantitative and qualitative answers are both required. Now suppose that Congress decides not to act. What could the Fed do to return the economy to full-employment? Explain fully including a mention of the mechanism of the Fed action (and illustrate the mechanism of the Fed action with a supply and demand graph applied to the money market).

2. Assume the economy experiences a wave of pessimism after news that a major firm has used corrupt accounting practices. First, use the aggregate demand/aggregate supply framework to depict what effect this would have on the price level and on real GDP in the short-run. Second, show how the price level and Real GDP will change over time after this initial shock if no action is taken by either Congress or the Fed. Please label the initial equilibrium A, the short-run equilibrium B, and the long-run equilibrium C. Now, on a new graph, show how the price level and Real GDP will change if the Fed intervenes optimally through the use of monetary policy after this initial shock. Finally, please provide and explain one reason why Fed intervention might be undesirable in response to this economic shock.

3. Please discuss two criticisms of using fiscal policy to achieve short-run stability in real GDP and prices.

4. Please discuss one criticism of using monetary policy to achieve short-run stability in real GDP and prices.

Deskins, Sample Exam Questions

5. Assume the economy experiences a negative supply shock after the expected price level rises following news that energy prices may rise in the near future. Please use the aggregate demand/aggregate supply framework to depict what effect this would have on the price level and on real GDP in the short-run. No explanation required. Now, on a second graph that incorporates this first shock, show how the price level and Real GDP will change in the short-run if the Fed intervenes optimally through the use of monetary policy simultaneously with this initial shock. Hint: Remember the Feds primary goal. Explain briefly.

Chapter 17 1. In the late 1960s, the Fed attempted to use monetary policy to reduce unemployment below its natural rate. Please use a Phillips curve diagram to show the short- and longrun effects of this policy. Explain. 2. Please discuss the disinflation that occurred during Paul Volckers Fed chairmanship in the early 1980s. Provide a fully developed Phillips curve diagram that shows the various steps in the process. Include (a) an explanation of why Volcker undertook this action, (b) a discussion of why unemployment rose in the short-run, and (c) the long-run effects of the disinflation. Be sure to incorporate a discussion of inflationary expectations into your answer. 3. In the early 1980s, under the leadership of Paul Volcker, the Fed used monetary policy to reduce inflation. Please use a Phillips curve diagram to show the short- and long-run effects of this policy. Explain briefly. Also, briefly explain how the transition discussed above would have happened if the Feds credibility had been stronger.

Chapter 18 1. There is disagreement as to the whether the federal government should strive to achieve a balanced budget. Please discuss fully the various reasons why a balanced budget would be beneficial and why it would be undesirable. Organize your answer in the space below.

Deskins, Sample Exam Questions

2. There is disagreement in the economics profession as to the appropriateness of imposing a monetary growth rule. That is, a law that would direct the FOMC to increase the money supply steadily at a certain rate and would thus remove all of its discretion. Please discuss the reasons why such a rule would be desirable and also some reasons why it would not. Be sure to discuss how the Feds ultimate long-run objective fits into the debate. Finally, which do you think is best rule or no rule?

3. There is disagreement as to the whether the tax code should be modified to encourage saving. Please discuss the reason(s) why such a reform would be beneficial and why it would be undesirable. Organize your answer in the space below.

Chapter 14 1. Please use the analytical techniques we developed in class to explain how an increase in the U.S. government budget deficit will affect the real exchange rate. Be sure to include (1) a graph of the market for loanable funds in the U.S., (2) a graph that shows the amount of net capital outflow as a function of the interest rate, and (3) a graph representing the market for foreign currency exchange. Provide a brief written description in addition to the graphs.

2. Please illustrate graphically how a decrease in the tax rate on interest income would affect a) the real exchange rate and b) the quantity of net exports. Explain briefly.

Comparative Economic Systems 1. Karl Marx argued for complete government ownership of the means of production. In one paragraph, please explain his reasoning for why a Communist system was a natural progression from Capitalism. Be sure to mention of Marxs labor theory of value and his view on how the worker class was exploited by the owners of capital.

2. Karl Marx argued that a Communist system was a natural progression from Capitalism. Please discuss how Western economic system evolved after his analysis? More specifically, did the degree to which government controls the means of production change as Marx predicted? If not, how did the actual course of events in the West differ?