PRACTICE QUESTIONS 5-

MULTIPLE CHOICE QUESTIONS:

1. From Say's Law we derived the following identity: C+S+T=C+I+G. Does this imply that saving equals investment and taxes equal government expenditure?

A. Yes

B. No

2. In the loanable funds market, what is IMPLIED by a vertical demand curve for the government?

A. Government does not play any role in determining the equilibrium interest rate.

B. Government's decision on the level of the deficit is not affected by the private demand for funds.

C. Government does not play any role in determining aggregate demand for funds.

D. Government's decision on the level of the deficit is not affected by the market interest rate.

3.  Deleted from file:  Poor question

4. For the same increase in private investment (I), an increase in the marginal propensity to consume (MPC) will result in a __________ increase in equilibrium GDP (Y).

A. higher

B. lower

5. Which of the following is true about the concept of complete crowding out in the classical model?

a) Any change in government policy can have no effect on the economy.

b) Any change in the government deficit can have no effect on the economy.

c) Any change in the government deficit can have no effect on total spending.

d) Any change in the government deficit is counteracted by the same change in investment (private demand for loanable funds).

6. Recall the money market equilibrium equation: M=kPY. Assume now that k (the proportion of income held as cash) is constant. Which of the following statements is true?

a) An increase in the money supply of $200 million will increase the equilibrium GDP by $200 million.

b) An increase in GDP may increase the money supply and reduce the price level at the same time.

c) A 10% increase in money supply will increase the price level by 10%.

d) If the price level increases by 5% either the money supply will increase by 5% or GDP will decrease by 5%

PROBLEMS:

1. Consider the following schedule for the demand and supply of loanable funds:

a) Fill in the above table.

b) When the government deficit (G-T) equals $1000, what is the equilibrium amount of loans and the equilibrium interest rate?

c) Sketch a graph of your results from (b).

d) Find the equilibrium amount of loans and the equilibrium interest rate when the government deficit equals (i) $1400; (ii) $600.

e) Sketch two graphs illustrating the change in the equilibrium amount of loans and the equilibrium interest rate when the government deficit changes (i) from $1000 to $1400; (ii) from $1000 to $600. Mark clearly the initial and final equilibriums.

f) Why is the government's demand for loanable funds independent of the interest rate while the private demand for loanable funds is dependent on the interest rate?

2. Recall the relationship between money demand and supply: M=kPY. Suppose it is a strong tradition for people in Econland to keep 10% of their income in the form of money. Real GDP (Y) for the year 2003 is 500 billion.

a) If the money supply (M) is $1000 billion in 2003, what is the price level?

b) Suppose the government of Econland increases the money supply in 2004 to $1200 billion. What is the price level in 2004?

c) Find the inflation rate between 2003 and 2004.

3. Consider the following labor demand and supply curves: (w = real wage)

L^D = 50-2w

L^S = w-10

a) Sketch these curves on a graph. (make sure real wages are on the vertical axis)

b) Before we go into calculations, let's first distinguish factors that affect the labor market. Place the following factors in the correct column and determine the direction of change:

- Technological advancement in production

- Merger followed by a downsizing

- A recent baby boom (which increases the number of dependents for some people in the workforce)

- An increase in the practice of Buddhism that advocates a simple life with reduced consumption             

c) Go back to the equations. Find the equilibrium real wage and employment level.

d) Suppose there is a technological advance that affects the labor demand, so that the new demand is: L^D = 65-2w. Find the new equilibrium real wage and employment level.

e) Now suppose that INSTEAD OF the technological advance, the economy is in a recession and the employment level is only 8. At this level of employment, what is the real wage demanders are willing to pay and what is the real wage suppliers are wiling to accept?

f) What is the real wage associated with an employment level of 14 for demanders? For suppliers?

g) For both (e) and (f) what real wage do you think firms will pay? Explain your answer.

h) How will the economy adjust towards equilibrium at an employment level of 14?

4. Consider the aggregate expenditure model:

Y=C + I + G + NX

where consumption is a function of aggregate income:

C=a + bY

Assume taxes equal zero in this economy.

a) If the marginal propensity to consume (MPC) is 0.8, what is the expenditure multiplier?

b) Find GDP when a=10, I=100, G=60 and NX=50.

c) What is the change in GDP if investment is increased by 20, holding everything else constant?

d) What is the change in GDP if government expenditure is increased by 20%, holding everything else constant?