EC101 PRINCIPLES OF MACROECONOMICS – Other things being equal, the higher the price level

Faculty
of Business and Economics

EC101: PRINCIPLES OF MACROECONOMICS
DFL
SEMESTER I 2012

TEST
2

TIME ALLOWED: TWO HOURS
[10 minutes extra reading
time allowed]

INSTRUCTIONS

1. There arefour parts in this Test 2 paper.

Section
Title

Nature of Questions

No
of Questions

Total
Marks

Part A

Multiple Choice

15

15 marks

Part B

True or False and Why?

5

10 marks

Part C

Short Answer

4

20
marks

Part D

Problem

1

15
marks

2. This paper will be marked out of 60 and
it accounts for 15% of the overall mark for

the course.

3.
Non-programmable calculators are permitted.

4. Answer ALL questions in the Answer
Booklet provided.

PART
A: “MULTIPLE CHOICE’ – Based Questions (15
marks)

Answer
all questions.
Write the letter corresponding to your best choice beside the question
number in your Answer Booklet. Each
question is worth 1 mark.

1. Other things being equal, the higher the
price level, the lower the level of real output purchased. This occurs because
of:
A. the wealth effect
B. consumer spending on capital goods
C. the full –employment unemployment rate
D. the sensitivity to demand-pull inflation

2. Which of the following set of events
would most likely reduce aggregate demand?
A. a reduction in the excess capital of the
existing capital stock
B. a reduction in business and personal tax
rates
C. an increase in investment spending
D. an increase in personal income tax rates

3. Which of the following would most likely
increase aggregate supply?
A. an increase in the prices of imported
goods
B. an increase in productivity
C. a decrease in business subsidies
D. a decrease in net exports

Use the table below to answer question 4 – 7

National Income(GDP)

Consumption

Investment

Government Expenditure

0

400

50

50

500

800

50

50

1000

1200

50

50

1500

1600

50

50

2000

2000

50

50

2500

2400

50

50

3000

2800

50

50

3500

3200

50

50

4. The marginal propensity to consume is:
A.0.2
B. 0.4
C. 0.6
D. 0.8

5. The equilibrium level of national income
is:
A. $2000
B. $2500
C. $3000
D. $3500

6. The equation for the consumption
function is
A. C = -400 + 0.2Y
B. C = 400 + 0.2Y
C. C = 400 + 0.8Y
D. C = -400 + 0.8Y

7. At income level $2000, the economic
activity of the economy:
A.
is in equilibrium
B.
will tend to expand
C.
will tend to be contracting
D.
may be expanding or contracting

8. Holding the money deposits of businesses
and households and making loans to the public are the basic functions of:
A.
the Reserve Bank
B.
commercial banks and thrift institutions
C.
Board of Governors of the Reserve Bank
D.
Insurance Corporation

9. If you deposit $1 200 in a commercial
bank which has an 18 percent reserve requirement, the bank will have increased:
A.
required reserves by $216
B.
excess reserves by $900
C.
excess reserves by $1200
D.
required reserves by $1 200

10. A single commercial bank must meet a 25
percent reserve requirement. If it initially has no excess reserves and then
$2000 in cash is deposited in the bank, it can increase its loans by a maximum
of:
A.
$2000
B.
$1250
C.
$1500
D.
$1000

11. The use of government spending and
taxation for the purpose of stabilizing the economy is called:
A. exchange rate policy
B. monetary policy
C. fiscal policy
D. trade policy

12. Which of the following is true of
contractionary fiscal policy?
A.
the government budget is balanced
B.
Aggregate demand increases.
C.
the tax rate increases
D. a
budget deficit occurs

13.
In order to remove a given deflationary/recessionary gap, the government
could –
A. decrease aggregate demand by budgeting
for a deficit
B. increase aggregate demand by budgeting
for a deficit
C. decrease aggregate demand by budgeting
for a surplus
D. increase aggregate demand by budgeting
for a surplus

14. The balanced-budget multiplier suggests
that when taxes and government spending are increased by the same amount, there
will be (hint: compare government expenditure multiplier and taxation
multiplier formulas)
A. no change in the equilibrium level of
output
B. a decrease in the equilibrium level of
output
C. an increase in the equilibrium level of
output
D. first an increase and then a decrease in
the equilibrium level of output.

15.The
time which elapses between the beginning of a recession or an inflationary
episode and the identification of the macroeconomic problem is referred to as
(an)
A. law making lag
B. recognition lag
C. operational lag
D. impact lag

PART
B: “TRUE or FALSE and WHY?” –
Questions (10 marks)

Answer
all questions and justify your answer.Each
question is worth 2 marks.

1.
An increase in business taxes
will increase investment demand.
i)
Answer True or False
ii)
Why?

2.
The marginal propensity to
consume shows the fraction of any level of total income that is consumed.
i)
Answer True or False
ii)
Why?

3.
In the simple model, any
increase in autonomous investment will give rise to an even larger increase in
the equilibrium level of income.
i)
Answer True or False
ii)
Why?

4.
The larger the budget surplus
the more expansionary is the government budget.
i)
Answer True or False
ii)
Why?

5.
Banks can create money – that
is demand deposits, through their borrowing and lending activities.
i)
Answer True or False
ii)
Why?

PART
C: “SHORT ANSWER” Questions. (20
marks)

Answer
all questions. Each question is worth 5 marks.

i) What are the components of aggregate expenditure?

ii) In the
Keynesian model, state at least two components which vary with changes in
output/ real GDP?

2. i) What are the three major functions of
money?
ii) Describe how drastic inflation can
undermine the ability of money to perform these three basic functions.

3. i) Consider an economy that is operating at full
employment equilibrium. Graphically
illustrate the effect of an increase in government spending (G) on the
price level and the level of GDP in the short run.
ii) Explain with the aid of an AD-SAS-LAS diagram,
how long run adjustments will take place in this economy as a result of the
event in i) above?

4. i) Explain how banks create deposits by
making advances.
ii) Describe the factors that limit how much
credit and deposits the banks are able to create.

Part
D: “Problem” – Based Questions
(15 marks)

A simple macroeconomic model of an economy
is estimated at end of 2009 giving the
following information:

Y = C + I + G +
X-IM

C = 100 + 0.8 YD

YD = Y – T + TR

IM = 20 + 0.4Y

I = 50; G = 60;
TR = 70; X = 80; T = 0.2Y

Price level: GDP
deflator 110 (2006/2007=100)

Where C denotes
consumption expenditure, I level of investment, G government expenditure, X
exports, IM imports, YD disposable income, Y real GDP, T tax revenue, TR
transfer payments (Think of C, I, G etc as being measured in millions of
dollars)

a)
What is the equilibrium level
of real GDP?
b)
Show the economy’s
macroeconomic equilibrium using two sets of diagrams:
i) the AE diagram (Keynesian cross diagram)
ii) the typical AD-AS diagram.
iii) Indicate
the equilibrium expenditure, equilibrium real GDP, and the equilibrium price
level using actual figures.
c)
Determine the size of the
autonomous expenditure multiplier, and comment on what happens to the
multiplier if there is no foreign trade?
d)
If the full employment level of GDP is $750m,
calculate the size and the type of output gap persistent in the economy.
e)
Calculate the change in
government expenditure required to eliminate the output gap in part d
above.