FA24 Practice Final Exam Version A PDF

Econ 1012, Hovander Practice Final Exam (Version A) Section I: Vocabulary (2 points each; 26 points total) For each of the following statements or situations, choose a term from the list that best fits. (In cases where two terms might apply, choose the most specific applicable term.) Autonomous...

Econ 1012, Hovander Practice Final Exam (Version A) Section I: Vocabulary (2 points each; 26 points total) For each of the following statements or situations, choose a term from the list that best fits. (In cases where two terms might apply, choose the most specific applicable term.) Autonomous Consumption Life-Cycle Savings Base Year Long Run Bequest Savings Market Basket Budget Balance Marketplace Costs Business Cycle Monetary Base Commercial Paper Market Money Market Funds Commodity Money Money Multiplier Commodity Backed Money Mortgage-Backed Securities Commodity Substitution Bias National Savings Consumption Function Net Capital Inflow CPI Net Exports Credit Default Swap Net Present Value Crowding Out Open-Market Operations Cyclical Unemployment Potential Output Deflation Precautionary Savings Direct Fiscal Policy Private Savings Discount Rate Quality Adjustment Bias Discount Window Rate of Return Recessionary Gap Disinflation Regional Federal Reserve Banks Divine Coincidence Reserve Ratio Dual Mandate Reserve Requirement Expansionary Gap Securitization Excess Reserves Short Run Federal Funds Rate Shoe-Leather Costs Fiat Money Stagflation Final Good Sticky Wages Fisher Effect Structural Unemployment Frictional Unemployment Subprime Mortgages Human Capital Tight Monetary Policy Income-Expenditure Multiplier Treasury Bills Indirect Fiscal Policy Unit-of-Account Costs Inflation Unplanned Investment Interest Rate Effect Wealth Effect Intermediate Good Wealth Redistribution Lender of Last Resort 1) All major currencies today are in the form of this. 2) I need to cut back on my spending each month because I am planning to purchase a house, and I also need to think about how I will pay for my child's college tuition in a few years. 3) This form of fiscal policy has a greater impact per dollar than other fiscal policy measures. 4) AIG sold insurance policies on ___________, which then put the company in a dangerous position when the housing bubble burst. 5) If investment spending in a country were to exceed its national savings in a given year, we know that __________ would be negative for that year. 6) This measure reflects the amount of public savings in an economy. 7) When aggregate prices increase, the purchasing power of certain assets (e.g. currency, funds held in time deposits, funds held in savings accounts, etc.) decreases. When this happens, autonomous consumption spending decreases. 8) Increases in this would lead to increases in productivity, increases in YP and increases in SRAS. 9) The flour I purchase is for use in my bakery, rather than for personal use. 10) The decline in lending standards can be seen in part by the large number of _________ issued. 11) This can be caused by things such as minimum wages, labor unions and efficiency wages. 12) These were created due to the "mainstreet" vs. "wallstreet" divide. 13) This can be used to "deflate" nominal values so they are comparable from year to year. Section II: Calculation 1) Suppose that the population of individuals aged 16 and over is 4 million, the number of individuals officially counted as unemployed is 0.3 million, and the labor-force participation rate is 75%. What is the unemployment rate? 2) Suppose the CPI in 2020 is 250 and the CPI in 2021 is 240. a) What is the inflation rate between 2020 and 2021? Based on this information, what is the economy experiencing over this time period? b) Suppose you are considering taking out a loan and the nominal interest rate is 5%. Assuming the inflation rate remains stable at the rate calculated in a), what is the real interest rate on the loan? c) Suppose the average price of a medium pizza in 2020 is $10, and the average price of a pizza in 2021 is $9.75. Compare these prices in real terms. Are pizza lovers better or worse off in 2021? 3) A logging company (owned and operated in the U.S. harvested 2 million MBF of timber in 2020. That same year, the logging company sold 1 million MBF to a saw mill located in the U.S. at the market price of $300 per MBF. The rest of the timber went unsold that year. Suppose the saw mill used all of the timber purchased in 2020 to produce lumber. It sold half of the lumber to the government and half to a construction company for use in various projects that were not completed in 2020. The total market value of the timber sold was $400 Million. Using the expenditure approach, calculate the total impact on 2020 U.S. GDP that resulted from these specific events. Explicitly show the effect on each expenditure category: C, I, G, NX 4) Suppose the current level of real GDP in the economy is $25 trillion, however experts estimate that potential output is $20 trillion. a) Is this a long-run or a short-run situation? b) Calculate the output gap (calculate this as a percentage of potential real GDP, as shown in class). Is this an expansionary or recessionary gap? c) Suppose the marginal propensity to consume is 0.8. Further suppose the SRAS is perfectly elastic, there are are no transfer payments, and income taxes are collected at a tax rate of 25%. By how much would the government need to change its spending to close the output gap using direct methods? d) An influential group of individuals opposes the idea of closing the output gap. Instead, the group is advocating that the government should do everything it can to maintain this high level of GDP through fiscal policy. i. What fiscal policy tools could be used to support this high level of GDP? Provide a complete list, and be specific about whether each would increase or decrease. ii. What arguments could you provide for why this would be a bad idea? (Be sure to give at least two sound arguments.) e) Suppose that the government has decided that fiscal policy action in any form is not appropriate. Instead, the Federal Reserve has decided to take monetary action to close the output gap. How should the Fed adjust its target Federal Funds rate to accomplish this? (Should the target be higher or lower than the current rate?) f) Explain how a change in interest rates would affect the economy and would help close the output gap. g) Consider the following actions and categorize them as one of the following: A. Appropriate for the Fed to take under the old (scarce reserve) framework B. Appropriate for the Fed to take under the new (ample reserve) framework C. Inappropriate for the Fed to take given the current economic conditions D. Impossible for the Fed to take i. Increase monetary base ii. Decrease monetary base iii. Increase IORB iv. Decrease IORB v. Increase taxes iv. Decrease taxes h) Suppose the reserve requirement for banks is 10%, banks maintain zero excess reserves, and individuals put all of their funds into checkable deposits. By how much will the Fed need to change the monetary base if it wants to change the money supply by $200 billion? (Either + or - depending on what would move the economy in the correct direction.)  i) Assume the Fed conducts all of its open-market operations with the bank shown below. On both balance sheets, write the debits and credits that would result from the open- market operation required to accomplish the desired change specified in h). Bank’s Balance Assets Liabilities Sheet: $270 Billion Loans $300 Billion Deposits $30 Billion Bank Reserves $50 Billion Treasury Bills Fed’s Balance Assets Liabilities Sheet: $X Assets $X Monetary Base j) Calculate this bank’s reserve ratio and state whether or not it has excess reserves (calculate after the open-market operation). Use this to discuss the process by which this operation leads to a change in the money supply of the desired amount. k) Calculate the bank's capital. Given that T-Bills are a type of bond, what would happen to the value of capital held by this bank if both the inflation rate and interest rates increased? 5) Suppose you are considering investing in a machine that will cost you $20,000, can be resold at the end of the year for $15,000 and will provide $6,000 in revenues for the year. For simplicity, assume that all revenues are realized at the end of the year. a) At what interest rate would you be indifferent between making the investment or not? b) Would your answer to part a) change if you instead kept the machine for two years, sold it at the end of the second year for $15,000, and received $3,000 in revenues at the end of each of the two years? If so, would the interest rate be higher or lower? 6) Through research, you have found that the marginal propensity to save in your country is 0.1 and the current level of autonomous consumption is $70 billion. You have also found that planned investment spending in your country is $60 billion, government expenditures are $50 billion and net exports are zero. (Assume no taxes.) a) Solve algebraically for the Income-Expenditure equilibrium level of real GDP. b) Illustrate this equilibrium using a Keynesian cross diagram. Label fully. Section III: Short Answer 1) Long-run economic growth is one of the overarching macroeconomic goals discussed throughout the semester. i. How do economists traditionally measure long-run economic growth? ii. What are two of the main factors discussed in class that contribute to increases in average labor productivity, and hence economic growth? iii. In what ways might the traditional measure of economic growth (stated in i.) be lacking or misleading? Provide two sound arguments. iv. What is natural capital accounting and what does it seek to accomplish? How does this relate to arguments made in the global community against solely looking at the traditional measure of economic growth? 2) Translate the following statements into elements of the Income-Expenditure model and use the model to evaluate the effects: “Declining house prices discourage new construction.” “More generally, sharp declines in house prices make consumers feel poorer, and thus less willing to spend.” (How would you represent these in the I-E model? What does the model predict as a result?) 3) A key trigger of the financial crisis of 2008 was the burst of the housing bubble and the associated mortgage losses. i. Explain what is meant by an asset "bubble". ii. How did the decline in lending standards contribute to the housing bubble? iii. Why did the decline in housing prices cause borrowers to default on their mortgages? (Hence leading to the mortgage losses?) iv. Why did the decline in the housing prices ultimately have a much more severe impact on the economy than the decline in dot-com stock prices had in the early 2000's? Link your answer to at least two distinct vulnerabilities (either in the public or private sector) that Bernanke discussed. 4) What is the primary goal of diversification? For diversification to accomplish this goal, what must be true about the stocks (and other financial assets) in an individual’s portfolio? Consider two hypothetical portfolios, Portfolio A and Portfolio B. Each portfolio represents a 50:50 blend of two stocks. This part of the problem will ask you to create hypothetical price information over three years for the stocks in each portfolio. Fill the price information in the tables below according to the following guidelines: - Construct the price information for the stocks in Portfolio A to illustrate a case where diversification is successfully accomplishing its primary goal. - Construct the price information for the stocks in Portfolio B as a counterexample to illustrate a case where “diversification” has not done much to help the investor. Portfolio A Price Year 1 Price Year 2 Price Year 3 Stock 1 Stock 2 Portfolio B Price Year 1 Price Year 2 Price Year 3 Stock 1 Stock 2