Posted: November 23rd, 2022

ECON 1951 • PRACTICE EXAM 2

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THOMPSON RIVERS UNIVERSITY,
OPEN LEARNING
ECON 1951 • PRINCIPLES OF
MACROECONOMICS
PRACTICE EXAMINATION
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ECON 1951 • PRACTICE EXAM 2
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Part A—Short-Answer Questions are worth a total of 55 marks.
Part B—Multiple-Choice Questions are worth a total of 45 marks.
In planning how you will allocate your time, allow about a minute and a half per
mark.
Short-Answer Questions for Practice Final Exam
1. Trace out, step by step, the impact on the economy of an increase in the
money supply in the context of a flexible exchange rate, and explain
whether monetary policy is stronger or weaker in an open economy than
in a closed economy. (8 marks)
ECON 1951 • PRACTICE EXAM 3
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2. Explain (4 marks each):
a. What are discouraged workers, and how can they cause
paradoxical movements in measured unemployment?
b. What is the monetarist rule, the main argument in favor of
adopting it, and the main argument against?
c. What is the multiplier, and how it is useful?
d. What are the two main circumstances in which a budget deficit
could be viewed as placing a burden on future generations, and
why?
ECON 1951 • PRACTICE EXAM 4
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3. In your answers to the following questions, be sure that you clearly
articulate the reasoning you used to obtain your numerical answers:
a. Suppose for the Canadian economy “the” multiplier is 3, the income
multiplier with respect to the money supply is 4, and the money
multiplier is 5. If the government decreases its spending by
i. $6 billion and directs the Bank of Canada to buy $2 billion worth of
bonds, what will happen to the income level? (4 marks)
b. Suppose the Canadian economy, on a fixed exchange rate, is at a full
employment equilibrium in which the long-run real rate of growth is
2%, and the real interest rate is 4%. In the United States, which you
can consider to be the “rest-of-the-world,” long-run real growth is 2%,
the nominal interest rate is 8%, and the risk premium (Canada is
riskier) is 1%. (6 marks)
i. What is Canada’s inflation rate?
ii. What is Canada’s nominal interest rate?
iii. Suppose now you are told that the exchange rate is flexible and
that the value of the Canadian dollar is falling by 6% per year.
What is Canada’s inflation rate now?
ECON 1951 • PRACTICE EXAM 5
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c. Suppose the sum of consumption, investment, and government
spending is $620 billion; the sum of income payments is $500 billion,
including transfer payments of $5 billion; we imported $3 billion
more than we exported; subsidies are $2 billion; depreciation is $70
billion; and indirect taxes are $62 billion. From this information,
what is measured GDP? (4 marks)
ECON 1951 • PRACTICE EXAM 6
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4. The following questions are worth 3 marks each:
a. Explain the crowding-out effect and why it makes an expansionary
fiscal policy less effective.
b. “Several bond issues will raise $400 million, with the Bank of Canada
picking up at least $200 million. The Bank of Canada can also be
counted on to take down more of the bonds than the planned $200
million it has announced if they seem to be selling badly.”
i. What are the implications for the Canadian money supply when
the Bank of Canada picks up $200 million of these bonds?
ii. What does the second sentence imply about the Bank of
Canada’s monetary policy?
c. “Reacting to Thursday’s flash second-quarter news that the U.S.
economy has grown three whole percentage points, people were
headed for the bond market exits.” Explain why people would react
this way to this news.
d. Why does an easy money policy lower the real interest rate but increase the
nominal interest rate? (4marks) “Why has the governor of the Bank of
Canada argued for a stable Canadian dollar and zero inflation? Aren’t these
inconsistent goals?” Explain why these goals are consistent or are
inconsistent.
e. “The Governor of the Bank of Canada was telling everyone to slow down
when he announced an increase in the Bank rate. Clearly, Ottawa’s
thinking is that what the economy needs now is not a speedy recovery
from recession, but one that is slow, drawn out and, in many respects,
painful.” What rationale can be offered for this approach?
ECON 1951 • PRACTICE EXAMINATION 8 OF 21
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Multiple-Choice Questions for Practice Final Exam
1. “The government insists that the CPI measures consumer prices, not the cost
of living. But don’t shoot the CPI—whether bringing good news or bad, it’s
the best messenger we’ve got.” During a typical inflation:
a. The CPI rises by less than the cost of living.
b. The CPI rises by more than the cost of living.
c. The CPI and the cost of living rise by the same amount.
d. No consistent relationship exists between rises in the CPI and in the cost of
living.
2. If inventories fall by $2 billion, consumption increases by $10 billion,
unemployment insurance payments decline by $4 billion, and imports rise by
$1 billion, measured GDP should rise by:
a. $5 billion
b. $7 billion
c. $9 billion
d. $11 billion
3. The CPI (base year 1989) for 1990 is 110, for 1991 is 120, and for 1992 is
If the base year is changed from 1989 to 1992, what is the CPI for 1990?
a. 90 or less
b. Above 90 but not above 100
c. Between 100 and 110
d. More than 110
ECON 1951 • PRACTICE EXAMINATION 9 OF 21
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4. “That is why the jump in May’s unemployment rate—from 7.2 percent to percent,
the highest during this business cycle—caused dismay. Yet this may be missing
the point. The number of people in the labour force in the month of May jumped
by 43,000.” The higher unemployment rate was probably caused by:
a. A fall in employment
b. An increase in the participation rate
c. An increase in the number of discouraged workers
d. All of the above
5. “Nationally, the monthly survey of households found 37,000 more people at
work in February than in January, but many of the new jobs were only part
time, Statistics Canada reported.” From this information, we can conclude that:
a. Unemployment has risen.
b. Unemployment has fallen.
c. Unemployment has remained constant.
d. Nothing can be said about unemployment.
6. Suppose the population over age 15 is 20 million, the participation rate is 60%,
and the unemployment rate is 10%. If the labour force grows by 0.2 million
and employment grows by 0.15 million, what does the unemployment rate
become?
a. 10% or less
b. More than 10% but not more than 10.2%
c. More than 10.2% but less than 10.4%
d. 10.4% or more
ECON 1951 • PRACTICE EXAMINATION 10 OF 21
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7. “What cannot be done, various reformers notwithstanding, is to impose on
any government the obligation to balance its budget annually. Consider the
consequences. If it did work, it would introduce a major destabilizing
element.” Forcing the government to balance its budget would be
destabilizing because a movement towards recession would:
a. Increase unemployment, which would prompt a decrease in tax rates or
an increase in government spending, both of which would create
inflation
b. Increase unemployment, which would prompt an increase in tax rates or
a decrease in government spending, both of which would create inflation
c. Decrease tax receipts, which would cause a budget deficit requiring an
increase in tax rates or a decrease in government spending, both of which
would worsen the recession
d. Decrease tax receipts, which would cause a budget surplus requiring an
increase in government spending or a decrease in tax rates, both of which
would worsen the recession
8. “The extent of the downturn surprised many analysts. According to the
Council, the real gross domestic product fell at an annual rate of 4 percent. If an
apparently unplanned build-up of inventories is taken into account, the rate of
decline is estimated at 7.6 percent.” What has happened here?
a. Aggregate supply and aggregate demand have fallen by 4%.
b. Aggregate supply and aggregate demand have fallen by 7.6%.
c. Aggregate supply has fallen by 7.6%, and aggregate demand has fallen
by 4%.
d. Aggregate supply has fallen by 4%, and aggregate demand has fallen
by 7.6%.
9. Suppose that the income multiplier with respect to government spending is 3,
and the marginal tax rate is 20%. If the government increases spending by $8
billion, the budget deficit will:
a. Decrease or be unaffected
b. Increase by $3b or less
c. Increase by more than $3b but less than $8b
d. Increase by $8b or more
ECON 1951 • PRACTICE EXAMINATION 11 OF 21
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10. Suppose an economy at full employment begins to experience a fall in
inventories. Which policy reaction is most appropriate?
a. Increase taxes
b. Increase transfer payments
c. Increase the money supply
d. Increase government spending
11. If we are at the natural rate of unemployment, an increase in aggregate
demand will lower unemployment in the short run:
a. Regardless of workers’ price rise estimate
b. If workers overestimate the consequent price rise
c. If workers underestimate the consequent price rise
d. If workers perfectly anticipate the consequent price rise
12. Complete the following statement: “Domestic investment did not fall as
sharply as did national saving because…”
a. Private saving increased.
b. The government deficit shrank.
c. Businesses borrowed at higher cost.
d. Businesses borrowed from foreigners.
13. Over the long run, the most important determinant of our standard of living
is:
a. Judicious use of fiscal policy to prevent recessions
b. Increases in productivity due to technological change
c. Avoidance of the unemployment caused by technological change
d. Maintenance of money supply growth approximately equal to the real rate
of growth
ECON 1951 • PRACTICE EXAMINATION 12 OF 21
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14. “The Bank of Canada based its monetary policy in the 1980s on the
assumption that velocity would continue its upward trend. Had they
assumed a constant velocity, money growth would have been
and inflation would have been than what we actually
experienced.” Fill in the blanks.
a. Higher; higher
b. Higher; lower
c. Lower; higher
d. Lower; lower
15. Suppose “the” multiplier is 3, the money multiplier is 6, and the income
multiplier with respect to the money supply is 4. The government increases
spending by $12 billion, but because the economy is operating at full capacity,
it wants to use monetary policy to offset the impact that this increase of
government spending will have on income. The central bank should:
a. Buy $1.5b bonds.
b. Buy $9b bonds.
c. Sell $1.5b bonds.
d. Sell $9b bonds.
16. Suppose velocity is increasing at 1% per year, the real rate of growth of the
economy is 2%, the real interest rate is 3%, and the rate of growth of the
money supply is 4%. The nominal interest rate should be approximately:
a. 4% or less
b. 5%
c. 6%
d. 7% or more
ECON 1951 • PRACTICE EXAMINATION 13 OF 21
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17. “Several government bond issues will raise $400 million, with the central bank
picking up at least $200 million. The central bank can also be counted on to take
down more of the bonds than the planned $200 million it has announced if they
seem to be selling badly.”
a. This scenario suggests that monetary policy is:
b. Flexible
c. Inconsistent
d. Targeting on a fixed interest rate
e. Targeting on a fixed growth rate of the money supply
18. “The average yield at this week’s auction of $17.8 billion of 91-day treasury
bills was 11.17 percent, up from 10.95 percent last week. The average bid price
was $97.290.” Compared to last week, the average bid price:
a. Has risen
b. Has fallen
c. Is unchanged
d. Cannot be determined
19. “Bonds rallied sharply yesterday, cheered on by the news that the
recession isn’t over yet. Prices climbed by as much as $8.75 for each
a. $1,000 face amount in the U.S. government securities market after the
Commerce Department reported that GDP fell by 0.1 percent in the
second quarter.” Bad news rallies bonds because it:
b. May cause the government to lower taxes
c. Is usually accompanied by higher interest rates
d. May cause the central bank to decrease the money supply
e. May cause the central bank to decrease interest rates
20. A bond due to mature and pay $1,000 in one year has a coupon of $85 and a
current price of $1,025. The interest rate is:
a. Below 6%
b. 6% or more, but not more than 8%
c. More than 8% but less than 8.5%
d. 8.5% or more
ECON 1951 • PRACTICE EXAMINATION 14 OF 21
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21. “News of economic weakness last week cleared the way for higher bond prices.
The New York market moved quickly to capitalize on this good bad news:
prices shot up more than a point in minutes.” Bond prices rose because:
a. Inflation expectations fell.
b. Unemployment is expected to fall.
c. The Fed is expected to lower interest rates.
d. Both a and c are correct.
22. “A decline in the rate of inflation is the one sure route to lower interest rates,
the central bank told us two years ago. Inflation is now only about one-third of
what it was two years ago, but interest rates are higher. How come?” The
promised results have not materialized because:
a. The demand for money has fallen.
b. The supply of money has increased.
c. Inflation expectations have not fallen.
d. None of the above are correct.
23. If monetary policy targets an unemployment level less than the natural rate of
unemployment, over time:
a. The interest rate should rise.
b. The exchange rate should rise.
c. Both real and nominal wages should fall.
d. The interest rate and GDP should remain roughly constant.
24. The real interest rate is the:
a. Nominal interest rate less the expected rate of inflation
b. Nominal interest rate plus the expected rate of inflation
c. Observed interest rate less the expected rate of inflation
d. Both a and c
ECON 1951 • PRACTICE EXAMINATION 15 OF 21
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25. “We’re not likely to see a really tight monetary policy; he made clear that the
central bank is following an ‘intentionally moderate’ monetary policy in order
to ‘minimize the strains involved in adjusting to a less inflationary economy.’
He points to the ‘awkward economic fact that in the short run anti-inflationary
policies tend to restrain output more than prices.’” In plain language, this
means that the central bank is adopting a policy of:
a. Raising interest rates markedly to cut back on output
b. Gradually reducing the rate of growth of the money supply
c. Attacking unemployment with a policy of gradually increasing the
money growth rate
d. Increasing the money supply at a low steady rate equal
approximately to the real rate of growth of the economy
26. “The evidence of the 1970s and beyond is that whenever governments
stepped in to administer stimulative medicine, they triggered runaway
inflation which finally had to be stopped with strong, painful doses of
recession.” This statement is consistent with:
a. The frequent underestimation of the NRU
b. An asymmetric short-run Phillips curve
c. Inflation expectations rising quickly but falling slowly
d. All of the above
27. The asymmetry of the short-run Phillips curve gives rise to what policy
conclusion?
a. Policy cannot decrease the unemployment level below the NRU.
b. Any policy to decrease the unemployment rate below the NRU will
accelerate inflation.
c. The cost of reducing inflation is greater than the benefit gained from
raising inflation.
d. The only effective policies for lowering unemployment are policies
reducing the NRU.
ECON 1951 • PRACTICE EXAMINATION 16 OF 21
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28. “But monetary policy cannot be tuned to real economic variables like growth or
employment, not only because policy takes effect with long and uncertain lags,
but because any commitment to real growth targets simply invites workers and
business to increase wages and prices at will, in the knowledge that the central
bank will ratify their demands via the money supply.” Ratifying demands via
the money supply means that money growth will be:
a. Fixed at a low, steady rate
b. Whatever is needed to prevent inflation
c. Whatever is needed to maintain full employment
d. Whatever is needed to maintain a desired interest rate
29. Suppose the money multiplier is 5, the real interest rate is 3%, the long- run
real rate of growth is 2%, the current money supply is $200 billion, velocity is
constant, and the nominal interest rate is 10%. Seigniorage is:
a. Less than or equal to $5b
b. Between $5b and $10b
c. Between $10b and $20b
d. Greater than or equal to $20b
30. “If we can’t borrow all of the funds we need to finance expenditures which we
are going to make in any event, we should at least look at the advisability of
the central bank itself financing some of those expenditures simply by creating
the money.” This suggestion is:
a. Unadvisable because it creates inflation
b. Advisable because it means lower taxes
c. Unadvisable because it creates unemployment
d. Advisable because it minimizes interest costs
ECON 1951 • PRACTICE EXAMINATION 17 OF 21
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31. Suppose currently an economy is experiencing $3 billion of extra taxes and $2
billion lower unemployment insurance payments than what would be the case
at its long-run average rate of unemployment. There is a budget deficit of $40
billion, a publicly held national debt of $400 billion, a money supply of $600
billion, a nominal growth rate of 5%, and an annual seigniorage of $4 billion.
The structural deficit of this economy is:
a. $10b or less
b. More than $10b but not more than $15b
c. More than $15b but not more than $20b
d. More than $20b
32. “Economists and important figures in the U.S. government have been
debating whether it is government spending deficits, restrictive monetary
policy, capital inflows, or anticipated inflation that is the real culprit for
interest-rate increases in the U.S.” Which of these definitely could not have
caused high interest rates?
a. Capital inflows
b. Anticipated inflation
c. Restrictive monetary policy
d. Government spending deficits
33. Suppose the central bank has intervened in the foreign exchange market to fix
the exchange rate by buying $4 billion. If the current account deficit is $10
billion, the capital account balance is a surplus of:
a. $4b
b. $6b
c. $10b
d. $14b
ECON 1951 • PRACTICE EXAMINATION 18 OF 21
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34. “The response has been to search out the middle ground. The central bank
has a simple operating formula: Some of the adjustment will be taken
through the exchange rate, some through interest rates, and the rest through
a loss of international reserves.” This policy involves a:
a. Fall in the exchange rate and a fall in the interest rate
b. Fall in the exchange rate and a rise in the interest rate
c. Rise in the exchange rate and a fall in the interest rate
d. Rise in the exchange rate and a rise in the interest rate
35. “As interest rates rose by record leaps this week, the dollar continued its slide.”
What is going on here?
a. The rise in interest rates is causing the dollar to fall.
b. The rise in interest rates is decreasing capital inflows.
c. The slide in the dollar must be causing the central bank to increase
interest rates.
d. Both a and b are correct.
36. Complete the following statement. “Canada’s official international
reserves rose to an all-time high in October as the Bank of Canada
acquired close to U.S. $600 million trying to…”
a. Prevent a fall in the Canadian dollar
b. Prevent a rise in the Canadian dollar
c. Deal with a balance of payments surplus via foreign exchange market
intervention
d. Both b and c
37. “This is the reason why the fixed exchange rate system was scrapped in 1971.
The U.S. had been pursuing an inflationary monetary policy to help pay for the
Vietnam war and new social programs, and its trading partners did not all
want to participate in it.” To avoid participating in this inflation, a trading
partner would have to adopt a flexible exchange rate and:
a. Raise its money growth rate and allow its currency to appreciate steadily
b. Raise its money growth rate and allow its currency to depreciate steadily
c. Lower its money growth rate and allow its currency to appreciate steadily
d. Lower its money growth rate and allow its currency to depreciate steadily
ECON 1951 • PRACTICE EXAMINATION 19 OF 21
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38. “The Bank of Canada began easing monetary conditions in response to the
recession and the resulting substantial reduction in inflationary pressures.”
While the Fed was also easing, the pace of easing in Canada exceeded that in
the United States, resulting in a 300 basis point narrowing in the Canada-U.S.
short-term interest rate spread. Surprisingly, this did not result in a decline in
the value of the Canadian dollar; in fact, it strengthened. This increase in the
value of the Canadian dollar can be explained by:
a. Inflation in Canada must have been falling faster than in the U.S.
b. Inflation in the U.S. must have been falling faster than in Canada.
c. The 300 point narrowing must have caused a widening of the real interest
rate spread.
d. Both a and c are correct.
39. Suppose the U.S. and Canadian economies, on a flexible exchange rate, are
both experiencing a real growth rate of 3%, but that the Canadian money
supply growth rate is 10% compared to only 6% in the U.S. Currently, 1 U.S.
dollar buys 1.2 Canadian dollars. How many Canadian dollars would you
guess 1 U.S. dollar will buy 2 years from now?
a. 1.2 or less
b. More than 1.2 but not more than 1.25
c. More than 1.25 but not more than 1.3
d. More than 1.3
40. In countries experiencing hyperinflation we should see:
a. Low interest rates and a depreciating currency
b. High interest rates and a depreciating currency
c. Low interest rates and an appreciating currency
d. High interest rates and an appreciating currency
ECON 1951 • PRACTICE EXAMINATION 20 OF 21
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41. “The Bank of Canada has made occasional attempts to lower interest rates and
accept some lowering of the dollar as a trade-off. Sometimes it works, and
sometimes, like last summer, we end up with the worst of all possible worlds—
higher interest rates and a lower dollar.ʺ This worst of all possible worlds most
likely happened because the Bank of Canada’s effort to lower interest rates:
a. Increased inflation, which increased the nominal interest rate and
depreciated the dollar
b. Caused capital inflows to fall, lowering the exchange rate, which raised
costs and thus increased the interest rate
c. Caused a balance of payments surplus, which automatically increased
the money supply, causing inflation that lowered the exchange rate and
increased the nominal interest rate
d. Increased the money supply, which under a flexible exchange rate
depreciated the dollar, requiring a higher interest rate to attract capital
inflows for international balance
42. “While the chartered banks have so far refrained from raising their rates, the
finance minister warned reporters that this situation cannot last. The Canadian
and U.S. economies are so interrelated, he said, that it will be impossible for
Canadian interest rates to remain much lower than U.S. rates for an extended
period of time.” This politician’s statement is:
a. False because if the exchange rate is fixed, Canada can have a lower
nominal interest rate if its inflation rate is lower
b. False because if the exchange rate is flexible, Canada can have a lower
nominal interest rate if its inflation rate is lower
c. True because so long as Canada is riskier than the U.S., its interest rate
must in the long run be higher than that of the U.S.
d. True because international arbitrage forces will ensure that the Canadian
and U.S. real interest rates are roughly the same, except for a risk
premium
ECON 1951 • PRACTICE EXAMINATION 21 OF 21
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43. “One question is whether the government can steel itself to bring its fiscal
policy into line with the central bank’s monetary policy. Will the government
be able to borrow the funds it will need to cover this year’s deficit out of the
existing money supply, which the Bank of Canada is trying to restrict?” If the
government tries to borrow more funds than are available, a rise will occur in:
a. Bond prices
b. Inflation
c. Interest rates
d. Unemployment
44. “The bang from a buck of direct government spending—say, highway
construction—is far greater than the punch from a tax cut of equal dollar
magnitude.” This happens because:
a. Some of the taxes are avoided.
b. A tax cut only increases aggregate demand by the marginalpropensity-to-save times the tax cut.
c. A tax cut only increases aggregate demand by the marginalpropensity-to-consume times the tax cut.
d. Higher government spending sets the multiplier in motion, whereas
a tax cut does not.
END OF EXAMINATION

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