PRACTICE FINAL EXAM #2

(with solutions)
ECON10003 INTRODUCTORY MACROECONOMICS

Exam Duration: 3 hours (writing) and 30 minutes (reading)
Exam Conditions: Open Book

Instructions

Part A consists of 20 multiple choice questions each worth 1.5 marks for a total of 30 marks.
Answer all questions using the Canvas quiz form online. Incorrect answers or no answer will
receive a zero mark.

Part B consists of 10 true/false questions each worth 3 marks for a total of 30 marks.
Answer all questions using the Canvas quiz form online. Make sure to include a explanation
of your reasoning. For each true/false question 1 mark will be awarded for a correct
true/false response and 2 marks will be awarded for a correct explanation.

Part A: Multiple Choice Questions

Part A consists of 20 multiple choice questions each worth 1.5 marks for a total of 30 marks.
Answer all questions using the Canvas quiz form online. Incorrect answers or no answer will
receive a zero mark.

Correct answers marked with a *.

1. A construction company produces a $1,000,000 new house using $300,000 worth of
wood, steel, and other materials in addition to $350,000 of labour hours. Which of the
following is true?
a. The contribution of the construction company to GDP is $1,000,000
b. The contribution of the construction company to GDP is $700,000*
c. Profit income is $650,000
d. None of the other options

2. If the value of all goods produced remains unchanged between 2020 and 2022 but
the price of all goods falls by 10% over this period, what can we say about the period
from 2020 to 2022?
a. The percentage change in real GDP will be larger than the percentage change
in nominal GDP *
b. The percentage change in nominal GDP will be larger than the percentage
change in real GDP
c. The percentage change in nominal GDP will equal the percentage change in
real GDP
d. We cannot compare changes in nominal GDP to changes in real GDP without
further information

3. If inflation is unexpectedly low, then we can expect that lenders will be _______ off
and borrowers will be _______ off, as a result.
a. better, better
b. better, worse*
c. worse, better
d. worse, worse

4. If the population of a country is 300 million, of whom 250 million are available to
work, the unemployment rate is 5% and the participation rate is 65%, the number of
employed and unemployed workers are, respectively:
a. 155.5 million and 8.750 million
b. 195.0 million and 15.5 million
c. 175.5 million and 12.55 million
d. 154.4 million and 8.125 million *

5. Consider a simple model where workers can be either employed or unemployed.
Suppose the labour force is L = 300 million workers, the job separation rate is 2% per
month and the job finding rate is 38% per month. Which of the following is true?
a. In steady state, 15 million workers are unemployed*
b. In steady state, fewer workers are losing their jobs than there are
unemployed workers finding a job
c. In steady state, 114 million workers are employed
d. None of the other options

6. Consider a simple Keynesian model with taxation. Suppose the marginal rate of tax is
0.4 and the marginal propensity to consume is 0.66. Then an increase in investment
expenditure of 100 units will:
a. Increase equilibrium output by approximately 150 units
b. Increase equilibrium output by approximately 166 units *
c. Increase equilibrium output by approximately 267 units
d. Increase equilibrium output by approximately 750 units

7. Suppose the existing stock of government debt is $500 billion. The interest rate is
5%. Government purchases are $25 billion, and government transfers another $50
billion. Tax revenue is $100 billion. The total budget surplus is:
a. $75 billion
b. $50 billion
c. $10 billion
d. $0 billion (the budget is balanced) *

8. Suppose potential GDP is growing at 1% per year and velocity is stable. According to
the quantity theory of money, a central bank that wants to target 2% inflation should
expand the money supply at what rate?
a. 3% *
b. 2%
c. 1%
d. 0%

9. Consider the AD-AS model. Suppose there is an increase in the central bank’s
inflation target. Which of the following is TRUE?
a. On impact, inflation will rise but short-run output will fall
b. On impact, inflation will rise and real interest rates will rise
c. There is no long-run effect on either output or the nominal interest rate
d. There is no long-run effect on either output or the real interest rate *

10. Consider an AD-AS model with AD curve − ∗ = −( − ∗) + " and AS curve = # + ( − ∗) + $ with parameter values = 0.5, = 1, = 1, = 0.5,
and with inflation target ∗ = 0.02 and potential output normalised to ∗ = 1.
Starting from a long-run equilibrium with # = ∗ suppose there is a temporary
demand shock " = −0.05. Which of the following is TRUE?
a. In the short run, output is 4% below trend *
b. In the short run, output is 4% above trend
c. In the short run, inflation is 3%
d. In the short and the long run, output is 4% below trend

11. Consider a closed economy. Household saving is $300, business saving is $400,
government purchases are $1000, government transfers and interest payments are
$500, government tax collections are $1300, and GDP is $5000. What is the fiscal
deficit?
a. $200 *
b. $1000
c. $0
d. $800

12. Consider the production function % = %(2%)&(2%)'(&. Capital in use is % = 25
units, labour is % = 25 units, % = 2 and = 0. If both capital and labour are
increased to 50 units each, how much does output increase?
a. from 50 units to 100 units
b. from 50 units to 200 units
c. from 625 units to 2500 units
d. from 100 units to 200 units *

13. Consider the production function % = %%&%'(& where % is total factor
productivity, % is labour, % is capital. Suppose = 0. If the growth rate of capital
per worker is 2 percent and the growth rate of output per worker is 1 percent, the
growth rate of total factor productivity is?
a. 1 percent *
b. 0.5 percent
c. 2 percent
d. 0 percent

14. Consider two countries, Brazil and the US. Suppose both countries have production
functions of the form = '/*+/*. Brazil has output per worker that is 0.20 times
that of the US and has capital per worker that is 0.17 times that of the US. Compared
to the US, the implied level of total factor productivity for Brazil is approximately?
a. 0.20
b. 3.33
c. 0.30
d. 0.36 *

15. Consider a Solow–Swan model with saving rate = 0.4, labour force growth , =0.05, constant productivity = 1, and depreciation = 0.05. If output per worker
is % = %/% = 200 and capital per worker is % = %/% = 1000, how would %
evolve over time?
a. % is above its steady state and decreases towards the steady state *
b. % is above its steady state and increases towards the steady state
c. % is below its steady state and decreases towards the steady state
d. % is at its steady state and remains constant

16. Consider a Ricardian trade model where both countries have expenditure share =0.25 on manufactures, Country 1 has - = 1 and . = 4 and = 100, while
Country 2 has -∗ = .∗ = 0.5 and ∗ = 100. With free trade, which of the following
is TRUE?
a. Country 1 produces 400 services and exports 200 services
b. Country 2 produces 100 manufactures and exports 50 manufactures
c. The relative wage is ∗⁄ = 3 *
d. None of the other options

17. Consider a small open economy that produces textiles. The world price of textiles is
less than the country’s autarky price of textiles. A tariff levied on imports of textiles
will:
a. Increase the producer surplus of domestic textile producers *
b. Increase the consumer surplus of domestic textile consumers
c. Decrease the producer surplus of foreign textile producers
d. None of the other options

18. Suppose the annual growth rate of the nominal exchange rate, expressed in euros
per Australian dollar, is 4%, while the Eurozone has an annual 6% inflation rate. If
purchasing power parity holds, what is the annual inflation rate in Australia?
a. 2% *
b. 6%
c. 10%
d. 0%

19. Consider the bilateral exchange rate between Australia and the US. Suppose the
demand for Australian dollars in the foreign exchange market is given by = 120 −50 where denotes the quantity of AUD and denotes the nominal exchange
rate expressed in USD per AUD. The supply of Australian dollars is given by =50 + 50. Now suppose the Reserve Bank of Australia pegs the exchange rate at D = 0.75. Which of the following is FALSE?
a. The exchange rate peg exceeds the market equilibrium exchange rate
b. There is excess demand for AUD *
c. The Reserve Bank of Australia needs to buy AUD to maintain the peg
d. None of the other options

20. Consider a small economy that does not permit international borrowing or lending.
The country’s autarky real interest rate is greater than the world real interest rate.
Now suppose the economy removed capital controls. Which of the following is
TRUE?
a. There is an excess demand for capital in the domestic economy and capital
flows in *
b. There is an excess demand for capital in the domestic economy and capital
flows out
c. There is an excess supply of capital in the domestic economy and capital
flows in
d. There is an excess supply of capital in the domestic economy and capital
flows out
Part B: True/False Questions

Part B consists of 10 true/false questions each worth 3 marks for a total of 30 marks.
Answer all questions using the Canvas quiz form online. Make sure to include an explanation
of your reasoning. For each question 1 mark will be awarded for a correct true/false
response and 2 marks will be awarded for a correct explanation.

Note: the solutions below give brief explanations that are simply intended to help you
understand why the answer is true/false. In other words, these are not intended to be
“model answers”.

QUESTION B1

If employment is increasing, the unemployment rate is decreasing.

False. Participation could be rising so that both employment and unemployment are
increasing.

QUESTION B2

Consider a standard Keynesian model but with two types of consumers, Type A who have
low marginal propensities to consume and Type B who have high marginal propensities to
consume.

The government wants to stimulate the economy while balancing the budget. If spending
is targeted equally on both types of consumers, but taxes are levied in greater amount on
Type B consumers, then the balanced-budget multiplier will be greater than one.

False. The balanced budget multiplier is equal to 1 when all consumers are alike. With two
types of consumers the multiplier can be different to 1 depending on the composition of
spending/taxation on high versus low MPC consumers. The idea is that higher taxation on
high MPC consumers will have a larger negative effect than the boost to demand from
lower taxation on lower MPC consumers. Hence the over-all multiplier will be less than 1.












QUESTION B3

Consider a standard AD-AS model.

An increase in the inflation target is associated with a short-run decrease in
unemployment but not a long-run decrease in unemployment.

True. An increase in the inflation target shifts out the AD curve along a SRAS, increasing
inflation and output on impact. Since output rises > ∗, unemployment falls < ∗ (by
Okun’s Law). But as inflation expectations adjust to the new higher inflation target and
lived experience of higher inflation, the SRAS curve shifts up along the new AD curve,
causing inflation to continue to rise to the new inflation target while output falls back to ∗
and hence unemployment rises back to ∗. So, in the long run there is no decrease in
unemployment.

QUESTION B4

Consider a standard AD-AS model.

If the SRAS curve is steep, a temporary tax cut leads to a relatively small increase in
inflation and relatively large decrease in unemployment.

False. A steeper SRAS curve will lead to a larger increase in inflation in response to a cut.
However, the effect on output will be smaller all else equal. Through Okun’s Law the
smaller output effect translates into a smaller reduction in unemployment.

QUESTION B5

Consider a standard AD-AS model.

The economy is affected by the following sequence of events. In period 1 there is a shock
to the economy that is temporary. In period 2, the shock ends. But having observed an
inflation outcome different to the inflation target, inflation expectations change from the
inflation target to a value exactly equal to the observed inflation in period 1 (that is,
expectations are not `anchored’).

A temporary negative demand shock would lead to output below potential in period 1, but
above potential in period 2.

True. A temporary negative demand shock shifts the AD inwards which leads to a decline
in inflation and output in period 1. In period 2 the AD curve returns to its initial position,
but the SRAS curves shifts downwards due to the revision in inflation expectations. Hence
we have a negative demand shock followed by a negative supply shock in which output
rises above potential and inflation falls below target.

QUESTION B6

Consider the Solow-Swan model. Along a balanced growth path, output per worker grows
at the same rate as total factor productivity.

True. Output per effective worker ∕ is constant (in steady state) so ⁄ grows at the
same rate as total factor productivity .

QUESTION B7

Consider the Solow-Swan model. A one-time increase in the saving rate will increase the
long run level of investment per worker but will not increase the long run level of output
per worker.

False. An increase in the saving rate will shift up the investment per worker curve along an
unchanged depreciation per worker curve so there will be a new higher steady state level
of capital per worker in the long run. In the new steady state, investment per worker is
higher and output per worker is higher because = () and is higher.

QUESTION B8

Consider a small open economy country that produces coffee. The world price of coffee is
greater than the country’s autarky price of coffees. Opening to trade will decrease the
consumer surplus of domestic coffee consumers.

True. Since / > 0 the country begins to export coffee and this reduces the consumer
surplus of domestic coffee consumers (they consume less and pay more per unit).

QUESTION B9

Consider a country that pegs the value of its currency to the US dollar. Suppose the level of
the exchange rate peg is low relative to market expectations of its fundamental value. A
speculative attack by currency investors is likely to lead to the domestic central bank
acquiring more US dollars.

True. Since the exchange rate is undervalued, a speculative attack would take the form of
investors buying the local currency. To meet that demand the domestic central bank would
have to supply its own currency in exchange for US dollars, thereby acquiring more US
dollars.