Paper code CC0304 Year 2015 , Semester 1 Page 1 of 11

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ECON1002
Introductory Macroeconomics

Final Examination
Semester 1, 2015

Time Allowed: Two Hours + 10 minutes reading time

This examination paper consists of 10 pages

INSTRUCTIONS TO CANDIDATES

Listed below are example instructions, please amend as appropriate

1. This is a closed book exam.
2. A simple calculator (programmable versions and PDA’s not allowed) may be
taken into the exam room.
Calculator Make Model

3. The paper consists of two sections (A and B). Section A consists of 30

multiple choice questions and is worth 30 marks and Section B consists of 2
conceptual/analytical/discussion problems and is worth 30 marks. Answer both
questions in Section B. The whole exam is worth 50% of the final grade from
this course.
4. For Section A, enter your answers onto the computer multiple choice answer
sheet provided. For Section B, answer all questions in the spaces provided on
this question paper.
5. The question paper must be returned with the multiple choice answer script.
6. Take care to write legibly. Write your final answers in ink, not pencil.
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SECTION A: Multiple Choice Questions (30 marks)

1. Consider a hypothetical economy in which the GDP deflator is 0.5 and real GDP is $100.
Which of the following is most correct?
a. Nominal GDP is 50 and this economy is experiencing inflation.
b. Nominal GDP is 50 and this economy is experiencing deflation.
c. Nominal GDP is 200 and this economy is experiencing inflation.
d. Nominal GDP is 200 and this economy is experiencing deflation.

2. The unemployment rate for an economy in which the labour force is 20 million people and
the number of employed people is 17 million is equal to:
a. 5%
b. 10%
c. 15%
d. 20%

3. The main difference between the basic Keynesian and Aggregate Demand/Aggregate
Supply (AD/AS) models discussed in class is that:
a. There is no role for government in the AD/AS model.
b. The economy is self-correcting in the Keynesian model, but not in the AD/AS
model.
c. The economy is self-correcting in the AD/AS model, but not in the Keynesian
model.
d. The Keynesian model focuses on the short run only, while the AD/AS model
focuses on the long run only.

Questions 4 and 5 relate to the following information.

Consider a simple Keynesian economy in which C=100+0.5Y, G=50, IP=50 and NX=0; where C is
consumption, Y is income, G is government spending, IP is planned investment and NX is
exports. The potential output of this economy is 400.

4. If IP increases by 50 (and everything else stays the same), equilibrium income will increase
by:
a. 100
b. 250
c. 400
d. 500

5. At the original equilibrium, this economy is experiencing:

a. Cyclical unemployment only
b. Frictional and cyclical unemployment only
c. Structural and cyclical unemployment only
d. Structural and frictional unemployment only

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6. Assume the amount of currency in circulation in an economy is $100 billion, current

deposits with banks are $400 billion and deposits in the private non-bank sector are $200
billion. Also assume that current nominal GDP is $1000 billion. What is the current
velocity of M1 in this economy?
a. 1.42
b. 2
c. 3.33
d. 10

7. Which of the following statements is most correct for Australia’s financial system?
a. Commercial bank reserves can only be lent between banks.
b. Commercial banks only lend out existing reserves held with the Central Bank.
c. The Central Bank controls the money supply by setting the reserve-deposit ratio.
d. The Central Bank controls the quantity of loans by controlling the quantity of
reserves.

8. Money in the financial system is destroyed when:

a. Commercial banks issue new loans.
b. Commercial banks buy government bonds from private non-banks.
c. The central bank buys government bonds from insurance companies.
d. A borrower goes bankrupt and her debt is written off (i.e. cancelled).

9. The Reserve Bank of Australia reduces the overnight cash rate. Which of the following
best describes the impact on the demand for and supply of 90-day Treasury Bills?
a. Both the supply and demand curves for 90-day treasury bills shift left.
b. Both the supply and demand curves for 90-day treasury bills shift right.
c. The supply curve for 90-day treasury bills shifts right and the demand curve for 90-
day treasury bills shifts left.
d. The supply curve for 90-day treasury bills shifts left and the demand curve for 90-
day treasury bills shifts right.

10. According to the Taylor Rule, Central Banks tend to:

a. Raise interest rates when they observe a contractionary gap and low inflation.
b. Raise interest rates when they observe an expansionary gap and low inflation.
c. Reduce interest rates when they observe a contractionary gap and low inflation.
d. Reduce interest rates when they observe an expansionary gap and low inflation.

11. The Central Bank policy reaction function is likely to shift downwards parallel when the
Central Bank:
a. Increases the emphasis on inflation in their policy reaction function.
b. Decreases the emphasis on inflation in their policy reaction function.
c. Increases the emphasis on a contractionary gap in their policy reaction function.
d. Increases the emphasis on an expansionary gap in their policy reaction function.

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12. The Australian dollar – US dollar exchange rate changes from $A1=$US0.80 to
$A1=$US0.85. Which of the following is most likely to result from this change?
a. Demand for Australia’s exports will increase
b. The Reserve Bank of Australia will increase interest rates
c. Demand for foreign imports by Australians will decrease
d. Australia’s foreign debt repayments in Australian dollar terms will decrease

13. A country facing recession has fixed its currency to that of a country which is experiencing
rapid economic growth. Compared to a situation in which the recession country’s
exchange rate floats freely against all other currencies, this arrangement is likely to:
a. Increase aggregate demand in the recession country as its exports become more
internationally competitive and its consumers demand less imports.
b. Decrease aggregate demand in the recession country as its exports become less
internationally competitive and its consumers demand more imports.
c. Decrease aggregate demand in the recession country as its exports become more
internationally competitive and its consumers demand fewer imports.
d. Increase aggregate demand in the recession country as its exports become more
internationally competitive and its consumers demand more imports.

14. Which of the following is most likely to shift the aggregate supply curve to the left or
upwards?
a. An increase in inflation.
b. A positive inflation shock.
c. An increase in inflationary expectations
d. An improvement in technology that leads to higher output

Questions 15 and 16 refer to the following information.

Consider an economy that is initially at its full-employment equilibrium output and has an
inflation rate that is above the central bank’s target rate.

15. If aggregate supply decreases (at every level of inflation):

a. Policymakers should do nothing
b. The government should decrease spending
c. The Central Bank should raise its inflation target
d. The Central Bank should decrease interest rates

16. If aggregate demand increases (at every level of inflation):

a. Policymakers should do nothing
b. The government should increase spending
c. The government should decrease spending
d. The Central Bank should decrease interest rates

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17. Real GDP per person is most likely to increase if, all other things being equal:
a. The number of people working increases
b. Real GDP and the number of people working both increase
c. Average labour productivity and the population both increase
d. Average labour productivity and the number of people working both increase

18. The Cobb-Douglas production function, Y = AK α Lβ with α + β > 1 is characterised by:

a. Constant returns to scale
b. Increasing returns to scale
c. Decreasing returns to scale
d. Diminishing marginal product of labour but not capital.

19. An economy’s production function is given by Y = AK 0.2 L0.8 . If GDP growth is 5%, the
capital stock is growing at 8% and the labour force is growing at 4%, then total factor
productivity growth is equal to:
a. 0.1%
b. 0.2%
c. 0.5%
d. 0.8%

20. The convergence hypothesis of the Solow-Swan model implies that:

a. Countries with relatively high per capita capital stocks tend to grow more quickly
than countries with lower per capita capital stocks.
b. Countries with relatively low per capita capital stocks tend to grow more quickly
than countries with higher per capita capital stocks.
c. Countries with relatively low per capita capital stocks tend to reach their steady
state more quickly than countries with higher per capita capital stocks.
d. Countries with relatively high per capita capital stocks tend to reach their steady
state more quickly than countries with higher per capita capital stocks.

21. Which of the following is most likely to lead to an appreciation of the Australian dollar?
a. A reduction in interest rates by the European Central Bank.
b. An increase in interest rates by the European Central Bank.
c. An increased demand for foreign-made goods by Australian consumers.
d. An increased demand for American-made goods by American consumers.

22. An Australian manufacturer borrows $1,000,000 from a US bank in order to pay for a new
machine (priced at $1,000,000) imported from Germany. This transaction will be recorded
in Australia’s balance of payments as:
a. A debit of $1,000,000 on both the current and capital accounts.
b. A credit of $1,000,000 on both the current and capital accounts.
c. A credit of $1,000,000 on the current account and a debit of $1,000,000 on the
capital account.
d. A debit of $1,000,000 on the current account and a credit of $1,000,000 on the
capital account.

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23. Consider an economy that operates a fixed exchange rate. Which of the following
statements about this economy’s balance of payments (= current account balance + capital
account balance) is correct:
a. If the balance of payments > 0, then the central bank will need to sell domestic
currency to maintain the current exchange rate.
b. If the balance of payments > 0, then the central bank will need to buy domestic
currency to maintain the current exchange rate.
c. If the balance of payments = 0, then the central bank will need to sell domestic
currency to maintain the current exchange rate.
d. If the balance of payments = 0, then the central bank will need to buy domestic
currency to maintain the current exchange rate.

24. Consider an economy in which private saving = $100 billion, investment = $200 billion and
net exports = -$150 billion. In this case, the government budget outcome is:
a. A deficit of $50 billion.
b. A deficit of $150 billion.
c. A surplus of $50 billion.
d. A surplus of $150 billion.

25. The data in the table below refers to an economy with a flexible exchange rate.

Balance of Payments item $ billion

Balance on goods and services 100
Net income -300
Balance on capital account 100
Balance on financial account 50

According to the data in the table, this economy has:

a. Net current transfers of $50 billion
b. Net current transfers of $150 billion
c. A current account deficit of $50 billion
d. A current account surplus of $150 billion

26. Purchasing power parity may not hold if:

a. Markets are perfectly competitive
b. Countries have different inflation rates
c. There are non-traded goods or services
d. There is free trade in goods and services

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27. Assume that Australia’s trade weighted index has increased. If purchasing power parity
holds then, this most likely implies that:
a. Australian inflation has increased relative to that of its trading partners.
b. Australian inflation has decreased relative to that of its trading partners.
c. The prices of goods and services are now, on average, lower in Australia than in
Australia’s trading partners.
d. The prices of goods and services are now, on average, higher in Australia than in
Australia’s trading partners.

Questions 28 and 29 refer to the following information.

The demand for and supply of Mexican pesos in the foreign exchange market is given by:
Demand for pesos: 5000 − 3,000e
Supply of pesos: 1000 + 2,000e ,
where e is measured in dollars per peso. Assume that the official value of the peso is fixed at
e=0.5.

28. The fundamental value of the peso is given by:

a. 0.5 dollars per peso
b. 0.6 dollars per peso
c. 0.7 dollars per peso
d. 0.8 dollars per peso

29. At the official (i.e. fixed) value of the peso, Mexico has:
a. A balance of payments surplus of $750.
b. A balance of payments surplus of $2,500.
c. A balance of payments deficit of $1,500.
d. A balance of payments deficit of $5,000.

30. According to the textbook, The Great Moderation in developed economies since the mid-
1980s may have been the result of:
a. Better management of inventories
b. A shift away from services towards manufacturing
c. Central banks playing a less active role in managing inflation
d. A reduced openness to trade and international capital flows

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SECTION B: Essay/Short-answer/Analytical Questions (30 marks)

Instructions: Answer both questions in this section. If you use diagrams to illustrate your
arguments, then explain and label them carefully. Wherever possible explain the intuition and
logic underpinning your argument. Please show all working.

Question 1. (20 marks)

An economy is experiencing a contractionary gap and an inflation rate below the central bank’s
target rate.

a) In response, the central bank decides to increase its target inflation rate. On an aggregate
demand – aggregate supply (AD/AS) diagram show the short run AND long-run impact of
this policy change on the economy. Label your diagram carefully and explain in words
what it shows. (8 marks)

b) Imagine, instead, that the central bank responds by implementing a policy of quantitative
easing. Explain carefully in words and using diagrams how this policy can increase
economic activity. In your answer, be sure to discuss in detail the impact of quantitative
easing on the balance sheets of financial institutions. (12 marks)

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Question 2 (10 marks)

Consider two countries. Country 1 has a production function given by =2 and

Country 2 has a production function given by = , where Y is total output, K measures
total capital in the economy and L is the total amount of labour. Assume that both countries
have the same depreciation rate (2%) and the same population growth rate (3%).

a) The governments of both countries 1 and 2 would like to achieve an identical standard of
living for their people; namely, output per person of 8. Calculate the savings rate that each
country will need to have in order to achieve this targeted standard of living. (6 marks)

b) Using words and/or a diagram, provide economic intuition for your answer in part (a).
(4 marks)

END OF EXAM
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