UBC Okanagan

Department of Economics

Economics 205

February 05, 2015

Midterm Examination II
Instructions: Ensure your mobile phone is turned off. Remove all head ware. Calculators and
other electronic aids are not permitted. Answer the multiple choice questions on the bubble
sheets and the analytical (short answer) questions in the examination booklet provided.
Ensure that both your name and student number are on the bubble sheet and examination
booklet. Read through the exam before starting and allocate your time appropriately. There are
two sections: I. Multiple choice and II. Analytical questions. You have 1 hour and 20 minutes to
complete the exam.

I.
A)
B)
C)
D)

A)
B)
C)
D)

A)
B)
C)
D)

Multiple Choice (2 Marks Each)

1. The assumption of continuous market clearing means that:

sellers can sell all that they want at the going price.
buyers can buy all that they want at the going price.
in any given month, buyers can buy all that they want and sellers can sell all that they want
at the going price.
at any given instant, buyers can buy all that they want and sellers can sell all that they want
at the going price.
2. How does the distinction between flexible and sticky prices affect the study of
macroeconomics?
The study of flexible prices is confined to microeconomics, while macroeconomics
focuses on sticky prices.
Macroeconomists use flexible prices to explain inflation and sticky prices to explain
unemployment.
Flexible prices are typically assumed in the study of the long run, while sticky prices are
assumed in the study of the short run.
Endogenous variables are measured using flexible prices, while exogenous variables are
measured using sticky prices.
3. Real GDP is measured in _____ dollars ____ time.
current; at a point in
current; over a period of
constant; at a point in
constant; over a period of

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A)
B)
C)
D)

4. In the national income accounts, net exports equal:

exported goods minus imported goods.
exported goods and services minus imported goods and services.
exported goods minus imported services.
exported goods and services plus imported goods and services.

A)
B)
C)
D)

5. GNP equals GDP ______ income earned domestically by foreigners ______ income that
nationals earn abroad.
plus; plus
minus; minus
minus; plus
plus; minus

A)
B)
C)
D)

6. Okun's Law is the _______ relationship between real GDP and the _________.
negative; unemployment rate
negative; inflation rate
positive; unemployment rate
positive; inflation rate

A)
B)
C)
D)

7. A farmer grows wheat and sells it to a miller for $1; the miller turns the wheat into flour
and sells it to a baker for $3; the baker uses the flour to make bread and sells the bread
for $6. The value added by the miller is:
$1.
$2.
$3.
$6.

A)
B)
C)
D)

8. If output is described by the production function Y = AK 0.2L0.8, then the production

function has:
constant returns to scale.
diminishing returns to scale.
increasing returns to scale.
a degree of returns to scale that cannot be determined from the information given.

A)
B)
C)
D)

9. People use money as a store of value when they:

hold money to transfer purchasing power into the future.
use money as a measure of economic transactions.
use money to buy goods and services.
hold money to gain power and esteem.

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10. If the money supply increases 12 percent, velocity decreases 4 percent, and the price
level increases 5 percent, then the change in real GDP must be ______ percent.
A) 3
B) 4
C) 9
D) 11
11. If the real return on government bonds is 3 percent and the expected rate of inflation is 4
percent, then the cost of holding money is ______ percent.
A) 1
B) 3
C) 4
D) 7
12. In a small open economy, if exports equal $20 billion, imports equal $30 billion, and
domestic national saving equals $25 billion, then net capital outflow equals:
A) $25 billion.
B) $10 billion.
C) $10 billion.
D) $25 billion.
13. A trade deficit can be financed in all of the following methods except by:
A) borrowing from foreigners.
B) selling domestic assets to foreigners.
C) selling foreign assets owned by domestic residents to foreigners.
D) borrowing from domestic lenders.

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Use the following to answer question 14:

Exhibit: Saving and Investment in a Small Open Economy

14. (Exhibit: Saving and Investment in a Small Open Economy) In a small open economy if
the world interest rate is r1, then the economy has:
A) a trade surplus.
B) balanced trade.
C) a trade deficit.
D) negative capital outflows.

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Use the following to answer question 15:

Exhibit: Policies Influence Real Exchange Rate

15. (Exhibit: Policies Influence Real Exchange Rate) Which of the graphs illustrates the
impact on the real exchange rate of contractionary fiscal at home, in the basic version of
the small open economy model?
A) (A)
B) (B)
C) (C)
D) (D)

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II.

Analytical Questions

16. In September 1995, Patrick Buchanan, a Republican candidate for U.S. president, proposed a 10
percent tariff on Japanese imports to the United States, a 20 percent tariff on Chinese imports to
the United States, and an unspecified social tariff on imports from third-world countries.
a. Use the long-run model of a small open economy to illustrate graphically the impact of
these trade policies on the U.S. exchange rate and the trade balance. Assume that the
country starts from a position of trade balance, i.e., exports equal imports. Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction the curves shift
v. the new long-run equilibrium values.
b. Based on your graphical analysis, explain the predicted impact of Mr. Buchanan's proposed
policies. Specifically state what happens to the exchange rate, the trade balance, the volume
of imports, and the volume of exports.
17. Assume that the demand for real money balance (M/P) is M/P = 0.6Y 100i, where Y is
national income and i is the nominal interest rate. The real interest rate r is fixed at 3
percent by the investment and saving functions. The expected inflation rate equals the
rate of nominal money growth.
a.
b.

If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what
must i and P be?
If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, what
must i and P be?

18. Suppose a government education program succeeds in getting households to save more
(you may interpret this as a downward shift in the consumption function).
a.
Using the long-run model of the economy developed in Chapter 3,
graphically illustrate the affect of the higher saving rate by households. Be
sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction curves shift
v. the terminal equilibrium values.
b.
State in words what happens to:
i. the real interest rate
ii. national saving
iii. investment
iv. consumption
v. output.

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19. Explain why the value of GDP in 2014 would or would not change as a result of each of
the following transactions:
a. In 2014, the Smith family purchases a new house that was built in
2014.
b. In 2014, the Jones family purchases a house that was built in 2001.
c. In 2014, a construction company purchases windows to put in the
Smith family home that was built in 2014.
d. In 2014, Mr. Jones paints all of the rooms of the Jones family house
purchased in 2014.
e. In 2014, Mr. Smith uses an online brokerage service to purchase shares
of stock in a construction company.

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Answer Key
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.

D
C
D
B
C
A
B
A
A
A
D
B
D
A
A
a.

b. Under Mr. Buchanan's policy, the dollar exchange rate would appreciate but the trade
balance would remain unchanged. However, the volume of imports will decrease (because
of the tariffs) and the volume of exports will decrease by the same amount (because of the
appreciation of the exchange rate).
1
17. a.
2
i = 4 percent, P =
b.
i = 5 percent, P = 1
18. a.

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b.

i. real interest rate decreases

ii. national saving increases
iii. investment increases
iv. consumption decreases
v. output is unchanged, fixed because it is determined by the factors of
production
19. a. GDP in 2014 increases by the purchase price of the house, which is a newly produced
good.
b. GDP in 2014 does not change because the house is not a newly produced good, since
it was built in 2001. Transactions involving used goods are not included in GDP.
c. GDP in 2014 does not change directly because the windows are intermediate goods,
not final goods. The value of intermediate goods is not included in GDP to avoid double
counting. The value of the windows is implicitly included in the price of the house.
d. GDP in 2014 does not change because home production is not included in GDP.
e. GDP in 2014 does not change because financial transactions do not represent the
production of final goods and services and are not included in GDP.

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