ECO3203

First Exam Study Guide

Part 1- Multiple-choice Practice Questions
1) GDP in current dollars is equivalent to which of the following?
A) real GDP
B) GDP in terms of goods
C) GDP in 2000 dollars
D) GDP in constant dollars
E) none of the above

2) Which of the following does not represent real GDP?

A) GDP in current dollars
B) GDP in terms of goods
C) GDP in base year dollars
D) GDP in constant dollars

3) Based on the notation presented in the handout 3, which of the following expressions represents real GDP?
A) Yt
B) PtYt
C) Yt/Pt
D) $Yt/Pt

4) Suppose we switch the base year from 2000 to 2008. This change in the base year will
cause
A) nominal GDP in every year to increase.
B) nominal GDP in every year to decrease.
C) both nominal and real GDP in every year to decrease.
D) real GDP in every year to decrease.
E) none of the above

5) Pure inflation occurs when

A) nominal wages rise faster than all prices.
B) all prices rise faster than nominal wages.
C) all prices and nominal wages rise by the same percentage.
D) the GDP deflator and Consumer Price Index rise by the same percentage. E) none of the above

6) Which of the following factors is not believed to affect output in the long run?
A) technology
B) monetary policy
C) the size of the labor force
D) the capital stock

7) The Okun's law simply shows the relationship between

A) inflation and unemployment rate.
B) output growth and unemployment.
C) inflation and output growth.
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D) output growth and money supply.

8) The Phillips curve simply describes the relationship between

A) output growth and unemployment.
B) inflation and output growth.
C) output growth and money supply.
D) inflation and unemployment.

9) For the U.S. economy, which of the following represents the largest component of GDP?
A) imports
B) investment
C) government spending
D) exports
E) none of the above

10) Which of the following is an endogenous variable in our model of the goods market?
A) consumption (C)
B) disposable income (YD)
C) saving (S)
D) total income (Y)
E) all of the above

11) Disposable income equals

A) income minus saving.
B) income minus both saving and taxes.
C) consumption minus taxes.
D) the sum of consumption and saving.
E) none of the above

12) The marginal propensity to consume represents

A) the level of consumption that occurs if disposable income is zero.
B) the ratio of total consumption to disposable income.
C) total income minus total taxes.
D) the change in output caused by a one-unit change in autonomous demand.
E) the change in consumption caused by a one-unit change in disposable income.

13) Which of the following occurs when disposable income is zero?

A) consumption must be zero
B) saving must be zero
C) saving must be positive
D) consumption is negative
E) none of the above

14) Equilibrium in the goods market requires that

A) production equals income.
B) production equals demand.
C) consumption equals saving.
D) consumption equals income.
E) government spending equals taxes minus transfers.

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15) An economy is in equilibrium when which of the following conditions is satisfied?
A) consumption equals saving
B) output equals consumption
C) total saving equals zero
D) total saving equals investment
E) all of the above

17) Which of the following would tend to make the multiplier smaller?
A) an increase in the marginal propensity to consume
B) an increase in the marginal propensity to save
C) a reduction in taxes
D) a reduction in government spending
E) none of the above

18) Which of the following represents total saving for an economy?

A) the sum of private saving and fixed investment
B) the sum of private saving and consumption
C) the sum of taxes and government spending
D) the excess of taxes over government spending
E) none of the above

19) Based on our understanding of the paradox of saving, we know that a reduction in the desire to save will
cause A) an increase in equilibrium GDP.
B) a reduction in GDP.
C) an increase in the desire to invest.
D) no change in equilibrium GDP.
E) a permanent reduction in the level of saving.

20) Which of the following events will cause a reduction in equilibrium output?
A) an increase in the marginal propensity to save
B) an increase in taxes
C) a reduction in the marginal propensity to consume
D) all of the above
E) none of the above

21) Based on our understanding of consumption and saving, we know that the marginal propensity to consume and the
marginal propensity to save must
A) be equal to each other.
B) sum to exactly one.
C) sum to less than one.
D) sum to more than one.
E) be equal to the multiplier.

22) Suppose there is an increase in autonomous consumption. Specifically, suppose c 0 increases where C = c0 + c1YD.
This increase in autonomous consumption will cause which of the following to increase?
A) equilibrium income
B) equilibrium disposable income
C) demand
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D) all of the above
E) none of the above

23) For a closed economy, which of the following conditions must be satisfied for equilibrium to be
maintained?
A) G = T
B) X = IM = 0
C) C = S
D) none of the above

24) Autonomous spending in a closed economy equals which of the following?

A) c0 + I + G - c1T
B) C + I + G
C) Z
D) c0 + I + G + c1T

25) An increase in the marginal propensity to save from .1 to .2 will cause

A) an increase in the multiplier and a given change in autonomous consumption (c 0) to have a smaller effect on output.
B) an increase in the multiplier and a given change in autonomous consumption (c 0) to have a larger effect on output.
C) a reduction in the multiplier and a given change in autonomous consumption (c 0) to have a smaller effect on
output.
D) a reduction in the multiplier and a given change in autonomous consumption (c 0) to have a larger effect on output.

26) When a closed economy is in equilibrium, we know with certainty that

A) I = S + (T - G).
B) I = S.
C) I = S + (G - T).
D) G = T and S = I.

27) An increase in the desire to save by households will cause

A) a reduction in output.
B) a reduction in investment.
C) an increase in output.
D) no change in investment and no change in output.

28) A tax cut will cause

A) a reduction in
investment.
B) an increase in investment.
C) no change in investment.
D) no change in autonomous spending.

29) Based on our understanding of the model presented in class, we know with certainty that an equal and simultaneous
reduction in G and T will cause
A) an increase in output.
B) no change in output.
C) a reduction in output.
D) an increase in investment.

31) Inventory investment refers to

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A) the difference between production and sales in a given year.
B) fixed investment.
C) nonresidential investment.
D) the purchase by firms of new machines.

32) Suppose the consumption equation is represented by the following: C = 250 + .75Y D, then private savings
is
A) -250+0.25YD.
B) -250+0.75YD.
C) -1000+0.25YD.
D) -1000+0.75YD.

33) If C = 2000 + .9YD, what decrease in taxes must occur for equilibrium output to increase by 1000?
A) 111
B) 100
C) 1000
D) 500

34) Which of the following about IS relation is not correct?

A) It is the relation between interest rate and savings.
B) It is the equilibrium condition for the goods market.
C) It stands for "Investment equals saving."
D) It shows what firms want to invest must be equal to what people and the government want to save.

35) Which of the following is a characteristic of bonds?

A) pay zero nominal interest
B) can be used for transactions
C) are sold for a price that varies inversely with the interest rate
D) all of the above
E) none of the above

36) Which of the following is a component of money?

A) bonds
B) saving
C) income
D) stocks
E) none of the above

37) The money demand curve will shift to the right when which of the following occurs?
A) an increase in income
B) a reduction in the interest rate
C) an increase in the money supply
D) all of the above

38) The money demand curve will shift to the left when which of the following occurs?
A) a reduction in the interest rate
B) an increase in the interest rate
C) an open market sale of bonds by the central bank
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D) an increase in income
E) none of the above

39) Which of the following affects the demand for money?

A) prices
B) nominal income
C) interest rate
D) all of the above

40) Which of the following is not an asset on a bank's balance sheet?

A) reserves
B) loans
C) checkable deposits
D) all of the above
E) none of the above

43) Which of the following generally occurs when a central bank pursues expansionary monetary
policy?
A) the central bank purchases bonds and the interest rate increases.
B) the central bank purchases bonds and the interest rate decreases.
C) the central bank sells bonds and the interest rate increases.
D) the central bank sells bonds and the interest rate decreases.

44) Which of the following is an asset for both a bank and a central bank?
A) currency
B) deposits
C) bonds
D) all of the above
E) none of the above

45) Which of the following is a component of the monetary base?

A) bonds held by banks, loans, and bank reserves
B) currency in circulation plus bank reserves
C) currency in circulation plus checkable deposits
D) bonds held by banks plus checkable deposits
E) the sum of currency in circulation, bank reserves, and checkable deposits

46) Which of the following events will cause the interest rate to increase?
A) an open market sale of bonds
B) an increase in the reserve deposit ratio (i.e., θ)
C) an increase in income
D) all of the above

47) We would expect which of the following to occur when the central bank conducts an open market sale of
bonds?
A) a reduction in the monetary base (H)
B) a reduction in the money multiplier
C) an increase in H
D) an increase in the money multiplier
48) When a liquidity trap situation exists, the most appropriate policy to increase output would
be
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A) a central bank sale of bonds.
B) an increase in government spending.
C) a central bank purchase of bonds.
D) none of the above

49) The IS curve will shift to the right when which of the following occurs?
A) an increase in the money supply
B) an increase in government spending
C) a reduction in the interest rate
D) all of the above
E) none of the above

50) During 2008 in the United States, business confidence fell significantly. Which of the following will occur as a result
of this reduction in business confidence?
A) The LM curve will shift up.
B) The LM curve will shift down.
C) The IS curve will shift rightward.
D) The IS curve will shift leftward.
E) The IS curve will shift rightward, and the LM curve will shift up.

51) Suppose investment spending is not very sensitive to the interest rate. Given this information, we know
that
A) the IS curve should be relatively flat.
B) the IS curve should be relatively steep.
C) the LM curve should be relatively flat.
D) the LM curve should be relatively steep.
E) neither the IS nor the LM curve will be affected.

52) For each interest rate, the LM curve illustrates the level of output where
A) the goods market is in equilibrium.
B) inventory investment equals zero.
C) money supply equals money demand.
D) all of the above
E) none of the above

53) Which of the following statements is consistent with a given (i.e., fixed) LM
curve?
A) A reduction in the interest rate causes investment spending to increase.
B) A reduction in the interest rate causes money demand to decrease.
C) A reduction in the interest rate causes an increase in the money supply.
D) An increase in output causes an increase in demand for goods.
E) An increase in output causes an increase in money demand.

54) Which of the following is the definition for the real supply of money?
A) The stock of money measured in terms of goods, not dollars.
B) The stock of high powered money only.
C) The real value of currency in circulation only.
D) The actual quantity of money, rather than the officially reported quantity.
E) The ratio of the real GDP to the nominal money supply.

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55) Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for
this economy?
A) Production equals demand.
B) The quantity supplied of bonds equals the quantity demanded of bonds.
C) The money supply equals money demand.
D) Financial markets are in equilibrium.
E) all of the above

56) Suppose the economy is operating on the LM curve but not on the IS curve. Given this information, we know that
A) the goods market is in equilibrium and the money market is not in equilibrium.
B) the money market and bond markets are in equilibrium and the goods market is not in equilibrium.
C) the money market and goods market are in equilibrium and the bond market is not in equilibrium.
D) the money, bond, and goods markets are all in equilibrium.

57) An increase in the money supply will cause an increase in which of the following
variables?
A) output
B) investment
C) consumption
D) all of the above
E) none of the above

58) Suppose there is a fiscal contraction. Which of the following is a complete list of the variables that must
decrease?
A) consumption
B) consumption and investment
C) consumption and output
D) consumption, output and the interest rate
E) consumption, output and investment

59) A fiscal contraction will tend to cause which of the following to occur?
A) a reduction in the interest rate and a reduction in investment
B) a reduction in the interest rate and an upward shift in the LM curve
C) a reduction in the interest rate and an ambiguous effect on investment
D) no change in output if the Fed simultaneously pursues contractionary monetary policy
E) None of the above

60) Assume that investment does not depend on the interest rate. A reduction in the money supply will cause which of
the following for this economy?
A) no change in the interest rate
B) no change in output
C) a reduction in investment
D) an increase in investment

61) An increase in the reserve deposit ratio, θ, will most likely have which of the following
effects?
A) a rightward shift in the IS curve
B) a leftward shift in the IS curve
C) an upward shift in the LM curve
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D) a downward shift in the LM curve

62) An increase in the aggregate price level, P, will most likely have which of the following
effects?
A) a rightward shift in the IS curve
B) a leftward shift in the IS curve
C) an upward shift in the LM curve
D) a downward shift in the LM curve

63) The IS curve will not shift when which of the following occurs?
A) a reduction in government spending
B) a reduction in the interest rate
C) a reduction in consumer confidence
D) all of the above

64) If government spending and taxes increase by the same amount,

A) the IS curve does not shift
B) the IS curve shifts leftward
C) the IS curve shifts rightward
D) the LM curve shifts downward

65) Suppose there is a simultaneous fiscal expansion and monetary expansion. We know with certainty
that
A) output will increase.
B) output will decrease.
C) the interest rate will increase.
D) both output and the interest rate will increase.

66) Suppose there is a simultaneous fiscal expansion and monetary contraction. We know with certainty
that
A) output will increase.
B) output will decrease.
C) the interest rate will increase.
D) both output and the interest rate will increase.

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Part 1.5 – Incorrect Questions

1) GDP in current dollars is equivalent to which of the following?

A) real GDP
B) GDP in terms of goods
C) GDP in 2000 dollars
D) GDP in constant dollars
E) none of the above

10) Which of the following is an endogenous variable in our model of the goods market?
A) consumption (C)
B) disposable income (YD)
C) saving (S)
D) total income (Y)
E) all of the above

18) Which of the following represents total saving for an economy?

A) the sum of private saving and fixed investment
B) the sum of private saving and consumption
C) the sum of taxes and government spending
D) the excess of taxes over government spending
E) none of the above

22) Suppose there is an increase in autonomous consumption. Specifically, suppose c 0 increases where C = c0 + c1YD.
This increase in autonomous consumption will cause which of the following to increase?
A) equilibrium income
B) equilibrium disposable income
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C) demand
D) all of the above

25) An increase in the marginal propensity to save from .1 to .2 will cause

A) an increase in the multiplier and a given change in autonomous consumption (c 0) to have a smaller effect on output.
B) an increase in the multiplier and a given change in autonomous consumption (c 0) to have a larger effect on output.
C) a reduction in the multiplier and a given change in autonomous consumption (c 0) to have a smaller effect on
output.
D) a reduction in the multiplier and a given change in autonomous consumption (c 0) to have a larger effect on output.

29) Based on our understanding of the model presented in class, we know with certainty that an equal and simultaneous
reduction in G and T will cause
A) an increase in output.
B) no change in output.
C) a reduction in output.
D) an increase in investment.

35) Which of the following is a characteristic of bonds?

A) pay zero nominal interest
B) can be used for transactions
C) are sold for a price that varies inversely with the interest rate

37) The money demand curve will shift to the right when which of the following occurs?
A) an increase in income
B) a reduction in the interest rate
C) an increase in the money supply
D) all of the above

38) The money demand curve will shift to the left when which of the following occurs?
A) a reduction in the interest rate
B) an increase in the interest rate
C) an open market sale of bonds by the central bank
D) an increase in income
E) none of the above

44) Which of the following is an asset for both a bank and a central bank?
A) currency
B) deposits
C) bonds

46) Which of the following events will cause the interest rate to increase?
A) an open market sale of bonds
B) an increase in the reserve deposit ratio (i.e., θ)
C) an increase in income
D) all of the above

50) During 2008 in the United States, business confidence fell significantly. Which of the following will occur as a result
of this reduction in business confidence?
A) The LM curve will shift up.
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B) The LM curve will shift down.
C) The IS curve will shift rightward.
D) The IS curve will shift leftward.
E) The IS curve will shift rightward, and the LM curve will shift up.

52) For each interest rate, the LM curve illustrates the level of output where
A) the goods market is in equilibrium.
B) inventory investment equals zero.
C) money supply equals money demand.

53) Which of the following statements is consistent with a given (i.e., fixed) LM
curve?
A) A reduction in the interest rate causes investment spending to increase.
B) A reduction in the interest rate causes money demand to decrease.
C) A reduction in the interest rate causes an increase in the money supply.
D) An increase in output causes an increase in demand for goods.
E) An increase in output causes an increase in money demand.

55) Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for
this economy?
A) Production equals demand.
B) The quantity supplied of bonds equals the quantity demanded of bonds.
C) The money supply equals money demand.
D) Financial markets are in equilibrium.
E) all of the above

60) Assume that investment does not depend on the interest rate. A reduction in the money supply will cause which of
the following for this economy?
A) no change in the interest rate
B) no change in output
C) a reduction in investment
D) an increase in investment

61) An increase in the reserve deposit ratio, θ, will most likely have which of the following
effects?
A) a rightward shift in the IS curve
B) a leftward shift in the IS curve
C) an upward shift in the LM curve
D) a downward shift in the LM curve

66) Suppose there is a simultaneous fiscal expansion and monetary contraction. We know with certainty
that
A) output will increase.
B) output will decrease.
C) the interest rate will increase.
D) both output and the interest rate will increase.

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Part 2 – True/False/Uncertain Question
Label each of the following statements true, false, or uncertain. Explain briefly. No credit will be given for correct (T, F, U) without
explaining.

1) When the unemployment rate is high, the participation rate is also likely to be high.
2) The rate of unemployment tends to fall during expansions and rise during recessions.
3) If the Japanese CPI is currently at 108 and the U.S. CPI is at 104, then the Japanese rate of inflation is higher than the U.S. rate of
inflation.
4) The rate of inflation computed using the CPI is a better index of inflation than the rate of inflation computed using the GDP
deflator.
5) Okun’s law shows that when output growth is lower than normal, the unemployment rate tends to rise.
6) Periods of negative GDP growth are called recessions.
7) When the economy is functioning normally, the unemployment rate is zero.
8) The Phillips curve is a relation between the level of prices and the level of unemployment.
9) The equilibrium condition for the goods market states that consumption equals output.
10) The propensity to consume has to be positive, but otherwise, it can take on any positive value.
11) One factor in the 2009 recession was a drop in the value of the parameter c0.
12) Fiscal policy describes the choice of government spending and taxes and is treated as exogenous in our goods market model.
13) The equilibrium condition for the goods market states that consumption equals output.
14) An increase of one unit in government spending leads to an increase of one unit in equilibrium output.
15) An increase in the propensity to consume leads to a decrease in output.
16) Income and financial wealth are both examples of stock variables.
17) The term investment, as used by economists, refers to the purchase of bonds and shares of stock.
18) The demand for money does not depend on the interest rate because only bonds earn interest.
19) A large proportion of U.S. currency appears to be held outside the United States.
20) The central bank can increase the supply of money by selling bonds in the market for bonds.
21) The Federal Reserve can determine the money supply, but it cannot change interest rates.
22) Bond prices and interest rates always move in opposite directions.
23) An increase in income (GDP) will always be accompanied by an increase in interest rates when the money supply is not
increased.
24) The main determinants of investment are the level of sales and the interest rate.
25) If all the exogenous variables in the IS relation are constant, then a higher level of output can be achieved only by lowering the
interest rate.
26) The IS curve is downward sloping because goods market equilibrium implies that an increase in taxes leads to a lower level of
output.
27) If government spending and taxes increase by the same amount, the IS curve does not shift.
28) The LM curve is horizontal at the central bank’s policy choice of the interest rate.
29) The real money supply is constant along the LM curve.
30) If the nominal money supply is $400 billion and the price level rises from an index value of 100 to an index value of 103; the real
money supply rises.
31) If the nominal money supply rises from $400 billion to $420 billion and the price level rises from an index value of 100 to 102,
the real money supply rises.
32) An increase in government spending leads to a decrease in investment in the IS-LM model.
33) The nominal interest rate is measured in terms of goods; the real interest rate is measured in terms of money.
34) As long as expected inflation remains roughly constant, the movements in the real interest rate are roughly equal to the
movements in the nominal interest rate.
35) When expected inflation increases, the real rate of interest falls.
36) All bonds have equal risk of default and thus pay equal rates of interest.
37) The nominal policy interest rate is set by the central bank.
38) An increase in a bank’s leverage ratio tends to increase both the expected profit of the bank and the risk of the bank going
bankrupt.
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39) The real borrowing rate and the real policy rate always move in the same direction.
40) It can be difficult to value assets of banks and other financial intermediaries, particularly in a financial crisis.
41) When a bank has high leverage and low liquidity, it may have to sell assets at fire sale prices.
42) Banks and other financial intermediaries have assets that are less liquid than their liabilities.
43) House prices have risen constantly since the year 2000.
44) The fiscal stimulus program adopted by the United States in response to the financial crisis helped offset the decline in aggregate
demand and reduce the size of the recession.
45) The fiscal stimulus program adopted by the United States included a large increase in the deficit measured as a percent of GDP.

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