FAPM Economics February 2016

Mock Exam

There are two sections to this exam: Section A and Section B.

Section A is comprised of 25 multiple choice questions.

Each correct answer is one mark.
There are 25 marks in total for Section A.
There is no negative marking.

Section B is comprised of three questions. Each question has 25 marks.

Answer all three questions.

There are 100 marks available.

Write clearly and legibly.

Explain the answers.

A calculator may be used.

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Section A. Multiple Choice Questions

A.1) Suppose that G = 1100, T = 900, S = 140, and NX = –90. How much of our final
product is used for investment?
A) 110
B) 200
C) 230
D) 50
E) 30

A.2) Along a downward-sloping money demand schedule, as the interest rate falls
A) The quantity of money demanded falls.
B) The quantity of money demanded rises.
C) Real income rises.
D) Real income falls.

A.3) When the demand for money becomes less responsive to changes in income, the LM
curve becomes ________ and it also shifts to the _______.
A) flatter, left
B) flatter, right
C) steeper, left
D) steeper, right

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A.4) An increase in the real money supply will have its maximum effect on the equilibrium
level of GDP when the
A) LM curve is vertical.
B) LM curve is horizontal.
C) IS curve is vertical.
D) IS curve is negatively sloped.

A.5) The three ways of reducing a government budget deficit are to

A) Decrease government spending, reduce consumption, increase the tax rate.
B) Increase government spending, decrease real income, reduce the tax rate.
C) Decrease government spending, increase real income, reduce the tax rate.
D) Decrease government spending, increase real income, increase the tax rate.

A.6) For this question, assume that investment spending depends only on the interest rate and
no longer depends on output. Given this information, an increase in government spending:
A) May cause investment to increase or to decrease.
B) Will have no effect on output.
C) Will cause an increase in output and have no effect on the interest rate.
D) Will cause investment to increase.
E) Will cause investment to decrease.

A.7) Suppose there is an increase in consumer confidence. Which of the following represents
the complete list of variables that must increase in response to this increase in consumer
confidence?
A) Consumption and output.
B) Consumption, investment and output.
C) Consumption.
D) Consumption and investment.
E) Consumption, output and the interest rate.

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A.8) Suppose there is a simultaneous tax increase and open market purchase of bonds. Which
of the following must occur as a result of this?
A) Output increases
B) Output decreases
C) The interest rate decreases
D) Both output and the interest rate increase
E) The interest rate increases

A.9) If a country runs a current account surplus and national private savings equals domestic i
nvestment, then the combined governmental accounts 
A)  Must be balanced. 
B)  Must be positive. 
C)  Must be negative. 
D)  Could be either negative or positive, depending on the capital account. 
E)  Could be either negative or positive, depending on the net international investment
position. 

 
A.10) If all government budgets are balanced and S is greater than I then 
A)  The net international investment position must be positive. 
B)  The capital account must be positive. 
C)  The capital account must be negative. 
D)  The net international investment position must be negative. 
E)  Both A and B. 
 

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Use the Table A.1 to answer questions A.11 and A.12. All values are net.   

Table A.1.

Purchase of official reserve assets in Austria by foreigners                  100 
Purchase of nonreserve assets in Austria by foreigners                         500 
Purchase of official reserve assets by the Austrian government            50 
Purchase of nonreserve foreign assets by the Austrian government     25 
Purchase of private foreign assets by Austrians                                      400     

A.11)  Based on Table A.1 the capital account balance is equal to 
A)  +25. 
B)   -25. 
C)   -125. 
D)  +125. 
E)   -225. 

A.12)  Based on Table A.1 if the values in the table are amended to reflect a net increase in
Austrian foreign direct investment of 100, then the new balance for the capital account
balance becomes 
A)   -75. 
B)   -25. 
C)  +25. 
D)  +75. 
E)  +225. 

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A.13) Which of the following is not true about this national income equation  
S + (T – G) = I + CA? 
A)  For the current account, CA, to improve, there needs to be less investment than would
otherwise be the case.
B)  For the current account, CA, to improve, we may have to save more to maintain the same 
amount of investment that includes foreign saving. 
C)  For the current account, CA, to improve, the government may have to run budget surplus
D)  A reduction in the trade deficit with one country will simply show up as an increase in a
trade deficit with another country.
E)  None of the above. 
 

A.14) Which of the following is not true about the national income identity given by the
equation   
S + (T – G) = I + CA?
A)  If CA is positive, national saving finances the purchase of our goods by foreign users. 
B)  If CA is negative, our investment exceeds our national savings. 
C)  A negative CA may imply that foreigners have confidence in a country’s economy. 
D)  If CA is negative and large, a country risks foreigners owning a large piece of its assets. 
E)  None of the above. 

A.15) Arbitrage creates mutually consistent exchange rates because

A) It causes a currency to appreciate to balance imports with exports
B) It causes a currency to depreciate to balance exports with imports
C) Floating exchange rates are always in a state of flux
D) When a currency is purchased at a low price in one market and sold at a high price in
another the prices converge
E) When a currency is sold at a low price in one market and purchased at a high price in
another the prices converge

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A.16) One potential problem for a country with fixed exchange rates is that
A) A decrease in the demand for its currency can create a drain on foreign exchange reserves
used to maintain the exchange rate
B) The currency is probably prone to depreciation
C) Exchange rates are fixed as a result of the devaluation of the currency
D) A current account deficit will result
E) Merchandise imports will exceed merchandise exports

Table A.2.

Component Amount (billions of dollars)

Investment, I 700
Net taxes, T 1,300
Government purchases, G 1,200
Exports, X 1,500
Imports, M 1,700

A.17) In Table A.2 the government sector surplus or deficit (its budget balance) is a
A) Surplus of $100 billion.
B) Surplus of $200 billion.
C) Deficit of $200 billion.
D) Deficit of $100 billion.

A.18) In Table A.2 the private sector has a

A) Deficit of $400 billion.
B) Deficit of $200 billion.
C) Surplus of $300 billion.
D) Deficit of $300 billion.

A.19) In Table A.2 saving must be

A) -$400 billion.
B) $400 billion.
C) -$300 billion.
D) $300 billion.

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A.20) Suppose the target exchange rate set by the Fed is 100 yen per dollar. If the demand for
dollars temporarily increases, to maintain the target exchange rate, the Fed can
A) Violate interest rate parity.
B) Sell dollars.
C) Buy dollars.
D) Violate purchasing power parity.

A.21) Suppose that the yen-dollar foreign exchange rate changes from 130 yen per dollar to
140 yen per dollar. Then the yen has
A) Depreciated against the dollar, and the dollar has appreciated against the yen.
B) Appreciated against the dollar, and the dollar has depreciated against the yen.
C) Depreciated against the dollar, and the dollar has depreciated against the yen.
D) Appreciated against the dollar, and the dollar has appreciated against the yen.

Table A.3.

Investor Expected future value of a dollar (francs per dollar)

Investor A 120
Investor B 100
Investor C 85

A.22) Using Table A.3 if the current market value of the dollar is 90 francs,
A) Investor A expects dollar appreciation, but B and C expect depreciation.
B) All three investors expect the dollar to appreciate.
C) Investor C expects dollar depreciation, but A and B expect appreciation.
D) All three investors expect the dollar to depreciate.

A.23) Using Table A.3 if the current market value of the dollar is 110 francs,
A) All three investors expect the dollar to depreciate.
B) Investor C expects dollar depreciation, but A and B expect appreciation.
C) Investor A expects dollar appreciation, but B and C expect depreciation.
D) All three investors expect the dollar to appreciate.

A.24) Suppose the exchange rate between the U.S. dollar and the French franc is 0.25 francs
per dollar. If a television sells for 100 francs in France, what is the dollar price of the
television set?
A) $200
B) $25
C) $50
D) $400

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A.25) The target exchange rate set by the Fed is 100 pesos per dollar. If the demand for
dollars
temporarily increases
A) The Fed must sell pesos.
B) The Fed can meet the target by selling dollars.
C) The Fed cannot maintain the target rate.
D) The Fed can meet the target by buying dollars.

Total 25 Marks

Section B. Essay Questions.

Question B.1.

Discuss the effects of the following on the equilibrium values of the output, employment, the
real and nominal interest rate, consumption, investment, and the price level in the domestic
economy.

Note: in the answers to the following it is preferable to use a figure to back up the
explanation.

A) Tougher immigration laws reduce the influx of working-age population from the
overseas economy.
Answer: Tougher immigration laws will reduce the growth rate of the working age
population. This will in turn decrease the degree of economic productivity. This causes a left
shift in the IS schedule with a lower equilibrium level of output and interest rates. Assuming
that inflation is constant there is a reduction in the real interest rate. The reason for this is that
if the number of workers per unit of capital falls then the productivity per worker increases
hence the wage rate would increase relative to the return on capital. It follows that the return
on capital falls.

B) Increased volatility in the stock market of the principle trading partner of the
domestic country.

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Answer: The increased volatility in the foreign country induces uncertainty about future
wealth. Present consumption is thus reduced and saving increased. This reduction leads to a
fall in imports as well as a left shift in the IS schedule. The reduced level of GDP is
accompanied by a decrease in the nominal interest rate.
The fall in foreign GDP in turn causes domestic GDP to fall and the IS schedule to
shift left. The real and nominal exchange rates will adjust to reflect the changes in income.
Depending on the size of the shifts in GDP and the importance of the domestic export market
there may be an appreciation or depreciation of the exchange rate. What is however
unambiguous is the fall in domestic GDP.

C) Government policy aimed at achieving tax equity by an increase in the corporate

tax rate.
Answer: If there is an increase in corporate tax there will be less incentive to invest. The level
of investment will therefore fall and there will be a fall in GDP. This causes a left shift in the
IS schedule and a lower equilibrium level of GDP and nominal interest rate.

D) A reduction on stock market brokerage costs due to improved computerisation.

Answer: The fall in brokerage costs leads to a fall in the demand for money at every interest
rate and level of income as the lowered costs will lead to an increase in investment in bonds.
This leads to a left shift in the money demand schedule and disequilibrium in the money
market as money demand is less than money supply. In order to bring about equilibrium in
the money market there needs to be a fall in the interest rate which comes about due to the
increased demand in bonds. This effect causes a left shift in the LM schedule for which there
is a new equilibrium at a higher level of GDP and a lower nominal interest rate.

25 Marks

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Question B.2.

Analyse the following statement, discussing what would happen in both the long and short
run if such advice were followed by the South African Reserve Bank (SARB).

“The increase in the stock market has increased people’s wealth. As a result, their
consumption has increased, increasing aggregate demand and output. So the SARB needs to
increase the money supply, since with higher income people’s demand for real money
balances will be higher.”

Answer: To be discussed in class.

25 Marks

Question B.3.

Discuss the housing bubble and sub-prime mortgage crisis in the US.

Answer: See lecture notes

25 Marks

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