Part I. Multiple Choice (2 pts. each - 80 pts overall)
1. Which of these will not increase the supply curve associated with producing tires:
a. improvements in the machines which produce tires
b. an increase in the price of tires
c. lower wages for nonunion workers in the tire industry
d. decrease in the corporation tax rate

2. In a typical production possibilities curve (PPC) relationship, we know that:
a. decreases in unemployment cause the PPC to shift outward
b. higher demand for one product (vs. another) cause the PPC to shift outward for that product
c. lower productivity causes the PPC to shift inward
d. producing only one product is always inefficient
e. all of the above

The table below corresponds with Country W's production possibilities relationship and should be used to answer question 3.

4. Minimum wage laws are likely to have which of the following indirect effects:
a. there are labor shortages
b. firms paying the minimum wage can discriminate among potential workers when hiring
c. there is a higher rate of unemployment in minimum wage jobs
d. minimum wage laws cause increases in the supply of labor

5. Which of the following are one of the (proper) steps used in constructing a price index:
a. multiply the current and base year’s prices by the quantity purchased in each of those years
b. add up each year’s prices and divide by the base year’s prices
c. multiply the current and base year prices by the same quantities
d. multiply the current and base year quantities by the base year prices

6. A worker makes $50,000 in nominal income, both during 1990 and 1991. If 1990 is the base year, then what is this worker’s real income in 1991 if the inflation rate is 4% between those two years?
(if necessary, round your answer to the nearest thousand)
a. $52,000
b. $50,000
c. $44,000
d. $48,000
e. none of the above

7. Demand-pull inflation may result (directly) from:
a. large decreases in the income tax rate
b. large decreases in government expenditure
c. rising wage rates, without offsetting increases in productivity
d. large increases in the labor force

8. The U.S. government currently maintains a more than 5 trillion dollar debt. Given its sizeable debt, how does inflation affect the U.S. government?
a. the U.S. government is better off with inflation, because borrowers benefit from inflation
b. the U.S. government is worse off with inflation, because borrowers do not benefit from inflation
c. the U.S. government is no better or worse off with inflation, because inflation does not affect borrowers
d. not enough information is given to answer this question

The table below corresponds with Questions #9-10

Out of work, but:	Employed, but:
actively looking for a job: 40	with full-time jobs: 470
have given up looking for jobs: 15	with part-time jobs: 90

Of all the officially unemployed workers (above) 15 are voluntarily unemployed.

9. How many workers are involuntarily unemployed in this economy?
a. 0
b. 10
c. 15
d. 40
e. none of the above

10. If there was no change in the labor force, then what would be the natural rate of unemployment in this economy?
a. 15/470 (3.2%)
b. 15/600 (2.5%)
c. 70/600 (11.7%)
d. 40/560 (7.1%)
e. none of the above

11. Which of the following would not be included in the U.S. gross domestic product:
a. changes in inventories of foreign goods produced in the U.S.
b. new home construction in Kentucky
c. buying a new Toyota automobile at a local car dealership
d. new capital purchases made here in Kentucky
e. buying a Big Mac at the McDonalds in Moscow, Russia

12. Why is it important to adjust the consumer price index (cpi) for changes in product quality?
a. because rising quality causes the cpi to show lesser inflation than is otherwise true
b. because rising quality leads to higher demand, which causes prices to fall
c. because rising quality tends to inflate the cpi
d. because rising quality makes it necessary to change the base year less frequently

13. Potential GDP is defined as:
a. the output achieved when only voluntary unemployment exists
b. the output achieved when all factors are employed
c. the output achieved when all available factors are employed
d. the output achieved when the economy is located at a point on its PPC

14. Structural unemployment is characterized as:
a. unemployment that results from technological change
b. unemployment that results from periods of contraction in the business cycle
c. unemployment that results from workers being laid off at any time during the year
d. unemployment that results from workers leaving their jobs to seek more preferable employment

15. What happens if inventories decrease unexpectedly between this year and next year?
a. the level of aggregate expenditure increases
b. equilibrium GDP increases
c. Investment expenditure decreases
d. Consumption expenditures decrease
e. equilibrium GDP is increased above potential GDP

The following corresponds with Questions #16 and #17.
If the marginal propensity to consume is 0.7, autonomous consumption is $800, and there are no taxes. Assume further that the price level is fixed (constant) and that the only expenditure besides consumption is autonomous investment of $1000.

16. Suppose equilibrium GDP is 10,000 (i.e. Y* = 10,000). Using this with the information above, what is the average propensity to save (APS) in this economy?
a. 0.3
b. 800/10,000
c. 2200/10,000
d. 7800/10,000
e. unable to calculate, not enough information is provided

17. If the marginal propensity to save in this economy increases to 0.5, then what happens to the value of this economy’s government expenditure multiplier?
a. the multiplier increases from 3.3 to 5
b. the multiplier decreases from 3.3 to 2
c. the multiplier increases from 1.4 to 2
d. the multiplier decreases from 2 to 1.4
e. not enough information is given to answer this question

18. What is the key difference between the AE model and the AD/AS models (from lecture):
a. the AE model assumes a fixed price level, AD/AS assumes a flexible price level
b. the AE model assumes that expenditures are autonomous, AD/AS does not
c. the AE model has investment that changes with changes in the interest rate, AD/AS does not
d. the AE model does not incorporate the concept of Potential GDP, AD/AS does incorporate this concept

19. If inventories rise unexpectedly in the AE model, then:
a. aggregate demand is greater than aggregate supply
b. aggregate demand is less than aggregate supply
c. aggregate expenditure is greater than output
d. aggregate expenditure is less than output

20. If Potential GDP is greater than equilibrium GDP, which of the following will close that gap:
a. increase government spending by less than the amount of this inflationary gap
b. decrease government spending by less than the amount of this inflationary gap
c. increase government spending by less than the amount of this recessionary gap
d. decrease government spending by less than the amount of this recessionary gap
e. increase government spending by the same amount as this recessionary gap

21. If the slope of an economy’s AE line is equal to their marginal propensity to consume (MPC), then under what conditions would this economy’s tax multiplier be just as large (in absolute value) as their government spending multiplier?
a. if their MPC = 0.8
b. if their MPC = 0.75
c. if their MPC = 0.5
d. if their MPC = 0.25
e. these multipliers would never be equal, no matter what the value of the MPC

22. Assume that the slope of Country B’s AE line equals their MPC. Which of the following is always true:
a. equilibrium output in Country B will increase by the same amount, whether government expenditure increases by $500 or whether taxes decrease by $500
b. equilibrium output in Country B will increase by the same amount, whether government expenditure increases by $500 or whether investment increases by $500
c. equilibrium output in Country B will increase by the same amount, whether investment increases by $500 or whether taxes decrease by $500
d. all of the above

23. Where is debt-financed government expenditure most likely to cause crowding out?
a. when the economy produces very low levels of output
b. when the economy is experiencing unemployment
c. when the economy has neither a recessionary nor an inflationary gap
d. when the economy is experiencing a government budget surplus
e. when the economy is experiencing inflation

24. In the AD/AS model, how would we know if Supply Side economics was successful at keeping the price level down and increasing output?
a. if AD and AS increase
b. if AD and AS decrease
c. if AD increases by more than AS
d. if AD increases by less than AS

25. If government chooses a new "budget philosophy" that causes greater swings in the business cycle to occur, then which philosophy have they most likely adopted:
a. the balance annually approach
b. the balance over the business cycle approach
c. the functional (or fiscal) finance approach
d. the debt over demand approach

26. What causes U.S. government debt to be a burden on future U.S. taxpayers?
a. when taxes must be raised
b. when the tax increase needed to pay off interest on the debt exceeds the interest received by U.S. citizens
c. when GDP increases, but so does the price level
d. when increased government debt causes imports to increase above exports

27. Which of the budget balancing philosophies from class focuses most strongly on maintaining full employment and low inflation?
a. balancing the budget every (fiscal) year
b. balancing the budget in a five year cycle
c. balancing the budget over the business cycle
d. functional finance approach
e. fiscal exchange approach

28. When comparing fiscal and monetary policy, which statement is most true:
a. fiscal policy should experience a shorter inside lag
b. monetary policy should experience a shorter inside lag
c. fiscal policy would experience a shorter recognition lag
d. fiscal policy is more easily reversed than monetary policy
e. monetary policy tends to be applied more directly than fiscal policy

29. Are credit cards considered money?
a. no, because credit cards defer monetary transactions
b. no, because not every consumer can use a credit card
c. no, because credit cards do not allow for one to make anonymous transactions
d. yes, because credit cards are used to make transactions

30. What is the best definition of M2?
a. the money supply consisting of all currency and checkable accounts
b. the money supply consisting of all currency, checkable and (most) savings accounts
c. the money demand consisting of liquid forms of money (e.g. cash and checks)
d. the money supply consisting of cash, credit card transactions and checking accounts
e. the money demand consisting of all transactions and speculative demand accounts

31. In class we discussed the three functions of money, but added a fourth function specific to currency. What fourth function does currency provide that is not necessary provided by the other forms of money in M1?
a. currency eliminates the problem of the double coincidence of wants
b. currency is a store of wealth
c. currency provides for anonymous transactions
d. currency is a medium of exchange
e. currency serves as an accounting unit

32. Gresham's Law states:
a. interest rates and money demand have a negative relationship
b. income and interest rates have a negative relationship
c. bad money chases out good money
d. greater debt leads to higher interest rates
e. a penny saved is investment spent

33. An open market purchase has what effect on the economy?
a. increases the money supply and lowers interest rates
b. increases the money supply and raises interest rates
c. decreases the money supply and lowers interest rates
d. decreases the money supply and raises interest rates

34. Assume that Bank A has $25,000 in demand deposits and $17,000 in total reserves. The remainder of the banks assets are loans. If the required reserve ratio is 10%, then what are this bank’s (current) required reserves?
a. $800
b. $2500
c. $4200
d. $1700
e. none of the above

35. How would a very large tax cut affect the Phillips curve (PC) initially:
a. shift the PC outward (where the inflation and unemployment rates rise)
b. shift the PC inward (where the inflation and unemployment rates fall)
c. not shift the PC, but there is movement up along the PC (where the inflation rate rises and unemployment rate falls)
d. not shift the PC, but there is movement down along the PC (where the inflation rate falls and unemployment rate rises)

36. When would you most likely expect the Fed to contract the money supply?
a. when the actual unemployment rate is greater than the natural rate of unemployment and the economy is experiencing a recessionary gap
b. when the actual unemployment rate is less than the natural rate of unemployment and the economy is experiencing a recessionary gap
c. when the actual unemployment rate is less than the natural rate of unemployment and the economy is experiencing an inflationary gap
d. when the actual unemployment rate is greater than the natural rate of unemployment and the economy is experiencing an inflationary gap

37. Using a PPC to illustrate your answer, what is the key difference between the concept of short run and long run growth?
a. short run growth occurs when the PPC shifts along one axis, long run growth is when it shifts along each axis
b. short run growth occurs when there is movement from points inside the PPC to points on the PPC itself, long run growth occurs when the PPC shifts outward
c. short run growth occurs when there are supply-related changes in the economy, long run growth when there are demand-related changes
d. short run growth is consistent with shifts in the PPC, long run growth is not consistent with shifts in the PPC

In lecture, we discussed two groups of economic policymakers, the Passive group and the Active group. Questions #38-40 address the distinctions between these two groups.

38. Which budget balancing philosophy would the Passive group most likely advocate:
a. Functional (or fiscal) finance
b. Balance over the business cycle
c. Balance annually
d. Aggregate demand management

39. The Passive group believes:
a. the economy’s self correcting mechanism operates very slowly, if at all
b. the price level is largely fixed (constant) in the short run
c. the AS curve is relatively horizontal (flat) in the short run
d. government should use rules when applying any type of policy

40. Which of the following does the Active group believe about investment:
a. investment is more sensitive to changing business conditions than changing interest rates
b. investment is largely stable over time
c. investment is more sensitive to changing interest rates than changing business conditions
d. investment is a much larger component of GDP than consumption
e. investment is very susceptible to problems like crowding out

Part II. Short Answer Questions (pts. given by each question: 60 pts. overall)

Questions #1-2 both correspond with the equations below. Show all work for full credit.