ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Department of Business Studies

Bachelor of Business Year 1

PRINCIPLES OF MACROECONOMICS /MACROECONOMICS 1
ECO102/ECO157
TUTORIAL QUESTION

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Chapter 23: Measuring a Nation’s Income

Section A (MCQ)

1. When a firm sells a good or a service, the sale contributes to the nation’s income
a. only if the buyer of the good or service is a household.
b. only if the buyer of the good or service is a household or another firm.
c. whether the buyer of the good or a service is a household, another firm, or the
government.
d. We have to know whether the item being sold is a good or a service in order to
answer the question.

2. Estimates of the values of which of the following non-market goods or services are
included in GDP?
a. the value of unpaid housework
b. the value of vegetables and other foods that people grow in their gardens
c. the estimated rental value of owner-occupied homes
d. All of the above are included.

3. Ralph pays someone to mow his lawn, while Mike mows his own lawn. Regarding these
two practices, which of the following statements is correct?
a. Only Ralph’s payments are included in GDP.
b. Ralph’s payments as well as the estimated value of Mike’s mowing services are
included in GDP.
c. Neither Ralph’s payments nor the estimated value of Mike's mowing services is
included in GDP.
d. Ralph’s payments are definitely included in GDP, while the estimated value of
Mike’s mowing services is included in GDP only if Mike voluntarily provides his
estimate of that value to the government.

4. During the third quarter of 2006, a firm produces consumer goods and adds some of
those goods to its inventory. During the fourth quarter of that year, the firm sells the
goods at a retail outlet, with the result that the value of its inventory at the end of the
fourth quarter is smaller than the value of its inventory at the end of the third quarter.
These actions affect which component(s) of fourth-quarter GDP?
a. These actions affect only consumption, and they affect consumption positively.
b. These actions affect only investment, and they affect investment positively.
c. These actions affect consumption positively and investment negatively.
d. These actions affect both consumption and investment positively.

5. To encourage formation of small businesses, the government could provide subsidies;

these subsidies
a. would not be included in GDP because they are transfer payments.
b. would be included in GDP because they are part of government expenditures.
c. would be included in GDP because they are part of investment expenditures.
d. would not be included in GDP because the government raises taxes to pay for
them.

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6. For an economy as a whole,

a. income is greater than expenditure
b. expenditure is greater than income.
c. income is equal to expenditure.
d. GDP measures income more precisely than it measures expenditure.

7. Gross domestic product is defined as

a. the market value of all final goods and services produced within a country in a
given period of time.
b. the market value of all tangible goods produced within a country in a given
period of time.
c. the quantity of all final goods and services supplied within a country in a given
period of time.
d. the quantity of all final goods and services demanded within a country in a given
period of time.

8. If a government made a previously-illegal activity such as gambling or prostitution legal,

then, other things equal, GDP
a. necessarily decreases.
b. necessarily increases.
c. doesn't change because both legal and illegal production is included in GDP.
d. doesn't change because these activities are never included in GDP.

9. Unemployment compensation is
a. part of GDP because it represents income.
b. part of GDP because the recipients must have worked in the past to qualify.
c. not part of GDP because it is a transfer payment.
d. not part of GDP because the payments reduce business profits.

10. In a certain economy in 2005, GDP amounted to $5,000; consumption amounted to

$3,000; government purchases were equal to investment; and the value of imports
exceeded the value of exports by $200. It follows that government purchases amounted
to
a. $900.
b. $1,100.
c. $1,250.
d. $1,325.

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Section B

Question 1
Why do economists use real GDP rather than nominal GDP to gauge economic well-being?

Question 2

Below are some data from the land of milk and honey.

Year Price of Milk Quantity of Milk Price of Honey Quantity of Honey

2001 $1 100 $2 50
2002 $1 200 $2 100
2003 $2 200 $4 100

Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2001 as the base
year.

Question 3

Consider the following data on a country’s GDP:

Year Nominal GDP Deflator
GDP (base year: 1992)
(billions)
1996 $7,662 110
1997 $8,111 112
a) What was the growth rate of nominal GDP between 1996 and 1997?
b) What was the growth rate of the GDP deflator between 1996 and 1997?
c) What was real GDP in 1996?
d) What was real GDP in 1997?
e) What was the growth rate of real GDP between 1996 and 1997?
f) Was the growth rate of nominal GDP higher or lower than the growth rate of real GDP?
Explain.

Question 4
Suppose you are watching a news report with a friend. The news report points out that a certain
African nation generates a GDP per capita of only $2,000 per year. Since your friend knows that
Malaysia's GDP per capita is approximately $20,000, he suggests that Malaysian are materially
10 times better off than the people of the African nation.
a) Is your friend’s statement accurate?
b) What general category of production is not captured by GDP in both Malaysia and the
African nation?
c) Provide some examples of this type of activity.
d) Why would the exclusion of this type of production affect the measurement of African
output more than Malaysian output?
e) Does this mean that residents of the African nation are as well off materially as residents
in Malaysia?

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Chapter 24: Measuring the cost of living

Section A (MCQ)

1. The first step in measuring the CPI is to

a. select the market basket.
b. conduct a monthly survey.
c. collect prices for the basket of goods and services.
d. interview businesses.

2. If the CPI is 120, this means that

a. prices are 120 percent higher than in the reference base period.
b. prices are 0.12 times higher than in the reference base period.
c. prices are 20 percent higher than in the reference base period.
d. the inflation rate must be positive.

3. Which of the following means that the CPI overstates the actual inflation rate?
a. New goods bias.
b. Quality change bias.
c. Outlet substitution bias.
d. All of the above cause the CPI to overstate inflation.

4. Economists use the term inflation to describe a situation in which

a. some prices are rising faster than others.
b. the economy's overall price level is rising.
c. the economy's overall price level is high, but not necessarily rising.
d. the economy's overall output of goods and services is rising faster than the
economy's overall price level.

5. What basket of goods is used to construct the CPI?

a. A random sample of all goods and services produced in the economy.
b. The goods and services that are typically bought by consumers as determined by
government surveys.
c. Only food, clothing, transportation, entertainment, and education.
d. The least expensive and the most expensive goods and services in each major
category of consumer expenditures

6. In the CPI, goods and services are weighted according to

a. how long a market has existed for each good or service.
b. the extent to which each good or service is regarded by the government as a
necessity.
c. how much consumers buy of each good or service.
d. the number of firms that produce and sell each good or service.

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7. Substitution bias in the CPI refers to the fact that the CPI
a. takes into account the substitution of goods by consumers when relative
prices change.
b. substitutes quality changes whenever they occur without taking account of
the cost of the quality changes.
c. substitutes relative prices for absolute prices of goods.
d. takes no account of the substitution of goods by consumers when relative
prices change.

8. The goal of the consumer price index is to measure changes in the

a. costs of production
b. cost of living.
c. relative prices of consumer goods.
d. production of consumer goods.

9. Which of the following is not a widely acknowledged problem with the CPI as a
measure of the cost of living?
a. substitution bias
b. introduction of new goods
c. unmeasured quality change
d. unmeasured price change

10. If the prices of Australian-made shoes imported into the United States increase, then, as
a result,
a. both the GDP deflator and the consumer price index increase.
b. neither the GDP deflator nor the consumer price index increases.
c. the GDP deflator increases but the consumer price index does not increase.
d. the consumer price index will increase, but the GDP deflator will not increase.

Section B

Question 1
Economists and policymakers monitor both the GDP deflator and the consumer price index to
gauge how quickly prices are rising. However, these two statistics may not always tell the same
story. Discuss two important differences that can cause them to diverge.

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Question 2
Calculate the consumer price index and the rate of inflation if given a fixed basket of goods of 4
hamburgers and 2 apples by taking the year 2001 as the base year.

Year Price($)
Hamburger Apple
2001 $1 $0.50
2002 $2 $1.00
2003 $3 $1.50

Question 3
Describe the three problems that make the consumer price index an imperfect measure of the
cost of living.

Question 4
Convert the salary of Mr. A in the year 1930 to dollars in the year 2000 by using the following
information.
a) A’s salary in the year 1930 was $80,000
b) The price level in the year 2000 was 160
c) The price level in the year 1930 was 52

Question 5
Suppose you’ve been talking to a friend’s father who told you that he gave up smoking cigarettes
in 1995. When you asked him why he quit, you got a surprising answer. Instead of reciting the
health benefits of quitting smoking, he said, "I quit because it was just getting too expensive. I
started smoking in 1965 and cigarettes were only 45 cents a pack. The last pack I bought was
$2.00 and I just couldn't justify spending more than four times as much on cigarettes as I used
to."
a) In 1965, the CPI was 31.5. In 1995 the CPI was 152.4. While it is commendable that your
friend’s father quit smoking, what is wrong with his explanation?
b) What is the equivalent cost of a 1965 pack of cigarettes measured in 1995 prices?
c) What is the equivalent cost of a 1995 pack of cigarettes measured in 1965 prices?
d) Do both methods give you the same conclusion?
e) The preceding example demonstrates what economists refer to as a "money illusion."
Why do you think economists might choose the phrase "money illusion" to describe this
behavior?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Chapter 25 : Production and Growth

Section A (MCQ)

1. Consider two countries. Country A has a population of 1,000, of whom 800 work 8
hours a day to make 128,000 final goods. Country B has a population of 2,000 of whom
1,800 work 6 hours a day to make 270,000 final goods
a. Country A has higher productivity and higher real GDP per person than Country
B.
b. Country A has lower productivity and lower real GDP per person than country B.
c. Country A has higher productivity, but lower real GDP per person than country
B.
d. Country B has lower productivity, but higher real GDP per person than country
B.

2. Real Foods produced 300,000 boxes of organic spiral noodles in 2014 and produced
360,000 boxes in 2015. They used the same total hours of work each year. In 2015 their
productivity
a. fell.
b. was the same as in 2014.
c. rose 20%.
d. rose 30%.
3. A nation's standard of living is determined by
a. its productivity.
b. its gross domestic product.
c. its national income.
d. how much it has relative to others.

4. If a production function has constant returns to scale, the output can be doubled if
a. labor alone doubles.
b. all inputs but labor double.
c. all of the inputs double.
d. None of the above is correct.

5. Suppose that there are diminishing returns to capital. Suppose also that two
countries are the same except one has more capital and so more real GDP per
person than the other. Finally, suppose that the saving rate in both countries
increases from 5 percent to 6 percent. Over the next ten years, we would expect
that
a. the growth rate will not change in either country.
b. the country that started with less capital will grow faster.
c. the country with started with more capital will grow faster.
d. both countries will grow at the same rate.

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6. The aggregate production function is graphed as

a. a downward-sloping curve.
b. an upward-sloping straight line.
c. an upward-sloping line that becomes flatter as the quantity of labor
increases.
d. an upward-sloping line that becomes steeper as the quantity of labor
increases.

7. If the real GDP is $13,000 billion and aggregate labor hours used in production are
270 billion, labor productivity equals
a. $6.50 per hour.
b. $45 per hour.
c. $48 per hour.
d. $650 per hour.

8. A recent survey by India's central bank reported that spending plans by firms on
large new projects fell by 46 percent in the year ending March 2016, compared
with the prior year. This decrease will most directly impact
a. physical capital growth.
b. human capital growth.
c. technological change.
d. population growth.

9. The aggregate production function shows how ________ varies with ________.
a. leisure time; labor
b. labor; leisure time
c. real GDP; labor
d. labor; capital

10. Labor productivity is defined as

a. total output attributable to labor.
b. total real GDP.
c. the growth rate of the labor force.
d. real GDP per hour of labor.

Section B

Question 1
List and describe four determinants of productivity.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Question 2
Why is productivity related to the standard of living? In your answer, be sure to explain what is
meant by productivity and standard.
Question 3
Why does a nation’s standard of living depend on property rights?

Question 4
You are discussing with some friends. The conversation turns to a supposed lack of growth and
opportunity in Europe when compared to some Asian countries such as Japan, South Korea,
Taiwan, and Singapore. One of your friends says, "These Asian countries must have cheated
somehow. That's the only way they could have possibly grown so quickly."
a) Have you learned anything in this chapter that would make you question your friend’s
allegation?
b) The phenomenal growth rate of Japan since World War II has often been referred to as
the "Japanese miracle." Is it a miracle or is it explainable?
c) Are the high growth rates found in these Asian countries without cost?

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Chapter 26: Saving, Investment, and Financial System

Section A (MCQ)
1. In a closed economy, a nation's investment must be financed by
a. private saving only.
b. the government's budget deficit.
c. borrowing from the rest of the world only.
d. national saving.

2. National savings is defined as the amount of

a. business saving.
b. household saving.
c. business saving and household saving.
d. private saving and public saving.

3. The nominal interest rate minus the real interest rate approximately equals the
a. rate of increase in the amount of investment.
b. inflation rate.
c. rate of increase in income.
d. rate the bank receives to cover lending costs.

4. Assume you save $1,000 in a bank account that pays 8 percent interest per year
and the inflation rate is 3 percent. At the end of the year, you have earned
a. a nominal return of $50.
b. a negative real return.
c. a real return of $50.
d. a real return of $80.

5. The demand for loanable funds is the relationship between loanable funds and the
________ other things remaining the same.
a. real interest rate
b. Income level
c. inflation rate
d. price level

6. A rise in the real interest rate

a. shifts the demand for loanable funds curve rightward.
b. shifts the demand for loanable funds curve leftward.
c. creates a movement upward along the demand for loanable funds curve.
d. creates a movement downward along the demand for loanable funds curve.

7. Investment is financed by which of the following?

I. Government spending
II. National saving
III. Borrowing from the rest of the world
a. I, II, and III
b. I and II only
c. I and III only

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d. II and III only

8. Which of the following explains why the demand for loanable funds is negatively
related to the real interest rate?
a. A lower real interest rate makes more investment projects profitable.
b. Consumers are willing to spend less and hence save more at higher real
interest rates.
c. Interest rate flexibility in financial markets assures an equilibrium in which
saving equals investment.
d. All of the above are reasons why the demand for loanable funds is
negatively related to the real interest rate.

9. All of the following are sources of loanable funds EXCEPT

a. business investment.
b. private saving.
c. government budget surplus.
d. international borrowing.

10. Suppose the market for loanable funds is in equilibrium. If the expected profit
falls, the equilibrium real interest rate ________ and the quantity of loanable funds
________.
a. rises; decreases
b. rises; increases
c. falls; decreases
d. falls; increases

Section B

Question 1
The following information describes a loanable funds market. Values are in billions.

Real Interest Rate(%) Quantity of Loanable Funds Quantity of Loanable Funds

Supplied($ Billion) Demanded($ Billion)
6 1,300 700
5 1,200 800
4 1,000 1,000
3 800 1,200
2 600 1,500

a) Plot the supply and demand for loanable funds. What is the equilibrium real interest rate and
the equilibrium level of saving and investment?
b) Why do "market forces" not allow 2 percent to be the real interest rate?
c) Suppose the government suddenly increases its budget deficit by $400 billion. What are the
new equilibrium real interest rate and the equilibrium level of saving and investment?

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Question 2
Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public
saving is $0.2 trillion. Assuming the economy is closed, calculate consumption, government
purchases, national saving, and investment.

Question 3

Suppose you are watching an opposition party spokesperson being interviewed on TV during an
election campaign. When questioned about their position on economic growth, the spokesperson
says, "We need to get this country growing again. We need to use tax incentives to stimulate
saving and investment, and we need to get the budget deficit down so that the government stops
absorbing our nation's savings."

a) If the opposition party’s spending plans remain unchanged from current government
spending, what inconsistency is implied by the spokesperson's statement?
b) If the opposition party truly wishes to decrease taxes and decrease the budget deficit,
what has the spokesperson implied about his party’s plans for government spending?
c) If policymakers want to increase growth, and if policymakers have to choose between tax
incentives to stimulate saving and tax incentives to stimulate investment, what might they
want to know about supply and demand in the loanable funds market before making their
decision?

Question 4
Examine the impact of the following events on the equilibrium interest rates, saving, and
investment using the market for loanable fund model. Each event is treated independently :
a) Investors are highly optimistic about the economic outlook and they want to expand their
business.
b) The government budget changes from a balanced budget to a deficit budget.

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Chapter 28: Unemployment

Section A (MCQ)

1. Cyclical unemployment is closely associated with

a. long-term economic growth.
b. short-run ups and downs of the economy.
c. fluctuations in the natural rate of unemployment.
d. changes in the minimum wage.

2. The labor force equals the

a. number of people who are employed.
b. number of unemployed people.
c. number of people employed plus the number of people unemployed.
d. adult population.

3. A college student who is not working or looking for a job is counted as

a. neither employed nor part of the labor force.
b. unemployed and in the labor force.
c. unemployed, but not in the labor force.
d. employed and in the labor force.

4. Tom loses his job and immediately begins looking for another. Other things are the
same, the unemployment rate
a. increases and the labor-force participation rate decreases.
b. increases and the labor-force participation rate is unaffected.
c. is unaffected, and the labor-force participation rate increases.
d. decreases, and the labor-force participation rate is unaffected.

5. The natural rate of unemployment is the

a. unemployment rate that would prevail with zero inflation.
b. rate associated with the highest possible level of GDP.
c. difference between the long-run and short-run unemployment rates.
d. amount of unemployment that the economy normally experiences.

6. Sam just lost his job, but isn't yet looking for a new one. Sam is
a. counted as unemployed and part of the labor force.
b. counted as unemployed, but not part of the labor force.
c. not counted as unemployed, but counted as part of the labor force.
d. not counted as unemployed, and not in the labor force.

7. Suppose the working-age population in Tiny Town is 100 people. Suppose 25 of these
people are NOT in the labor force, the ________ equals ________.
a. unemployment rate; 25/100 × 100
b. unemployment rate; 25/75 × 100
c. labor force; 75
d. labor force; 25/100 × 100

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8. The ________ is the total number of people aged 16 years and older (and not in jail,
hospital, or institutional care) while the ________ is the number of people employed
and unemployed.
a. labor force; working-age population
b. labor force participation rate; labor force
c. working-age population; labor force
d. working-age population; labor force participation rate

9. Using the definition of unemployment, which of the following individuals would be

unemployed?
a. A full-time student quits school, enters the labor market for the first time, and
searches for employment.
b. Because of the increased level of automobile imports, an employee of General
Motors is laid off but expects to be called back to work soon
c. Because of a reduction in the military budget, your next-door neighbor loses her
job in a plant where nuclear warheads are made and must look for a new job.
d. All of these individuals are unemployed.

10. The unemployment rate equals

a. (number of people employed/working age population) × 100.
b. (number of people unemployed/labor force) × 100.
c. (labor force/working age population) × 100.
d. (number of people employed/number of people age 16 and over) × 100.

Section B

Question 1

The Bureau of Labour Statistics announced that in December 1998, of all adult Americans,
138,547,000 were employed, 6,021,000 were unemployed, and 67,723,000 were not in the labor
force. How big was the labor force? What was the labor-force participation rate? What was the
unemployment rate?

Question 2
Use the following information about Employment Country. Numbers are in millions.
Labor Statistic 2020 2021
Population 223.6 226.5
Adult population 168.2 169.5
Number of unemployed 7.4 8.1
Number of employed 105.2 104.2

a) What is the labor force in 2020 and 2021?

b) What is the labor force participation rate in 2020 and 2021?
c) What is the unemployment rate in 2020 and 2021?

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d) From 2020 to 2021, the adult population went up while the labor force went down. Provide
some explanations why this might have occurred.
e) If the natural rate of unemployment in Employment Country is 6.6 percent, how much is
cyclical unemployment in 2020 and 2021? Is Employment Country likely to be
experiencing a recession in either of these years?

Question 3
Using a diagram of the labor market, show the effect of an increase in the minimum wage on the
wage paid to workers, the number of workers supplied, the number of workers demanded, and
the amount of unemployment.

Question 4
Explain four ways in which a firm might increase its profits by raising the wages it pays.

Question 5
Consider an economy with two labor markets, neither of which is unionized. Now suppose a
union is established in one market.
a. Show the effect of the union on the market in which it is formed. In what sense is the
quantity of labor employed in this market an inefficient quantity?
b. Show the effect of the union on the nonunionized market. What happens to the
equilibrium wage in this market?

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Chapter 29 : The Monetary System

Section A (MCQ)

1. Money
a. is more efficient than barter.
b. makes trades easier.
c. allows greater specialization.
d. All of the above are correct.

2. Changes in the quantity of money affect

a. interest rates.
b. Prices.
c. Production.
d. All of the above are correct

3. Which of the following best illustrates the medium of exchange function of

money?
a. You keep some money hidden in your shoe.
b. You keep track of the value of your assets in terms of currency.
c. You pay for your double latte using currency.
d. None of the above is correct.

4. Liquidity refers to
a. the ease with which an asset is converted to the medium of exchange.
b. a measurement of the intrinsic value of commodity money.
c. the suitability of an asset to serve as a store of value.
d. how many time a dollar circulates in a given year.

5. Which type of currency has intrinsic value?

a. Commodity money.
b. Fiat money.
c. Both commodity money and fiat money.
d. Neither commodity money nor fiat money.

6. M1 equals currency + demand deposits +

a. nothing else.
b. other checkable deposits.
c. traveler's checks + other checkable deposits.
d. traveler's checks + other checkable deposits + savings deposits.

7. You get money for babysitting the neighbors' children. This best illustrates which
function of money?
a. medium of exchange
b. unit of account
c. store of value
d. Liquidity

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8. The supply of money is determined by

a. the price level.
b. the Treasury and Congressional Budget Office.
c. the Federal Reserve System.
d. the demand for money

9. Which of the following is correct?

a. If the Fed purchases bonds in the open market, then the money supply curve
shifts right. A change in the price level does not shift the money supply
curve.
b. If the Fed sells bonds in the open market, then the money supply curve
shifts right. A change in the price level does not shift the money supply
curve.
c. If the Fed purchases bonds, then the money supply curve shifts right. An
increase in the price level shifts the money supply curve right.
d. If the Fed sells bonds, then the money supply curve shifts right. A decrease
in the price level shifts the money supply curve right.

10. Which of the following is a tool that is used by the Fed to control the quantity of
money?
a. open market operations
b. government expenditure multiplier
c. excess reserves
d. real interest rate

Section B

Question 1

a) Why don’t banks hold 100 percent reserves? How is the amount of reserves banks hold
related to the amount of money the banking system creates?
b) Suppose that the T-account for First National bank is as follows:

Assets Liabilities
Cash $500,000 Deposits $500,000

I) If the Central Bank requires banks to hold 5% of deposits as reserves, how much in
excess reserves does First National now hold?

II) What will be the total money supply?

Question 2
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Assume that Miss A deposits RM50,000 with Bank Y. Assume also that required reserves are 20
percent of checking deposits, and that banks hold no excess reserves and households hold no
currency. Explain the detailed process of money creation in the economy and calculate the size
of the money multiplier. Demonstrate your answers using banks’ T-account.

Question 3

a) What are the tools of monetary control used by central banks and explain how central banks
use them to control money supply?
b) Why is the central banks unable to fully control the money supply?

Chapter 30: Money Growth and Inflation

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Section A

1. What will happen to the price of bonds when the interest rate falls?
a. Bond prices will remain the same.
b. Bond prices will rise.
c. Bond prices will fall.
d. Ambiguous.

2. What will happen to the interest rate if the quantity of money demanded is less
than the quantity of money supplied?
a. Either increase or decrease, depending on the amount of excess demand.
b. Increase.
c. Decrease.
d. Unaffected.

3. What causes an increase in the equilibrium interest rate?

a. A decrease in the level of output (real GDP).
b. The purchase of government securities by the Fed.
c. An increase in the level of output (real GDP) and an increase in the money
supply.
d. The sale of government securities by the Fed.

4. Which of the following is NOT a monetary policy tool of the Federal Reserve?
a. Changes in required reserves.
b. Last resort loans.
c. Deposit insurance.
d. Open market operations.

5. The minimum percentage of deposits that a depository institution must hold and
cannot use for lending is known as the
a. Minimum rate.
b. required reserve ratio.
c. money multiplier.
d. discount rate.

6. The required reserve ratio

a. is the amount of money that banks require borrowers to reserve in their accounts.
b. is the fraction of a bank's total deposits that is required to be held in reserves.
c. increases when withdrawals from a bank are made.
d. is higher for banks that make riskier loans.

7. If the desired reserve ratio is 3 percent and deposits totaled $575 billion, banks would
hold
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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

a. $534.75 in reserves.
b. $17.25 billion in excess reserves.
c. $1,725 billion in currency.
d. $17.25 billion in reserves.

8. An increase in the price level makes the value of money

a. increase, so people want to hold more of it.
b. increase, so people want to hold less of it.
c. decrease, so people want to hold more of it.
d. decrease, so people want to hold less of it.

9. Which of the following is correct?

a. If the Fed purchases bonds in the open market, then the money supply curve
shifts right. A change in the price level does not shift the money supply
curve.
b. If the Fed sells bonds in the open market, then the money supply curve
shifts right. A change in the price level does not shift the money supply
curve.
c. If the Fed purchases bonds, then the money supply curve shifts right. An
increase in the price level shifts the money supply curve right.
d. If the Fed sells bonds, then the money supply curve shifts right. A decrease
in the price level shifts the money supply curve right.

10.

Refer to the above figure. If the money supply is MS2 and the value of money is 2,
a. the value of money is less than its equilibrium level.
b. the price level is higher than its equilibrium level.
c. the quantity of money demanded is greater than the quantity of money
supplied.
d. the quantity of money supplied is greater than the quantity of money
demanded.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Section B
Question 1

a) Explain the difference between nominal and real variables, and give two examples of
each. According to the principle of monetary neutrality, which variables are affected by
changes in the quantity of money?
b) According to Fisher's effect, how does an increase in the inflation rate affect the real
interest rate and the nominal interest rate?

Question 2

Suppose you explain the concept of an "inflation tax" to a friend. You correctly tell them, "When
a government prints money to cover its expenditures instead of taxing or borrowing, it causes
inflation. An inflation tax is simply the erosion of the value of money from this inflation.
Therefore, the burden of the tax lands on those who hold money." Your friend responds, "What's
so bad about that? Rich people have all the money so an inflation tax seems fair to me. Maybe
the government should finance all of its expenditures by printing money."

a) Is it true that rich people hold more money than poor people?
b) Do rich people hold a higher percentage of their income as money than poor people?
c) Compared to an income tax, does an inflation tax place a greater or lesser burden on the
poor?
d) Are there any other reasons why engaging in an inflation tax is not a good policy?

Question 3

Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real
GDP is $5 trillion.
I) What is the price level? What is the velocity of money?
II) Suppose that velocity is constant and the economy’s output of goods and services rises by
5% each year.
a) What will happen to nominal GDP and the price level next year if the
Reserve Bank keeps the money supply constant?
b) What money supply should the Reserve Bank set next year if it wants to
keep the price level stable?
c) What money supply should the Reserve Bank set next year if it wants
inflation of 10%?

Question 5
a) Income taxes treat nominal interest earned on savings as income even though much of the
nominal interest is simply to compensate for inflation. a. To see what this does to the
incentive to save, complete the following table for both the low-inflation and high-
inflation country.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Low Inflation Country High Inflation Country

Real Interest Rate 5% 5%
Inflation Rate 3% 11%
Nominal Interest Rate
Reduced Interest Rate due to
a 25% Tax
After-tax Nominal Interest
Rate
After-tax Real Interest Rate

b) What could the government do to eliminate this problem?

Chapter 31: Open Economy Macroeconomics : Basic Concept

Section A (MCQ)

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

1. When Safeway supermarkets in the United States buy strawberries from Mexico
a. it uses dollars to pay Mexican farmers.
b. it uses pesos to pay Mexican farmers.
c. it may use any currency it chooses.
d. the transaction shows up in the U.S. capital account.

2. When the value of one currency falls relative to another currency, the exchange
rate for the first currency has
a. depreciated.
b. appreciated.
c. demanded.
d. revalued.

3. Sonya, a citizen of Denmark, produces boots and shoes that she sells to department
stores in the United States. Other things the same, these sales
a. increase U.S. net exports and have no effect on Danish net exports.
b. decrease U.S. net exports and have no effect on Danish net exports.
c. increase U.S. net exports and decrease Danish net exports.
d. decrease U.S. net exports and increase Danish net exports.

4. Which of the following is an example of U.S. foreign portfolio investment?

a. Ruth, a U.S. citizen, buys bonds issued by a German corporation.
b. Larry, a citizen of Ireland, opens a fish and chips restaurant in the United
States.
c. Albert, a German citizen, buys stock in a U.S. computer company.
d. Dustin, a U.S. citizen, opens a country-western tavern in New Zealand.

5. If a country changes its corporate tax laws so that domestic firms build and
manage more firms overseas, then this country will
a. increase foreign direct investment which increases net capital outflow.
b. increase foreign direct investment which decreases net capital outflow.
c. increase foreign portfolio investment which increases net capital outflow.
d. increase foreign portfolio investment which decreases net capital outflow.

6. Which of the following would be U.S. foreign portfolio investment?

a. Disney builds a new amusement park near Barcelona, Spain.
b. A U.S. citizen buys stock in companies located in Asia.
c. A Dutch hotel chain opens a new hotel in the United States.
d. A citizen of Singapore buys a bond issued by a U.S. corporation.

7. A German company sells computers to a retailer in the United States. These sales
by themselves
a. have no affect on U.S. net exports and increase German net exports.
b. decrease U.S. net exports and increase German net exports.
c. increase U.S. and German net exports.
d. increase U.S. net exports and decrease German net exports.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

8. When the New Paradigm (an American company) buys shares of BMW stock (a
German company) for its pension fund, U.S. net capital outflow
a increases because an American company makes a portfolio investment in
Germany.
b. declines because an American company makes a portfolio investment in
Germany.
c. increases because an American company makes a direct investment in
Germany.
d. declines because an American company makes a direct investment in
Germany.

9. Greg, a U.S. citizen, opens an ice cream store in Bermuda. His expenditures are
U.S.
a foreign portfolio investment that increase U.S. net capital outflow.
b. foreign portfolio investment that decrease U.S. net capital outflow.
c. foreign direct investment that increase U.S. net capital outflow.
d. foreign direct investment that decrease U.S. net capital outflow.

10. Which of the following is correct?

a NCO = NX
b. NCO + I = NX
c. NX + NCO = Y
d. Y = NCO - I

Section B
Question 1
a) Define net exports and net capital outflow. Explain how and why they are related.
b) Explain the relationship between saving, investment, and net capital outflow.
c) How would the following transactions affect U.S. exports, imports, and net exports?
i. An American art professor spends the summer touring museums in Europe.
ii. Students in Paris flock to see the latest movie from Hollywood.
d) How would the following transactions affect U.S. net capital outflow? Also, state
whether each involves direct investment or portfolio investment.
i. An American cellular phone company establishes an office in the Czech Republic.
ii. Harrod’s of London sells stock to General Electric pension fund.
Question 2
a) A can of soda costs $0.75 in the U.S. and 12 pesos in Mexico. What would the peso–
dollar exchange rate be if the purchasing power parity holds? If a monetary expansion
causes all prices in Mexico to double, so that soda rose to 24 pesos, what would happen
to the peso-dollar exchange rate?
b) If a Japanese car costs 500,000 yen, a similar American car cost $10,000, and a dollar can
buy 100 yen, what are the nominal exchange rate and real exchange rate?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Question 3

Suppose you are having breakfast with your parents one Sunday. Your father is reading the paper
and comments on a report that the exchange rate for the ringgit has just hit its lowest value in a
decade. He reads on and then exclaims that JCB, a heavy equipment manufacturer, has reported
that sales of their earth-moving equipment have hit an all-time high. Your parents are shocked by
the report's positive view of the low value of the ringgit. They’ve recently abandoned plans to
visit Australia because of the ringgit’s low value.
a) Why might JCB and your parents have different opinions about the value of the dollar?
b) JCB imports many parts and raw materials for their manufacturing processes and they
sell many finished products abroad. If they are happy about a low ringgit, what must be
true about the ratio of JCB’s imports and exports?
c) If someone argues that a strong ringgit is "good for Malaysia" because Malaysian
residents can exchange some of their GDP for a greater amount of foreign GDP, is it true
that a strong ringgit is good for every Malaysian resident? Why?

Question 4
Suppose the price of a pair of Levi’s jeans is €40 in Spain and 400 pesos in the Philippines.
a) What is the nominal peso/euro exchange rate if purchasing-power parity holds?
b) Suppose the central bank in the Philippines is politically pressured to double the country’s
money supply, which doubles the price level in the Philippines. If purchasing-power parity
holds, what is the new peso/euro exchange rate? Did the peso appreciate or depreciate?
c) Suppose the ECB now doubles the Eurozone money supply, which doubles the price level in
the Eurozone, including, of course, Spain. If purchasing power parity holds, what is the new
value of the peso/euro exchange rate? Did the euro appreciate or depreciate?
d) Compare your answer to part (a) and part (c). What has happened to the exchange rate?
Why?

Chapter 32: A Macroeconomic Theory of The Open Economy

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Section A (MCQ)
1. A country has $100 million in net exports and $170 million in savings. Net capital
outflow is
a. $70 million and domestic investment is $170 million.
b. $70 million and domestic investment is $270 million.
c. $100 million and domestic investment is $70 million.
d. None of the above is correct.

2. In an open economy, the market for loanable funds equates national savings with
a. domestic investment.
b. net capital outflow.
c. the sum of national consumption and government spending.
d. the sum of domestic investment and net capital outflow.

3. Other things are the same, a higher real interest rate raises the quantity of
a. domestic investment.
b. net capital outflow.
c. loanable funds demanded.
d. loanable funds supplied.

4. An increase in the U.S. real interest rate induces

a. Americans to buy more foreign assets, which increases U.S. net capital
outflow.
b. Americans to buy more foreign assets, which reduces U.S. net capital
outflow.
c. foreigners to buy more U.S. assets, which reduces U.S. net capital outflow.
d. foreigners to buy more U.S. assets, which increases U.S. net capital outflow.

5. When a French vineyard establishes a distribution center in the U.S., U.S. net
capital outflow
a. increases because the foreign company makes a portfolio investment in the
U.S.
b. declines because the foreign company makes a portfolio investment in the
U.S.
c. increases because the foreign company makes a direct investment in capital
in the U.S.
d. declines because the foreign company makes a direct investment in capital
in the U.S.

6. Which of the following equations is always correct in an open economy?

a. I=Y-C
b. I=S
c. I = S - NCO
d. I = S + NX

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

7. If interest rates rose more in France than in the U.S., then other things were the
same
a. U.S. citizens would buy more French bonds and French citizens would buy
more U.S. bonds.
b. U.S. citizens would buy more French bonds and French citizens would buy
fewer U.S. bonds.
c. U.S. citizens would buy fewer French bonds and French citizens would buy
more U.S. bonds.
d. U.S. citizens would buy fewer French bonds and French citizens would buy
fewer U.S. bonds.
8. How much is the saving of a country with $50 million of domestic investment and
a net capital outflow of $15 million?
a. -$35 million.
b. $35 million.
c. -$65 million.
d. $65 million.

9. Which of the following increases when the real interest rate decreases, ceteris
paribus?
a. Domestic investment.
b. Net capital outflow.
c. Loanable funds supplied.
d. Loanable funds demanded.

10. The amount of dollars demanded in the market for foreign-currency exchange at a
given real exchange rate increases if
a. either U.S. imports decrease or U.S. exports increase.
b. either U.S. imports increase or U.S. exports decrease.
c. either U.S. imports or exports decrease.
d. either U.S. imports or exports increase.

Section B
Question 1
Describe the supply and demand in the market for loanable funds and the market for foreign
currency exchange. How are these markets linked?

Question 2
Why are budget deficits and trade deficits sometimes called twin deficits?

Question 3

Suppose that the government is considering an investment tax credit, which subsidizes domestic
investment. How does this policy affect national saving, domestic saving, domestic investment,
net capital outflow, the interest rate, the exchange rate, and the trade balance?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Question 4

Hong Kong has a capitalistic economic system. It was leased from China by Great Britain for
100 years. In 1997, it was returned to China, a socialist republic.
a) What do you think this event might have done to the net capital outflow of Hong Kong?
Why?
b) If the residents of Hong Kong chose Canada as a place to move some of their business
activity, what impact do you suppose this will have on the value of the Canadian interest
rate and exchange rate? Why?
c) Which Canadian industries, those engaged in importing or exporting, are likely to be
pleased with Hong Kong's investment in Canada? Why
d) What impact will Hong Kong's return to China have on the growth rate of Canada?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Chapter 28 (Parkin) :Expenditure Multipliers : The Keynesian Model

Section A(MCQ)

1. The Keynesian model of aggregate expenditure assumes that

a. individual firms' prices are flexible but the price level is fixed.
b. both individual firms' prices and the price level are flexible.
c. both individual firms' prices and the price level are fixed.
d. individual firms' prices are fixed but the price level is flexible.

2. An increase in real GDP leads to

a. a decrease aggregate planned expenditure.
b. no change in aggregate planned expenditure.
c. an increase in aggregate planned expenditure.
d. a change in aggregate planned expenditure but whether the change is an
increase or a decrease depends on whether nominal GDP increases or
decreases.

3. The consumption function relates consumption expenditure to

a. the interest rate.
b. disposable income.
c. saving.
d. the price level.

4. Autonomous consumption is equal to

a. consumption when disposable income is zero.
b. saving when consumption equals disposable income.
c. consumption caused by an increase in disposable income.
d. dissaving when disposable income is greater than zero.

5. The marginal propensity to consume refers to

a. the ratio of total consumption expenditure to total disposable income.
b. the additional saving that occurs out of an additional dollar of disposable
income.
c. the additional consumption expenditure that occurs out of an additional
dollar of investment.
d. the additional consumption expenditure that occurs out of an additional
dollar of disposable income.

6. Real GDP equals $20 billion and aggregate planned expenditure is $30 billion.
There is an unplanned ________ in inventories of ________ and real GDP will
________.
a. increase; $10 billion; increase
b. increase; $50 billion; decrease
c. decrease; $10 billion; increase
d. decrease; $10 billion; decrease

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

7. When autonomous expenditure increases, equilibrium aggregate expenditure

a. decreases by an equal amount to offset the unplanned portion.
b. increases by an equal amount.
c. decreases by a greater amount due to the multiplier.
d. increases by a greater amount due to the multiplier.

8. If investment increases by $300 and, in response, equilibrium aggregate

expenditure increases by $600, then the multiplier must be
a. 0.2.
b. 0.5.
c. 2.
d. 5.

9. An increase in the price level results in a

a. downward shift in the AE curve and a movement up along the AD curve.
b. downward shift in both the AE and AD curves.
c. downward shift in the AD curve and a movement down along the AE curve.
d. leftward movement along both the AE and AD curves.

10. In general, an increase in autonomous expenditure that is NOT created by a change

in the price level results in a
a. rightward shift of the AD curve.
b. movement upward along the AD curve.
c. movement downward along the AD curve.
d. leftward shift of the AD curve.

Section B

Question 1

In an economy, autonomous consumption expenditure is $50 billion, investment is $200 billion,

and
government expenditure is $250 billion. The marginal propensity to consume is 0.7 and net taxes
are $250 billion. Exports are $500 billion and imports are $450 billion. Assume that net taxes
and
imports are autonomous and the price level is fixed.
a) What is the consumption function?
b) What is the equation of the AE curve?
c) Calculate equilibrium expenditure.
d) Calculate the multiplier.
e) If investment decreases to $150 billion, what is the change in equilibrium expenditure?
f) Describe the process in part (e) that moves the economy to its new equilibrium expenditure.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Question 2

Real GDP C I G
(billions of (billions of (billions of (billions of
2009 dollars) 2009 dollars) 2009 dollars) 2009 dollars)
100 150 150 150
200 200 150 150
300 250 150 150
400 300 150 150
500 350 150 150
600 400 150 150
700 450 150 150
800 500 150 150
900 550 150 150

The above table gives information about the nation of North Hampton. There are no imports or
exports from North Hampton.
a) Find aggregate planned expenditure for each level of real GDP.
b) What is the equilibrium level of real GDP?

Question 3
An increase in the price level shifts the aggregate expenditure curve downward and results in a
movement along the aggregate demand curve. Why does an increase in the price level result in a
shift in the aggregate expenditure curve rather than a movement along it?

Question 4
How does the economy adjust so that aggregate planned expenditure equals real GDP?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Chapter 33: Aggregate Demand and Aggregate Supply

Section A (MCQ)
1. An aggregate supply curve depicts the relationship between
a. the price level and the quantity of nominal GDP supplied.
b. household expenditures and household income.
c. the price level and the quantity of real GDP supplied.
d. the money wage rate and the quantity of real GDP supplied.

2. In the macroeconomic long run

a. real GDP equals potential GDP.
b. the economy is at full employment.
c. regardless of the price level, the economy is producing at potential GDP.
d. All of the above are correct.

3. The short-run aggregate supply curve is upward-sloping because in the short run
the
a. money wage rate changes but the price level does not.
b. price level changes but the money wage rate does not.
c. both the money wage rate and the price level change.
d. neither the money wage rate nor the price level can change.

4. Which of the following changes does NOT shift the long-run aggregate supply
curve?
a. a decrease in the labor force
b. a fall in the price level
c. a rise in number of college graduates in the labor force
d. a tax hike that reduces the capital stock

5. Moving along the aggregate demand curve, a decrease in the quantity of real GDP
demanded is a result of
a. an increase in the price level.
b. a decrease in the price level.
c. an increase in income.
d. a decrease in income.

6. Which of the following can start inflation?

a. An increase in aggregate demand.
b. An increase in aggregate supply.
c. A decrease in aggregate supply.
d. Both answers A and C are correct.

7. Demand-pull inflation can be started by

a a decrease in the quantity of money.
b. an increase in government expenditure.
c. a decrease in net exports.
d. an increase in the price of oil.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

8. A leftward shift in the short-run aggregate supply curve

a. is the result of the Fed increasing the quantity of money.
b. is the result of a rise in the price of a key resource.
c. is the result of consumer expenditures exceeding available output.
d. increases both the price level and real GDP.

9. Suppose that the money prices of raw materials increase so that short-run
aggregate supply decreases. If the Federal Reserve does not respond, the higher
money price of raw materials will
I. repeatedly shift the aggregate demand curve rightward and raise the price level.
II. shift the aggregate demand curve rightward and the aggregate supply curve
leftward, raising prices.
III. result initially in lower employment and a higher price level.
a. I only
b. both I and II
c. both II and III
d. III only

10. The wealth effect, interest rate effect, and exchange rate effect are all explanations
for
a. the slope of short-run aggregate supply.
b. the slope of long-run aggregate supply.
c. the slope of the aggregate demand curve.
d. everything that makes the aggregate demand curve shift.

Section B

Question 1
Suppose the aggregate demand and short-run aggregate supply schedules for an economy whose
natural output equals $2,700 are given in the table.

Aggregate Quantity of Goods and Services

Price Level Demanded Supplied
0.50 $3,500 $1,000
0.75 3,000 2,000
1.00 2,500 2,500
1.25 2,000 2,700
1.50 1,500 2,800

a) Draw the aggregate demand, short-run aggregate supply, and long-run aggregate supply
curves.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

b) State the short-run equilibrium level of real GDP and the price level.
c) Characterize the current economic situation. Is there an inflationary or a recessionary
gap? If so, how large is it?

d) Explain how the economy will achieve its long-run equilibrium with and without
government intervention.

Question 2

Suppose the Central Bank expands the money supply, but because the public expects this action,
it simultaneously raises its expectation of the price level. What will happen to output and the
price level in the short run? Compare this result to the outcome of the Central Bank expanded the
money supply, but the public didn’t change its expectation of the price level.

Question 3

The energy price shock eases slightly as Germany allays

fears of an imminent Russia embargo
Gas and oil hit record highs before stabilizing as countries dependent on
Russian imports say measures likely to be introduced ‘step by step’
Gas prices and petrol hit an all-time high and oil neared record levels after the US said it had
discussed the prospect of an embargo on exports from Russia before pushback from Germany
eased the market tension.
The price of gas for delivery in the UK in April soared to 800p per therm at one point, up from
460p on Friday and 20 times the price of the same contract a year ago, before the autumn energy
price crunch and war in Ukraine hit.
European benchmark gas prices jumped by 79% to as high as €345 per megawatt-hour, while
Brent crude oil soared by more than 10% in early trading to $139 per barrel, a 14-year high and
close to the record of $147.50 set in July 2008.
Markets were responding to comments by the US Secretary of State, Andrew Blinken, who
referred to “very active discussions” with allies about escalating sanctions against the Kremlin
by banning the import of Russian oil and natural gas.
As commodity prices surged, the average cost of a litre of petrol at UK forecourts reached a new
record of 155.62p, according to the data firm Experian Catalist, while diesel was also at an all-
time high, at 161.28p.
Analysts at Bank of America said cutting off oil exports by Russia, the world’s second largest
supplier at 5m barrels a day, could send oil shooting to $200 a barrel.
Prices only eased after Germany’s new chancellor, Olaf Scholz, appeared to pour cold water on
the prospect of a coordinated transatlantic embargo on Russian oil and gas.
“Europe has deliberately exempted energy supplies from Russia from sanctions,” he said.
“Supplying Europe with energy for heat generation, mobility, electricity supply, and industry

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

cannot be secured in any other way at the moment. It is therefore of essential importance for the
provision of public services and the daily lives of our citizens.”
Europe sources about 40% of gas imports and about 27% of oil imports from Russia, but
Germany is more reliant than any other major economy on the continent on Kremlin-controlled
supplies.
After Scholz spoke, the UK benchmark gas price dropped back from 800p per therm to 500p,
still in record territory, while oil pared back some of its gains but was still up 4% at $123.
On the stock markets, the FTSE100 closed down 0.4% at 6959, while France’s Cac40 shed 1.3%
and Germany’s Dax was the worst affected, ending the day just under 2% lower. Panic on
trading floors sent safe havens sharply higher, with gold hitting as much as $2,000.86, its highest
since mid-2020. While Scholz’s comments calmed markets somewhat, the increasing seriousness
with which a fossil fuel embargo is being discussed is set to keep commodity prices high.
The Bank of America chief economist Ethan Harris said cutting off most of Russia’s energy
exports would be a “major shock to global markets”, and the loss of Russia’s 5m barrels could
see oil prices double to $200 a barrel.
Rising commodity prices will only add to the global inflationary pulse, with US consumer price
data this week expected to show annual growth at a stratospheric 7.9%, and the core measure at
6.4%.
It leaves a tough decision for the European Central Bank when it meets this week against a
backdrop of a sharply falling euro. The nightmare scenario of stagflation – where inflation
combines with stagnating growth – looms for the world economy.
“Given the potential for stagflation is very real, the ECB is likely to maintain maximum
flexibility with its [quantitative easing] programme at €20bn through the second quarter and
potentially beyond, thus effectively pushing out the timing of rate hikes,” said Tapas Strickland,
an economist at NAB. “Higher inflation forecasts, though, mean rate hikes will be needed on the
horizon.”
(Extracted from theguardian. com;7/3/22)

Read the above article to answer the following questions.

i) Use an appropriate economic model to explain the short-run effect of the soaring crude
oil price on the key macroeconomic variables.
ii) How significant is Russia's contribution to the oil and gas market? Explain the impact of
imposing an embargo on Russian oil and gas.
iii) Explain the term ‘stagflation’ and explain how soaring crude oil may cause economic
stagflation.
iv) Explain the term ‘quantitative easing’ and explain the purpose of implementing this
policy.

36
Chapter 34: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Section A(MCQ)

1. All of the following are part of fiscal policy EXCEPT

A) setting tax rates.
B) setting government spending.
C) choosing the size of the government deficit.
D) controlling the money supply.
2. A budget surplus occurs when the government
A) spending exceeds tax revenues.
B) tax revenues exceed spending.
C) tax revenues equals spending.
D) tax revenues equal Social Security expenditures.

3. When the economy is hit by spending fluctuations, the government can try to
minimize the effects by
A) changing government expenditures on goods.
B) changing taxes.
C) changing government expenditures on services.
D) all of the above
4. The key goal of monetary policy is to
A) reverse the productivity growth slowdown.
B) keep the budget deficit small and/or the budget surplus large.
C) lower taxes.
D) maintain low inflation.

5. Monetary policy affects real GDP by

a. changing aggregate supply.
b. creating budget surpluses.
c. changing aggregate demand.
d. creating budget deficits.

6. Liquidity preference refers directly to Keynes' theory concerning

a. the effects of changes in money demand and supply on interest rates.
b. the effects of changes in money demand and supply on exchange rates.
c. the effects of wealth on expenditures.
d. the difference between temporary and permanent changes in income.

7. According to the liquidity preference theory, an increase in the overall price level
of 10 percent
a. increases the equilibrium interest rate, which in turn decreases the quantity
of goods and services demanded.
b. decreases the equilibrium interest rate, which in turn increases the quantity
of goods and services demanded.
c. increases the quantity of money supplied by 10 percent, leaving the interest
rate and the quantity of goods and services demanded unchanged.
ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

d. decreases the quantity of money demanded by 10 percent, leaving the

interest rate and the quantity of goods and services demanded unchanged.

8. If expected inflation is constant and the nominal interest rate increases by 3.5
percentage points, then the real interest rate
a. increases by 3.5 percentage points.
b. increases, but by less than 3.5 percentage points.
c. decreases, but by less than 3.5 percentage points.
d. decreases by 3.5 percentage points.

9. When the interest rate increases, the opportunity cost of holding money
a. increases, so the quantity of money demanded increases.
b. increases, so the quantity of money demanded decreases.
c. decreases, so the quantity of money demanded increases.
d. decreases, so the quantity of money demanded decreases.

10. If the interest rate increases

a. or if the price level increases, then people will want to hold more money.
b. or if the price level increases, then people will want to hold less money.
c. or if the price level decreases, then people will want to hold more money.
d. or if the price level decreases, then people will want to hold less money.

Section B
Question 1
a) Distinguish between a multiplier effect and a crowding-out effect.
b) The economy is in recession. Shifting the AD curve rightward by $200b would
end the recession.
i) If MPC = 0.8 and there is no crowding out, how much should the government
increase its spending (G) to end the recession?

ii) If there is crowding out of $20b, how much should the government increase its
spending to end the recession?

Question 2
a) Explain the reasons why the aggregate demand (AD) curve slopes downward.
b) What are fiscal and monetary policies? Do they have an immediate effect on the
AD curve or the short-run aggregate supply (SRAS) curve?

Question 3
Suppose you are watching the news on television during a general election campaign.
The opening report is a story about today's announcement that the Bank of England
has raised interest rates by a quarter of a percent today to head off future inflation.
The report then moves to an interview with a politician from the governing party with
a marginal constituency in an industrial area. She says, "The Consumer Price Index
has not increased, yet the Bank of England is restricting growth in the economy,
supposedly to fight inflation. My constituents will want to know why they are going
to have to pay more for their mortgages, and why their jobs are being put at risk, and I
don't have a good answer. I think this is an outrage!"

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

a) What interest rate did the Bank of England raise?

b) State the Bank of England’s policy in terms of the money supply.
c) Why might the Bank of England raise interest rates before the CPI starts to
rise?

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Chapter 35: The Short-Run Tradeoff Between Inflation and Unemployment

Section A(MCQ)

1. One determinant of the natural rate of unemployment is the

a. rate of growth of the money supply.
b. minimum wage rate.
c. expected inflation rate.
d. All of the above are correct.

2. In the short run,

a. unemployment and inflation are positively related. In the long run they are
largely unrelated problems.
b. and in the long run inflation and unemployment are positively related.
c. unemployment and inflation are negatively related. In the long run they are
largely unrelated problems.
d. and in the long run inflation and unemployment are negatively related.

3. In the long run, which of the following depends primarily on the growth rate of the
money supply?
a. the natural rate of unemployment and the inflation rate
b. the natural rate of unemployment but not the inflation rate
c. the inflation rate but not the natural rate of unemployment
d. neither the natural rate of unemployment nor the inflation rate

4. The short-run Phillips curve shows the combinations of

a. unemployment and inflation that arise in the short run as aggregate demand
shifts the economy along the short-run aggregate supply curve.
b. unemployment and inflation that arise in the short run as short-run
aggregate supply shifts the economy along the aggregate demand curve.
c. real GDP and the price level that arise in the short run as short-run
aggregate supply shifts the economy along the aggregate demand curve.
d. None of the above is correct.

5. If a central bank decreases the money supply, then

a. prices, output, and unemployment rise.
b. prices and output rise and unemployment falls.
c. prices rise and output and unemployment fall.
d. prices and output fall and unemployment rises.

6. In the long run, policy that changes aggregate demand changes

a. both unemployment and the price level.
b. neither unemployment nor the price level.
c. only unemployment.
d. only the price level.

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

7. As the aggregate demand curve shifts leftward along a given aggregate supply
curve,
a. unemployment and inflation are higher.
b. unemployment and inflation are lower.
c. unemployment is higher and inflation is lower.
d. unemployment is lower and inflation is higher.

8. According to the short-run Phillips curve, inflation

a. and unemployment would fall if the policymakers decreased the money
supply.
b. would fall and unemployment would rise if policymakers decreased the
money supply.
c. and unemployment would fall if the policymakers increased the money
supply.
d. would fall and unemployment would rise if policymakers increased the
money supply.

9. The natural rate of unemployment

a. is constant over time.
b. varies over time, but can’t be changed by the government.
c. is the unemployment rate that the economy tends to move to in the long run.
d. depends on the rate at which the Fed increases the money supply.

10. Which of the following is correct according to the long-run Phillips curve?
a. No government policy, including changes in monetary growth, can change
the natural rate of unemployment.
b. Changes in the money supply growth rate are the only government policy
that can change the natural rate of unemployment.
c. Monetary policy cannot change the natural rate of unemployment, but other
government policies can.
d. Monetary policy and other government policies can both change the natural
rate of unemployment.

Section B
Question 1
a) Draw the short-run tradeoff between inflation and unemployment. How might
the Central Bank move the economy from one point on this curve to another?
b) Draw the long-run tradeoff between inflation and unemployment. Explain how
the short-run and long-run tradeoffs are related.
Question 2
Suppose a drought destroys farm crops and drives up the price of food. What is the
effect on the short-run tradeoff between inflation and unemployment?

Question 3

Use the following equation and information to answer the questions given below.

Unemployment rate = Natural rate of unemployment – α (Actual inflation – Expected

inflation)

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ECO102/ECO157 Principles of Macroeconomics/Macroeconomics 1 –Tutorial questions

Natural rate of unemployment = 5%

Expected inflation = 2%
Coefficient a in PC equation = 0.5
i) Plot the long-run Phillips curve.
ii) Find the unemployment rate for each of these values of actual inflation: 0%,
6%. Sketch the short-run PC.
iii) Suppose expected inflation rises to 4%. Repeat part (ii).
iv) Instead, suppose the natural rate of unemployment falls to 4%. Draw the new
long-run Phillips curve.

Question 4
The Fed Chairman is convinced that the economy is in danger of recession and
decides to take action. He implements an expansionary monetary policy to combat
the recession. Explain the unemployment and inflation outcomes for the economy if
workers and firms form their expectations using
i) rational expectations.
ii) adaptive expectations.
Use a short-run and long-run Phillips curve to illustrate your answer.

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