ECON 105 Practice “Final Exam”

Spring 2024

REVISED Apr 21, 2024 – Part (e) of question 2 had the graph mis-labeled.

Please note that this isn’t exactly a practice final exam. It is the length of a midterm, and only
includes questions from the chapters we covered after Midterm #2. The actual final exam will be
longer and will include questions from the whole course.

Multiple choice
The final exam will have 36 multiple choice questions, each worth 1.5 points.

1. A new Prime Minister comes to power and fulfills a campaign promise of raising tariffs on
some imported goods to protect Canadian jobs. Assuming our trading partners don't retaliate
by raising trade barriers against our products, the Prime Minister's action will:
a. cause a movement up and to the left along the aggregate demand curve.
b. shift the aggregate demand curve to the left.
c. have a neutral effect on aggregate demand, causing no change in aggregate
expenditure.
d. shift the aggregate demand curve to the right.

2. The short run in macroeconomic analysis is a period:

a. in which many production costs can be taken as fixed.
b. in which wages become fully flexible.
c. of two months, and the long run is more than 12 months.
d. in which interest rates are fixed.

3. Which statement involves positive analysis? Which statement involves normative analysis?
I. Government spending on defense was $22 billion in 2019.
II. The federal government should spend more on defense to protect us from our enemies.
a. I is positive; II is normative.
b. I is positive; II is positive.
c. I is normative; II is positive.
d. I is normative; II is normative.
4. Which of these statements is FALSE regarding economic efficiency?
a. Efficient outcomes will not make everyone happy.
b. If it is efficient, it is also equitable.
c. Efficient outcomes can make everyone better off.
d. The most efficient outcome is the one with the greatest economic surplus.

5. If interest rates rise:

a. the cost to borrow falls.
b. the cost of spending money falls.
c. this encourages people to spend more money.
d. this encourages people to save more money.

6. The long-run supply curve shows that aggregate output supplied _____ the aggregate price
level in the long run.
a. is positively related to
b. is negatively related to
c. is unrelated to
d. corresponds one-to-one with

7. Social insurance programs are:

a. government programs intended to protect families against economic hardships.
b. private insurance policies that protect families from hardships caused by government
actions.
c. private insurance policies that cover gaps in government-provided health care.
d. programs to help unemployed people have a social life.
8. Use the accompanying graph, which shows Becca and Marcella's marginal benefit curves for
slices of cheesecake, to answer the question.

When the price is $1, Becca will buy _____ slices, and Marcella will buy _____ slices.
a. nine; fifteen
b. two; four
c. six; nine
d. six; six

9. Analysts in your consulting firm concluded that the current rate of unemployment is greater
than the equilibrium rate, which leads you to conclude that:
a. actual GDP is equal to potential GDP.
b. actual GDP is greater than potential GDP.
c. actual GDP is less than potential GDP.
d. the economy is in an expansion.

10. Suppose the economy is operating in long-run equilibrium and that a positive demand shock
hits. We would expect a short-run _____ in real GDP and the price level and a long-run
_____ in the price level.
a. increase; increase
b. decrease; increase
c. decrease; decrease
d. increase; decrease

11. Which of these government regulations is LEAST likely to lead to market failure?
a. subsidies for vaccinations
b. limits on sugar imports
c. rent control
 d. farm subsidies

12. The neutral real interest rate is the real interest rate:
a. that occurs when the output gap is negative.
b. that occurs when the output gap is positive.
c. at which real GDP is equal to potential GDP.
d. at which the inflation rate is 0%.

13. Suppose that productivity increases as workers' health improves. This increase in
productivity will:
a. cause a movement up the short-run aggregate supply curve from left to right.
b. cause a movement down the short-run aggregate supply curve from right to left.
c. shift the short-run aggregate supply curve to the right.
d. shift the short-run aggregate supply curve to the left.

14. Assume an increase in aggregate demand. In the long run, as the economy self-corrects, the
price level will _____, and potential output will _____.
a. rise; increase
b. fall; decrease
c. rise; remain stable
d. fall; remain stable
15. Use the information in the graph below to answer the question. In which year was the
unemployment rate probably the closest to the equilibrium rate?

a. 2019
b. 2010
c. 2009
d. 2000

16. Which of these changes will lead to a decrease in the price level but an increase in the
quantity of output in an economy?
a. a rise in aggregate demand
b. a rise in aggregate supply
c. a fall in aggregate demand
d. a fall in aggregate supply
17. Use the figure below to answer the question. If the aggregate demand curve is AD':

a. a contractionary fiscal policy may be warranted.

b. an expansionary fiscal policy may be warranted.
c. the economy is in long-run equilibrium.
d. the economy is experiencing an inflationary gap.

18. Currently, actual GDP is below potential output and falling. To stabilize the economy, you'd
recommend _____ fiscal policy, which could include _____.
a. expansionary; increased government purchases and tax cuts
b. expansionary; decreased government purchases and a tax increase
c. contractionary; increased government purchases and tax cuts
d. contractionary; decreased government purchases and a tax increase
19. The figure below shows the weekly market for Beyond Meat hamburgers in Calgary. If 400
hamburgers are sold, consumer surplus will equal:

a. $650.
b. $400.
c. $225.
d. $450.

20. To say that business cycles are persistent means that:

a. they typically have short and sharp recessions, followed by long and gradual
expansions.
b. they usually last over 20 years.
c. current conditions typically continue in the near future.
d. growth rates in a cycle will always be higher than growth rates in the previous cycle.
Short answer
The final exam will have 4 to 6 short answer questions. They will collectively account for
slightly less than half of your grade.

1. Heat pumps in BC: An increasing number of homeowners in British Columbia are

replacing their existing heating systems with heat pumps. Suppose that the market for heat
pumps in BC is perfectly competitive and looks like this:

Price ($)

MC
(= supply)
20,000

10,000

5,000
MB
(= demand)

60,000 Heat pumps installed

a. Assuming for the moment that heat pumps have no externalities, find consumer
surplus (CS), producer surplus (PS), and total economic surplus (ES).
b. Assume for the rest of this question that each heat pump installed has a positive
externality of $3,000 because it will produce less pollution than the existing
heating system. The market then looks like this:

Price ($)

23,000
MC
(= supply)
20,000
13,000
11,000
10,000

MB
5,000

demand

60,000 72,000 Heat pumps installed

Find the efficient quantity of heat pumps.

c. Find the deadweight loss resulting from the externality.
d. The BC government has instituted a rebate program that gives $3k to each
household that installs a heat pump. Assuming the positive externality above
applies, will this reduce or increase surplus?
e. Suppose we are concerned about equity as well as efficiency. Is the rebate
program more likely to benefit low-income households or high-income
households? Explain.
2. Credit constraints in the global financial crisis: The global financial crisis of 2008 was
characterized by a general withdrawal of credit to many businesses. That is, many
businesses could not borrow at any interest rate. As a result, many investment projects that
would have been profitable in present value terms were not pursued. We can model this
credit withdrawal as a decline in investment spending at a given price level and interest rate.
a. In the AD-AS model, which curve(s) would this shift, and in what direction?
b. How would this shock affect the price level, i.e. would it increase, decrease, or
stay the same?
c. How would this shock affect real GDP, i.e. would it increase, decrease, or stay the
same?
d. How would this shock affect the unemployment rate, i.e. would it increase,
decrease, or stay the same?
e. Draw an AD-AS model that shows your results. It should include labels for both
axes, the AD curve before (labeled AD0) and after the shock (labeled AD1 if
applicable), the AS curve before (labeled AS0) and after (labeled AD1 if
applicable) the shock, the price level before (labeled P0) and after (labeled P1 if
applicable) the shock, and the real GDP level before (labeled Y0) and after
(labeled Y1 if applicable) the shock.
f. Suppose the Bank of Canada cuts (overnight nominal) interest rates to zero, but
the economy is still below its previous level of investment because of all the
businesses that lack credit access. Explain what quantitative easing is, and how it
might be useful in helping the economy recover.
3. The interaction of monetary and fiscal policy: The formula for the Taylor rule is:

(𝑡𝑎𝑟𝑔𝑒𝑡 𝑜𝑣𝑒𝑟𝑛𝑖𝑔ℎ𝑡 𝑟𝑎𝑡𝑒) − (𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒)

= (𝑛𝑒𝑢𝑡𝑟𝑎𝑙 𝑟𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)
+ 0.5 ∗ (𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 − 𝑡𝑎𝑟𝑔𝑒𝑡 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛)
+ (𝑜𝑢𝑡𝑝𝑢𝑡 𝑔𝑎𝑝)

Suppose that Canada’s current inflation rate is 2.8%, above the Bank of Canada’s target of
2.0%. The Bank estimates that the neutral real interest rate is 1.5% and that the output gap
is currently +1%. The Bank’s next monetary policy announcement is scheduled for April
10.
a. Find the nominal interest rate predicted by the Taylor rule.
b. The Bank of Canada’s current target for the overnight rate is 5%. Based on the
Taylor rule, do you expect the Bank to announce an increase, a decrease, or no
change in its target for the overnight rate?
c. Suppose that increases (decreases) to interest rates in the overnight market also
lead to increases (decreases) to interest rates on long-term government debt. How
will the Bank’s action in part (b) of this question affect Canada’s interest
payments on its existing debt (up/down/same)?
d. How will the Bank’s action in part (b) of this question affect Canada’s budget
deficit (up/down/same)? Assume no change to tax revenue or other government
spending.
Answer key
Multiple choice
1. d 11. a
2. a 12. c
3. a 13. c
4. b 14. c
5. d 15. a
6. c 16. b
7. a 17. b
8. d 18. a
9. c 19. b
10. a 20. c

Short answer
1. Heat pumps in BC: This kind of problem is a mix of mechanical applications of formulas
(for CS, PS, ES, and DWL), the ability to distinguish between related concepts (equilibrium
quantity versus efficient quantity, social MB versus private MB versus demand, social MC
versus private MC versus supply), and the ability to apply the concepts in a specific setting.
a. Assuming for the moment that heat pumps have no externalities, find consumer
surplus (CS), producer surplus (PS), and total economic surplus (ES).
Consumer surplus = 0.5*($20,000-$10,000)*60,000 = $300 million.
Producer surplus = 0.5*($10,000-$5,000)*60,000 = $150 million.
Economic surplus = $300 million + $150 million = $450 million.
b. The efficient quantity of heat pumps is the quantity at which MC=MB, or
72,000.
c. The deadweight loss is:
DWL = 0.5*($13,000-$10,000)*(72,000-60,000) = $18 million.
d. This will increase surplus because it will push quantities towards the efficient
level.
e. Since the rebate would go to homeowners with the resources to purchase a new
heating system, it is more likely to benefit high income households than low-
 income households. Note that the purpose of this kind of question is to ask you to
think about how the problem would apply in the real world. In the real world,
there are usually multiple considerations and possibilities, and different people
will think of different possibilities We would accept any thoughtful answer here,
even if it reaches a different conclusion from mine.

2. Credit constraints in the global financial crisis: This kind of problem will definitely
appear on the final exam. It asks you to use the AD-AS model to predict the effect of a shock
on the economy, You will be asked for predictions on what happens to key variables, for a
graph that shows those predictions, and for comments on suitable monetary and/or fiscal
policy responses. You may also be asked to distinguish between short run and long run
outcomes.
a. A decline in investment implies a decline in overall spending so the AD curve
would shift inwards.
b. The price level will decrease.
c. Real GDP will decrease.
d. The unemployment rate will increase.
e. Your graph should look like this:

Price
level
AS0
(P)

P0

P1

AD0
AD1

Y1 Y0
Real GDP (Y)
 f. Quantitative easing is an unconventional monetary policy in which the Bank
purchases assets other than short-term government bonds. For example, the Bank
could directly purchase bonds from companies who lack access to credit. This
would allow them to invest.

3. The interaction of monetary and fiscal policy: You do not need to memorize the Taylor
rule for the final exam, but you do need to be able to apply it. Note that this question
combines material from two chapters: the Taylor rule from Chapter 22 and the discussion
of debts, interest payments, and deficits in Chapter 23. The final exam will ask you to make
these kinds of connections.
a. The Taylor rule would predict :
(𝑡𝑎𝑟𝑔𝑒𝑡 𝑜𝑣𝑒𝑟𝑛𝑖𝑔ℎ𝑡 𝑟𝑎𝑡𝑒) = 2.8% + 1.5% + 0.5 ∗ (2.8% − 2.0%) + 1%
= 𝟓. 𝟕%
b. I would expect the Bank to increase its target for the overnight rate.
c. Since the interest rate has increased, Canada’s interest payments on debt would
increase.
d. Canada’s budget deficit would also increase.