Practice Midterm 2 Econ 1102 Name 1 RP 1 RP for writing name as it appears on onestop Section 1 RP 1 RP for section enrolled in TA Name 1RP 1RP for correct TA name NO programmable calculators NO cell phones NO notes NO collaboration with other students Time limit 50 minutes Each page may have has its own directions Follow the directions carefully Clearly indicate which question you are answering Replacement points are added to score of the page on which they are earned The only exception is the 3RP given for Name Section and TA Name these are added to your total score For full credit graphs must be completely LABELED and math work shown Be sure to justify your answers clearly and precisely for full credit Rambling incoherent or illegible responses shall be penalized even if correct Points are rewarded for answers consistent with those your instructor would give to the same question This exam is 8 pages including this front page numbered 1 8 2 3 4 5 RP Total PAGE 1 QUESTIONS 25 pts 13 RP 1 4 pt What are the four components of aggregate demand Consumption Investment Government Expenditure Net Exports 2 3 pts What is crowding out and how is it caused by expansionary fiscal policy Crowding out is the decrease in investment that results from decrease in public savings expansionary fiscal policy With expansionary fiscal policy the public savings decreases therefore the supply of loanable funds decreases This results in a higher interest rate and a lower demand for loans in the new equilibrium in the loanable funds market full credit if explained with diagrams 3 2 5 pts Define Fiscal Policy Changes in government purchases and or tax collections designed to achieve full employment and noninflationary domestic output Need the part in italics to get full credit 4 2 5 pts What is the official name for the paper currency used in the USA Is it commodity or fiat currency Explain The paper currency used in the USA is called Federal Reserve Notes It is an example of fiat currency because it is not backed up by the value of an underlying asset 5 2 5 pts Define Fractional Reserve Banking Banking system in which banks are required to keep a percentage fraction of checkable deposits in cash or with the central bank 6 2 5 pts What differentiates short run and long run aggregate supply In the short run input or output prices are sticky they do not immediate respond to changes in economic conditions In the long run all prices are fully flexible and accurate reflect the value of inputs and outputs 7 6 pt In 2004 an undersea earthquake in the Indian Ocean generated a large tsunami Explain how each of the following changes the price level in the affected countries the loss of life damage to roads and buildings the inflow of monetary aid and inflow of goods aid Cyclone kills a bunch of people AD decreases decrease local prices Cyclone damages infrastructure AS decreases Increase local prices Inflow of monetary aid AD increases Increase local prices Inflow of goods aid AS increases decrease local prices 8 2 pts Expansionary Fiscal Policy An increase in government purchases or a decrease in taxes or some combination of the two for the purpose of increasing aggregate demand 9 2 5 RP Economic investment Payments for new additions to the nation s capital stock whether public new roads and bridges or private new factories homes and equipment 10 2 5 RP Financial investment Buying or building an asset in expectation of earning financial gain new factories and homes but also old buildings plus stocks bonds and other financial assets 11 8 RP What is money Define any terms you use Money Anything that performs the following functions 1 Medium of Exchange An item that buyers give sellers when they want to purchase goods and services 2 Unit of Account The measure people use to post prices and record debts 3 Store of Value An item that people can use to transfer purchasing power from present to the future 1102 Practice Midterm 2 Page 2 of 6 PAGE 2 QUESTION 25 pts 8 RP 12 2 pts Draw an AD AS diagram that shows an economy in AD AS equilibrium AD 14 15 Prices 16 13 Quantity For the following four questions show how the AD SR AS or the LR AS line would shift your diagram above Assume you start at equilibrium unless stated otherwise 13 2 pt The government decides to build more roads and highways 1 pt for AD 1 pt for right 14 2 pt Show how the economy returns from 13 to an extended AD AS equilibrium without government intervention 1 pt for AS 1 pt for left 15 2 pt There is a sudden decrease in oil prices 16 2 pt Show how the economy returns from 15 to an extended AD AS equilibrium if the central bank uses monetary policy 1 pt for AD 1 pt left 17 2 pt What event could cause a decrease in the LR AS A war anything that decrease long run production is an acceptable answer 18 8 pts Using the money market loanable fund and AD AS diagram show how expansionary monetary policy can end a recession Nominal Interest Rate Nominal Interest Rate Money Loanable Fund Quantity 19 2 pts Define Monetary Neutrality The proposition that changes in the money supply do not affect real variables 20 3 pts What are the cons of commodity money Limits amount of money that can be printed Resources could be put to better use Value of resources need not be stable 21 3 RP Consider the following FOMC statement Is the Fed using expansionary or contractionary monetary policy or neither Is actual output above or below potential output The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent Financial markets remain under considerable stress and credit has tightened further for some businesses and households Moreover recent information indicates a deepening of the housing contraction as well as some softening in labor markets The Committee expects inflation to moderate in coming quarters but it will be necessary to continue to monitor inflation developments carefully Today s policy action combined with those taken earlier should help to promote moderate growth over time and to mitigate the risks to economic activity Expansionary monetary policy Actual Output is below potential output 22 5 RP List 5 costs of inflation Shoeleather costs menu costs relative price variability and the misallocation of resources confusion and inconvenience inflation induced tax distortions unexpected inflation causes redistributions of wealth 1102 Practice Midterm 2 Page 3 of 6 PAGE 3 QUESTIONS 25 pts 23 8 pt Gina has
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