Profiler - Final Examination Multiple Choice Questions Flashcards
The Chancellor has announced that the $100m tax decrease will be financed by a $100m decrease in government expenditure. What impact will these two actions have on national income?
A. None; the effects of one will cancel out the effects of the other
B. National income will be $100m lower than it otherwise would be
C. National income will be $100m higher than it otherwise would be
D. National income will be $75m × balanced budget multiplier higher than it otherwise would be
Despite the fact the investment function (marginal efficiency of investment curve) shifted downwards (to the left) investment expenditure actually increased. This increase in investment expenditure was caused by
I. a decrease in the rate of interest
II. positive expectations about economic growth
III. a decrease in the rate of unemployment
Which of the following is correct?
A. I only
B. I and III only
C. II and III only
D. I, II and III
The correct answer is A.
The investment function relates the volume of investment to different rates of interest and is constructed on the assumption of a given set of conditions. As these conditions change, the curve will shift. If decision makers become optimistic the curve will shift outwards (to the right) and if pessimism predominates the curve will shift downwards (to the left). Positive expectations about world economic growth, rising income, falling unemployment, favourable government attitude towards business, etc. will shift the curve to the right. Thus II and III are incorrect.
For the curve to shift to the left and for investment expenditure to be higher than it was before is possible at, and only at, a lower rate of interest.
Text Ref: The Investment Function
In an economy where taxes equal $40m, exports, government expenditure and investment expenditure are equal to each other and each equal to $200m. Households consume 75% of their disposable income. Imports equal 25% of national income. What is the equilibrium level of consumption expenditure?
A. $825m
B. $865m
C. $925m
D. $1140m
The policy makers have at last succeeded. This year national income (Y) equals potential output (Q), the inflation rate is zero and the economy is operating at full employment. The government has indicated that it will attempt to keep aggregate demand at its current level next year.
If it succeeds which of the following will occur?
A. The inflation rate will be positive because of expectations generated this year
B. Y will exceed Q because of the multiplier effect started this year
C. The unemployment rate will increase because Q will exceed Y next year
D. Aggregate demand cannot be kept at its current level if G and I both increase next year
The correct answer is C.
Since it is given that the economy is in equilibrium this year, Y = Q, then there will be no forces existing to cause Y to increase or to cause the price level to increase. Thus A and B are wrong. Since Y≡C + I + G + X − Z it is possible for any increases in both G and I to be offset by decreases in C and/or X and/or increases in Z to keep Y at its current level. Thus D is wrong. Q, however, will increase next year because of increases in the labour force, the capital stock and technological change and if Y remains at its current level a gap between Q and Y will emerge. U = f(Q − Y) and thus U will increase.
Text References:
- Relationship between Unemployment Rate, Potential Output and Actual Output
- The Inflation Rate
- Deflationary and Inflationary Gaps
Potential GNP (Q) may have been growing at only 2.5% per annum over the past three years but real GNP (Y) has been booming along at 3.5% per annum. The conclusions which can be drawn are both positive and negative; they are
I. the unemployment rate has been falling
II. an inflationary gap has arisen
III. aggregate demand now exceeds potential output
Which of the following is correct?
A. I only
B. I and II only
C. III only
D. I, II and III
The correct answer is A.
The unemployment rate is determined by the gap between Q and Y. When Q > Y there exists demand deficient unemployment; when Q = Y full employment exists and when Y > Q over full employment exists. If Y has been growing at a faster rate than Q over a three year period then the unemployment rate must be falling. Thus I is correct. Despite these growth rates, however, if Y is still less than Q a deflationary gap will persist and aggregate demand, by definition, will be less than Q; thus II and III are wrong.
Text References:
- Relationship between Unemployment Rate, Potential Output and Actual Output
- Deflationary and Inflationary Gaps
Last year the official national income statistics showed an increase in real GNP and a decline in money GNP. Assuming the data are accurate which of the following is correct?
A. The unemployment rate decreased
B. The inflation rate was negative
C. There was a deficit in the international trade accounts
D. There was a deflationary gap
The correct answer is B.
Changes in money GNP includes changes in price and quantity weights whereas changes in real GNP reflect changes only in quantity weights. Thus if real GNP increased and money GNP decreased prices had to have decreased. Thus B is correct. Despite real GNP increasing the unemployment rate could have increased had potential GNP been increasing at a faster rate than real GNP; thus A is incorrect. A trade deficit, imports exceeding exports, and a deflationary gap, potential output exceeding actual output, are not necessarily associated with either a rising real GNP or declining money GNP.
Text Ref: Deflationary and Inflationary Gaps
Investment expenditures were 0i2 before the marginal efficiency of investment schedule (MEI) shifted from I1 to I2. After the shift investment expenditures remained at 0i2.
Notation: I1 is the investment level 1; I2 is the investment level for period 2.
What could have caused investment expenditure to remain static?
A. An increase in the rate of interest
B. An increase in the ratio exports/GNP
C. An increase in the value of the accelerator
D. An increase in the unemployment rate
The correct answer is A.
Factors which cause optimism in the business community can lead to the MEI schedule shifting to the right and those with pessimist predictions can lead to the MEI schedule shifting to the left. Given the MEI schedule did shift to the right the only factor which could have caused I to remain static was a rise in the rate of interest, the rise being sufficient to cancel any factors causing the rightward shift of the MEI schedule.
Text References:
- The Multiplier
- The Investment Function
According to the modern Quantity Theory if potential output is increasing continuously at 2% per annum, real output at 4% per annum and the price level at 3% per annum which of the following shows by how much the money supply is increasing, approximately, per annum?
A. 3%
B. 5%
C. 6%
D. 7%
The correct answer is D.
The word ‘continuously’ indicates equilibrium. Had there been zero inflation the increase in real output of 4% per annum would have required an increase in the money supply of 4% per annum assuming no change in the velocity of circulation of money. Had national income been constant but had the price level been increasing at 3% per annum an annual increase in the money supply of 3% per annum would have been required to satisfy the increased demand for money due to inflation only. Thus the combination of real growth of 4% and inflation of 3% requires an increase in the money supply of approximately 7% per annum. Given the inflation rate the growth rate of potential output is irrelevant.
Text Ref: ‘The Modern Quantity Theory versus Keynes’.
Despite the existence of a budget deficit the government kept its election pledge and increased spending on hospitals and education. This extra government spending had no impact on national income, however, because there was 100% crowding out. What did occur however was
- the rate of interest increased
- the budget deficit increased
- investment and/or consumption expenditure decreased
Which of the following is correct?
A. I only
B. II only
C. II and III only
D. I, II and III
The correct answer is D.
100% crowding out means that the increase in government expenditure was matched by an equal decrease in consumption/investment expenditure caused by an increase in the rate of interest as shown below. Thus I is true.
Given Y≡C + I + G and there were no changes in Y after the increase in G then C and/or I had to decrease. Thus III is true.
Since a budget deficit existed before the increase in government expenditure and since there was no change in tax rates or Y then government revenues could not increase but expenditures did. Thus the deficit would increase. Thus II is true.
Text References:
- The Relation Between the Unemployment Rate (U), Potential Output (Q) and Actual Output (Y)
- The Government Sector
- The Development of Macroeconomic Models
- Introduction
- Causes and Effects of Inflation
- Anti-Inflationary Policies
The government increased expenditure and cut taxes and simultaneously the monetary authority increased the money supply. However despite those actions the unemployment rate increased. Which of the following explains the increase in the unemployment rate?
A. A decrease in the rate of interest discouraged savings
B. Potential output increased faster than national output
C. A decrease in the inflation rate caused a trade surplus
D. The Phillips Curve shifted to the right
The correct answer is B.
If savings were discouraged for any reason it would mean consumption had been encouraged, not a cause of increasing unemployment. Thus A is wrong. Similarly a trade surplus would make aggregate demand higher than it otherwise would have been. Thus C is wrong. A shift to the right of the Phillips Curve indicates that a given inflation rate is now associated with a higher unemployment rate than previously it does not explain why the unemployment rate increased. Thus D is wrong. The unemployment rate is determined by the gap between potential and actual output. If it has increased in the presence of increasing actual output it means potential output has increased at a greater rate than actual output.
Text References:
- The Relation Between the Unemployment Rate (U), Potential Output (Q) and Actual Output (Y)
- Potential and Actual Output
- The Central Bank and Monetary Policy
- The Solution to the Simple Model
An expansionary policy was enacted but it had no impact on the rate of interest on national income or the inflation rate. Which of the following explains the lack of success?
A. The Phillips Curve shifted to the right
B. The economy was at full employment
C. Investment expenditure was interest inelastic
D. The economy was in the liquidity trap
The correct answer is D.
A shift in the Phillips Curve which indicates the trade off between the inflation and unemployment rates does not explain the lack of success, or success, of any policy. Thus A is wrong. An expansionary policy enacted when the economy was at full employment would have increased the interest and/or inflation rate. Thus B is wrong. Interest inelasticity of investment expenditure indicates that changes in the rate of interest do not affect investment expenditure only; it does not explain the lack of impact on all other variables. Thus C is wrong.
If the expansionary policy were monetary and the economy were in the liquidity trap the lack of success is explained. An expansionary fiscal policy in the trap would have led to an increase in national income.
Text References:
- Introduction
- The Solution to the Simple Model
An expansionary monetary and fiscal policy reduced the unemployment rate but left the inflation rate unaltered. Which of the following contains the element of the national income accounts (C, I, G, X, Z), which is least likely to be affected to a significant degree by the expansionary policy in the short-run?
A. C
B. G
C. X
D. Z
The correct answer is C.
The expansionary policy reduced the unemployment rate (U). Since U is a function of the gap between potential output (Q) and national income (Y) it can be concluded that Y increased. If Y increased then C + I + G + X − Z increased. C, I and Z are normally functions of Y and therefore cannot be excluded. One of the tools of fiscal policy is ΔG and thus G cannot be excluded. Exports are a function of foreign GNP, relative inflation rates and the exchange rate primarily, the latter two factors with a lag. Thus exports of all the national income components are least likely to be affected in the short-run.
Text References:
- The Relation Between the Unemployment Rate (U), Potential Output (Q) and Actual Output (Y)
- The International Sector
- Causes and Effects of Inflation
- Anti-Inflationary Policies
The economy was at full employment and, fearing potential inflation, the government increased taxes and decreased government expenditure. Simultaneously the monetary authority decreased the money supply. Despite such actions overfull employment emerged and the inflation rate increased substantially. This indicates that
- the increased interest rate, caused by the decrease in the money supply, had no effect on consumption and/or investment expenditure
- excess aggregate demand lead to an increase in imports causing a balance of trade deficit
Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II
The correct answer is D.
The increased demand for money and decrease in the supply would cause interest rates to rise and make consumption and investment expenditures lower than they otherwise would have been but other factors such as expectations, inventory replacement and the income effect could have caused consumption and investment expenditures to increase more than offsetting the negative interest rate effect. Thus I is wrong. The increase in aggregate demand would lead to an increase in imports but a trade deficit is a withdrawal from the circulation flow, i.e. makes output lower than it otherwise would have been. Thus II is wrong also.
Text Ref: The International Sector
Which of the following helps explain how overfull employment can exist in a market economy?
A. In the short run the growth rate of national output can exceed the growth rate of potential output
B. Normal frictional and structural unemployment rates can fall in periods of excess demand for labour.
C. The Phillips Curve may shift to the left after periods of sustained unemployment
D. Immigration of foreign workers can make the labour force larger than it otherwise would have been
The correct answer is B.
This is really a definitional question.
The national rate of unemployment, or the full employment unemployment rate, is that rate which exists when demand deficient unemployment is zero, i.e. when the only unemployment consists of frictional, structural and seasonal elements. Overfull employment can exist when overtime is worked and frictional and structural rates fall below average because of the large number of unfilled vacancies in the labour markets.
Text References:
- The Inflation Rate
- Introduction
It may be difficult to establish facts or truths in macroeconomics but some do exist; for example if the government wants to
- balance the budget total government outlays must equal total government receipts
- increase tax revenues it must increase tax rates
- maintain full employment, when reached, it must continue increasing government expenditure
Which of the following is correct?
A. I only
B. I and III only
C. II only
D. I, II and III
The correct answer is A.
By definition the budget is balanced when total outlays equal total receipts. Thus I is true. The Laffer Curve indicates that tax revenues would be zero when the tax rate is zero and also when the tax rate is 100% since no one would work. Thus some tax rate TM exists when tax revenues are at a maximum. If the existing rate is below TM then increasing the tax rate will raise tax revenues whereas if the tax rate is greater then TM lowering the tax rate will increase tax revenues. Thus II is wrong. When the economy reaches full employment and assuming potential output is growing at, say, 3% per annum then aggregate demand must grow also at 3% per annum to maintain full employment. Increasing government expenditure is only one of the tools which can be used to stimulate the economy along with tax cuts and increasing the money supply. Thus III is wrong.
Text References:
- The Government Sector
- Fiscal Policy
- The International Sector
From the above data, in index form, representing an economy, it can be inferred that between years t and t + 1 there was
- deflation
- overfull employment
- a decrease in labour productivity
Which of the following is correct?
A. I only
B. I and III only
C. II and III only
D. I, II and III
The correct answer is A.
Since real output (GNP) grew at 5% and money GNP at only 4%, a deflation rate of approximately 1% occurred. Thus I is true. Although real output grew 5% and potential only 4% it could only be concluded that the economy was at overfull employment if, initially, actual GNP was more than 99% of potential GNP. Thus II is wrong. Real output increased by 5%, the labour force decreased by 2%. Thus labour productivity increased by 7% approximately. Thus III is wrong.
Text References:
- The Inflation Rate
- The Relation Between the Unemployment Rate (U), Potential Output (Q) and Actual Output (Y)
Which of the following points taken together indicate decreasing returns to the variable factor input capital?
A. U and X
B. U and V
C. U and W
D. U and Z
Which of the following points taken together indicate constant returns to scale?
A. U and X
B. U and V
C. U and Y
D. U and Z
The correct answer is C.
U, V and Z all appear in the same production frontier, i.e. where labour is in fixed supply and thus UV and UZ can exhibit returns to scale.
UY indicates a doubling of capital (4 to 8 units) a doubling of operators (1 to 2) and a doubling of output (300 to 600 units), i.e. constant returns to scale. Thus C is true. X does not appear on any production frontier. Thus A is wrong.
Which of the following points taken together indicate constant returns to the fixed factor input, labour?
A. V and T
B. V and U
C. V and W
D. V and Z
The correct answer is A.
Point W does not appear on any production frontier, thus C is wrong. Points V, U and Z are all on the same frontier and thus all exhibit different return to the fixed factor input, labour.
At point V returns to the fixed factor input are 100/1 = 100
At point T returns to the fixed factor input are 200/2 = 100. Thus A is correct.
In response to student requests the university announced that 10% of next year’s students fees would be allocated to the construction of sports facilities. The sum in question was $8 000 000 ($8 million). The students were asked to reveal their preferences. The votes were:
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What is the opportunity cost to the students of the swimming pool?
A. $8m
B. A reduction in student fees
C. The racquets centre
D. The racquets centre plus the playing fields
The correct answer is C.
The opportunity cost of the item chosen (the swimming pool complex) was the best alternative foregone. The only choices other than the swimming pool complex were the racquets centre (30% of votes) and the playing fields (20% of votes). Since the racquets centre received more votes than the playing fields, the racquets centre was the best alternative foregone. $8m was the cost, not the opportunity cost, thus A is wrong and a reduction in student fees was not a choice, thus B is wrong.
Text References:
- Marginal Analysis and Opportunity Cost
- Production Possibilities Curve
- Equilibrium of the Firm
Short run profit maximising (loss minimising) behaviour requires that the firm produce which of the following weekly outputs?
A. Zero
B. Ow
C. Ox
D. Oy
The correct answer is A.
A necessary but not sufficient condition for profit maximisation is that a firm produce that output at which MR = MC. The sufficient part requires that AR at such an output level ≥ AVC. At the price, P, in the figure AR < AVC at all output levels; the firm ceases to operate.
Text References:
- Firm Supply in the Short Run
- Market Supply in the Long Run
What short-run loss will the profit maximising (loss minimising) firm make?
A. (AR − AVC) × 0y
B. (ATC − AR) × 0x
C. (AR − AVC) × 0x
D. (ATC − AR) × 0y
The correct answer is B.
The firm will produce the output at which MR = MC to maximise profit/minimise loss, i.e. the firm will produce output ox. At output ox the average loss on each unit produced is ATC − AR; thus the total loss is (ATC − AR) × 0x.
Text References:
- Firm Supply in the Short Run
- Perfect Competition
The firm remains in business because
- its fixed costs are covered and some revenue remains to contribute to variable costs
- in the long run ATC will fall until it is tangential to the p = AR = MR line.
Which of the following is correct?
A. I only
B. II only
C. Both I and II
D. Neither I nor II
The correct answer is D.
The firm remains in business at the loss minimising output ox, p > AVC, i.e. all variable costs are covered and a contribution left (AR − AVC) × ox to set against fixed cost. Thus I is wrong. In the long run firms will leave the industry, the industry supply curve will shift to the left and price will increase. Assuming the firm was operating in an engineering efficient fashion there is no reason to expect the ATC curve to shift downwards. Thus II is wrong also.
Text References:
- Firm Supply in the Short Run
- Perfect Competition
The diagram shows for a profit maximising monopolist the marginal revenue curve (MR) derived from the demand curve facing the monopolist and the monopolist’s marginal cost (MC) and average fixed cost (AFC) curves.
The profit maximising output is 20 units per week, i.e. where MR = MC.
What price will the monopolist charge?
A. $10
B. $15
C. $20
D. The answer cannot be derived from the diagram and information given
Trade in goods and services between Germany and France is balanced. It is predicted however that the French franc will appreciate significantly against the German mark and average German prices which had been increasing at 5% per annum will increase at 1% per annum while French price increases will remain constant at 6% per annum. Assuming these predictions come true how will this news be greeted by French and German exporting firms?
The correct answer is C.
The appreciation of the French franc means the French will receive more marks for a given number of francs making German goods cheaper for French purchasers than they were before. This is good news for German exporters but bad news for French exporters, i.e. Germans receive fewer francs. Price increases in Germany have fallen to 1% while French price increases remain at 6%; this also makes German goods, up only 1% in price, relatively more attractive than French goods up 6% in price. This is good news for German exporters and bad news for French exporters.
Text Ref: Exchange Rates
