SO 151
Bremmer
November 8, 1996

3rd In-Class Exam - - Chapters 4-5, 7-12

Part I. Multiple Choice (3 points each). Indicate the best answer for each question in the space provided.
1. Assume the required reserve ratio is 16 2/3 percent and that depository institutions have $110 million in excess reserves. According to the simple money multiplier model, the maximum amount of money which the banking system could create is:
A. $110 million.
B. $330 million.
C. $660 million.
D. $1,353 million.

2. The First National Bank of Oklahoma has checkable deposits of $10,000,000 and reserves of $2,500,000; the required reserve ratio is 15 percent. What is the most this single bank can initially lend out?
A. $500,000
B. $750,000
C. $1,500,000
D. $1,000,000

3. If the required reserve ratio is 20 percent and depository institutions decide to hold additional excess reserves equal to 5 percent of any newly acquired checking deposits, then the effective money multiplier for the banking system will be:
A. 3.
B. 4.
C. 5.
D. 6.

4. In the Keynesian demand and supply of money model, a decrease in the price level causes:
A. the demand for money to shift to the left and the equilibrium interest rate will fall.
B. the demand for money will shift to the right and the equilibrium interest rate will rise.
C. the supply of money will shift to the right and the equilibrium interest rate will fall.
D. the supply of money will shift to the left and the equilibrium interest rate will increase.

5. Crowding out occurs when there is:
A. a fall in G due to an increase in C and I.
B. a reduction in tax revenues during a recession.
C. a reduction in C and I caused by higher interest rates that were a result of government deficits.
D. a reduction in C and I caused by lower interest rates.

6. All but which one of the following are costs of inflation?
A. Confused price signals.
B. Menu costs.
C. Lower interest rates.
D. Transfer of resources to the government.

7. Assume Smith is temporarily unemployed because he has voluntarily quit his job with company A and will begin a better job next week with company B. Smith will be considered as:
A. structurally unemployed.
B. frictionally unemployed.
C. cyclically unemployed.
D. seasonally unemployed.

8. In the simple Keynesian model, if output exceeds aggregate expenditures:
A. inventories will decrease, and firms will increase output.
B. inventories will increase, and firms will increase output.
C. inventories will increase, and firms will decrease output.
D. the economy is in equilibrium.

9. According to the Keynesian 45 model, if the mpc = 0.80, then a $150 billion increase in imports will cause the equilibrium level of real GDP to:
A. increase by $750 billion.
B. decrease by $750 billion.
C. increase by $150 billion.
D. decrease by $150 billion.

10. In the simple Keynesian model, the investment function will shift to the left as a result of:
A. an increase in expected profits caused by a decrease in labor costs.
B. increased business optimism with respect to future economic conditions.
C. a decrease in business taxes.
D. an increase in the excess productive capacity available in industry.

11. Regarding the simple Keynesian macroeconomic model, which of the following will not tend to shift the consumption function upward?
A. A currently small stock of consumer durables.
B. A currently low level of consumer indebtedness.
C. An increase in the interest rate.
D. A decline in the price level.

12. In the simple Keynesian 45 model, the autonomous spending multiplier:
A. is equal to -mpc/(1 - mpc).
B. is equal to 1/mpc.
C. will be larger, the steeper the slope of the investment function.
D. will be larger, the steeper the slope of the consumption function.

13. According to the simple Keynesian 45 model, if the economy is in a recession, then the discretionary fiscal policy or policies that would most likely be recommended to correct this macroeconomic problem would be:
A. increased government spending or increased lump sum taxes, or a combination of the two.
B. increased government spending or decreased lump sum taxes, or a combination of the two.
C. decreased government spending or increased lump sum taxes, or a combination of the two.
D. decreased government spending or decreased lump sum taxes, or a combination of the two.

14. In the simple Keynesian 45 degree model, the effect of a decline in lump sum taxes on the equilibrium level of real GDP will differ from the effect of an increase in government expenditures of the same amount because:
A. tax declines tend to be more inflationary.
B. households will not spend all of the increase in disposable income caused by the tax cut.
C. the mpc which applies to the incomes of households always exceeds the mpc which applies to business incomes.
D. the lump sum tax multiplier has a larger effect in absolute value the smaller the mpc.

15. In the simple Keynesian 45 degree model, if the government raises its expenditure on goods and services by $50 billion and at the same time increased lump sum taxes by $50 billion, the net effect on the economy will be:
A. to increase the equilibrium level of real GDP by less than $50 billion.
B. to increase the equilibrium level of real GDP by more than $50 billion.
C. to increase the equilibrium level of real GDP by $50 billion.
D. to make no change in the equilibrium level of GDP.

Part II. Short Answer Questions (55 points). For each of the following questions, give a short, concise, but complete answer. When explaining your answers, use complete sentences. When appropriate, use math, graphs, or equations to help explain your answers.

1. Using a Keynesian 45 degree model, show an economy that is experiencing an inflationary (or an expansionary) gap. Why is this situation called an "inflationary gap"? Explain. Using this diagram, describe the appropriate discretionary fiscal policy that will eliminate the inflationary gap. (10 points)

2. Using the Keynesian money supply and money demand model, explain why interest rates are procyclical (that is, show that the interest rate rises as GDP increases, and the interest rate falls as GDP declines). (10 points)

3. Briefly identify the following terms (10 points)
A. the discount rate
B. the federal funds rate
C. an open market purchase
4. Answer the next four questions on the basis of the following information about a simple economy. Figures are in billions of dollars. (Show your work for partial credit.) (10 points)
C = 25 + .75(Y - T)
I = 50
G = 70
X - M = 10
T = 30
A. Determine the equilibrium level of GDP for this economy.

B.Suppose households become more pessimistic about the future of the economy and autonomous consumption falls by $10 billion. How much will equilibrium income change (if any)?

C. Suppose the government desired to increase the equilibrium level of GDP by $120 billion. Holding everything else constant, how much would G have to change to reach this goal? Holding everything else constant, how much would lump sum taxes have to change to achieve this goal?

4. Answer the next three questions on the basis of the following consolidated balance sheet for the banking system. Assume the required reserve ratio is 12 percent and all figures are in billions of dollars. (Show your work for partial credit.) (15 points)
Assets Liabilities and Net Worth
Reserves $60 Checking Deposits $150
Securities 50 Bank Capital 135
Loans 175    


A. How many excess reserves are present (if any) in the banking system?

B. What is the maximum amount (if any) by which the banking system can expand the supply of money by lending?

C. Show the final balance sheet for the consolidated banking system after it has reached equilibrium and loaned all its excess reserves.