Eco2004s 2014 Test 2

University of Cape Town
School of Economics
ECO2004S
Test 2
9th October 2014
Time: 75 Minutes
INSTRUCTIONS
Fill in the answers on the MCQ sheet provided
Write your name, student number and test number on the MCQ sheet provided
Use PENCIL only on the MCQ answer sheet
Time: 75 Minutes
Total Questions: 30
Marks: Correct Answer + 4
Incorrect Answer - 1
No answer 0
1. If National Income is greater than the natural level of output then,

A) the unemployment rate is less than the natural unemployment rate.
B) the price level is greater than the expected price level.
C) the price level will be higher next period than it is this period.
D) all of the above
E) none of the above
2. A short-run monetary expansion will cause,
A) an increase in output
B) a fall in the interest rate
C) an increase in the price level
D) all of the above
3. If the economy is operating at the natural level of output, which of the following will keep the
composition of output (i.e., the percentage of GDP composed of consumption, investment, ... etc.)
unchanged in the medium run?
A) a reduction in government spending
B) a cut in taxes
C) a reduction in the desire to save
D) an increase in consumer confidence
E) an increase in the money supply
4. If the economy is operating at its natural level of output, then a fiscal contraction must cause
A) an increase in investment in the medium run
B) a reduction in investment in the short run
C) no change in investment in the medium run
D) an increase in investment in the short run
5. In the short run, a reduction in the price of oil will cause
A) a reduction in output
B) an increase in the price level
C) a reduction in the interest rate
D) all of the above
6. The original Phillips curve implied or assumed that,
A) the markup over labour costs was zero.
B) the expected rate of inflation would be zero.
C) the actual and expected rates of inflation would always be equal.
D) all of the above
7. During a deflation,
A) inflation and unemployment are both increasing
B) inflation and unemployment are both decreasing
C) the price level is decreasing
D) the rate of inflation is falling from, for example, 10% to 3%
E) the natural rate of unemployment is zero
2
8. Suppose bank A has assets of 250, liabilities of 190, and capital of 60. Its leverage ratio is
A) 0.14
B) 1.00
C) 1.32
D) 3.16
E) 4.17
9. Which of the following is most likely to coincide with a liquidity trap?
A) inflation is rising
B) inflation is constant
C) inflation is zero
D) individuals prefer to hold money rather than bonds
E) the real interest rate is negative
10. Which of the following factors did not contribute to the financial crisis?
A) The liabilities issued by banks were very liquid
B) The assets held by banks were often very illiquid
C) There was a sharp decline in housing prices in the United States
D) Banks held too much capital
E) Many banks experienced large losses as borrowers defaulted on their mortgages
11. Securitization allows financial intermediaries to
A) decrease the cost of borrowing
B) convert an illiquid portfolio of loans into highly liquid securities
C) attract more investors to buy and hold their securities
D) all of the above
12. Which of the following best defines the real exchange rate?
A) The price of domestic currency in terms of foreign currency.
B) The price of foreign bonds in terms of domestic bonds.
C) The price of domestic goods in terms of foreign goods
D) The price of foreign currency in terms of domestic currency
E) The price of domestic bonds in terms of foreign bonds
13. Suppose that over the past decade, U.S inflation is less than that in South Africa. Further assume
that during this same period, the U.S dollar depreciates relative to South African rand. Given this
information,
A) The real exchange rate in South Africa remains unchanged.
B) The real exchange rate in South Africa must appreciate.
C) The real exchange rate in South Africa must depreciate
D) The real exchange rate in South Africa can appreciate or remain the same, but not depreciate
E) The real exchange rate in South Africa can depreciate or remain the same, but not appreciate.
14. Suppose two countries make a credible commitment to fix their bilateral exchange rate in the short
run. In such a situation, we know that
A) The uncovered interest parity condition no longer holds
B) The real exchange rate must be constant as well
C) Each country can freely allow its interest rate to diverge from that of the other country
D) The interest rate in the two countries must be equal
E) Neither country will run a trade deficit
15. For this question, assume the interest rate parity condition holds. Also assume that the domestic
interest rate is 6.3% and that the foreign interest rate is 1.2%. Given this information, we would
expect that
A)
B)
C)
D)
E)
The domestic currency is expected to depreciate by 6.3%

The domestic currency is expected to appreciate by 7.5%
The domestic currency is expected to appreciate by 5.1%
16. If a countrys residents traditionally receive more income from holding foreign assets than foreign
residents receive as income from holding domestic assets, then that country traditionally has a
surplus in the net income balance. This figure will be recorded in . of the balance
of payments.
A) The financial account
B) The current account
C) The capital transfer account
D) The change in net gold and foreign reserves
E) The financial and foreign reserves account
17. In an open economy, an increase in government spending will cause
A) An increase in domestic output
B) An increase in imports
C) A reduction in net exports
D) All of the above
E) None of the above
18. An open economy with a low saving rate ( private and public) must have
A) Low investment only
B) High investment only
C) A trade surplus only
D) Low investment or a trade deficit
E) Low investment or a trade surplus
19. The quantity of imports will decrease when there is
A) An appreciation in the real exchange rate
B) A reduction in domestic output
C) A reduction in foreign output
D) All of the above
20. If the Marshall-Lerner condition holds then ---------------------in the exchange rate leads to ---------------- in the net exports
A) a real appreciation, no change
B) a real depreciation, a decrease
C) a real appreciation, a decrease
D) a real appreciation, an increase
E) an increase in the foreign output,
a decrease
21. The J-curve illustrates the effects of

A) changes in Y* on net exports
B) changes in Y on net exports
C) changes in the real exchange rate on net exports
D) changes in Y on imports
22. Suppose the rest of the world experiences a recession that causes a reduction in foreign income
(Y*). Which of the following impacts will be found in the domestic economy as it adjusts to the
drop in Y*?
A) A reduction in income and a reduction in imports
B) A reduction in imports and an increase in exports
C) The net exports line to shift up
D) An ambiguous effect on net exports
E) An increase in income and an increase in imports
23. An increase in the budget deficit can be reflected in
A) An increase in private saving
B) A reduction in investment
C) A reduction in net exports
D) All of the above
24. Suppose a country with a fixed exchange rate decides to reduce the price of its currency. This
change in policy is called,
A) An appreciation
B) A depreciation
C) A peg
D) A revaluation
E) A devaluation
25. For this question, assume that the economy is operating in the short run and in a fixed exchange
rate regime and that perfect capital mobility exists. Given this information, which of the following
will occur?
i) The domestic and foreign interest rates must be equal
ii) The central bank cannot use monetary policy to affect domestic output
iii) An expansionary fiscal policy will require the central bank to increase the money supply
iv) The domestic and foreign interest rates need not be equal
v) A contractionary fiscal policy will require the central bank to increase the money supply.
A) i only
B) i, ii and iii only
C) i, ii and v only
D) ii, iii and iv only
E) ii only
26. If taxes and the money supply increase simultaneously then, under flexible exchange rates, we
know with certainty that,
A) The exchange rate would appreciate and output would increase
B) The exchange rate would appreciate and output would decrease
C) The exchange rate would depreciate
D) The exchange rate would depreciate and output would increase
5
27. Suppose individuals wish to obtain the most accurate comparison of living standards between the
Canada and Saudi Arabia. To do so, one would convert Saudi Arabian Gross Domestic Product per
capita into dollars using
A) the current nominal exchange rate.
B) the prior year's real exchange rate.
C) an average of the last five years' exchange rates.
D) purchasing power parity methods.
E) the current real exchange rate.
28. For this question, assume that there are decreasing returns to capital, decreasing returns to labor,
and constant returns to scale. A reduction in the capital stock will cause which of the following?
A) an increase in output per capita
B) no change in output
C) a reduction in output
D) increase the capital-labour ratio
29. Suppose the stock of capital increases by 2% and employment increases by 2%. Given this
information, we know that
A) output will increase by 4%.
B) output per capita will increase by less than 4% and more than 2%.
C) output per capita will increase by 6%.
D) output will increase by less than 4% and more than 2%.
30. "Convergence" has been occurring among the OECD countries because
A) the richer countries give away more of their output than the poorer ones.
B) the procedures for measuring output per capita have been changing.
C) the richer countries have had higher growth rates than the poorer ones.
D) the poorer countries have had higher growth rates than the richer ones.
E) the poorer countries have had positive growth rates, while the richer ones have had negative growth
rates.
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University of Cape Town

1. If National Income is greater than the natural level of output then,

The domestic currency is expected to depreciate by 6.3%

21. The J-curve illustrates the effects of

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