ECON 2301 – Macroeconomics Principles Practice Questions - Midterm 2  MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the  question. 1. For the purpose of calculating GDP, investment is spending on a. stocks, bonds, and other financial assets. b. real estate and financial assets such as stocks and bonds. c. capital equipment, inventories, and structures, including household purchases of new housing. d. capital equipment, inventories, and structures, excluding household purchases of new housing. 2. In the economy of Macroland in 2010, consumption was $900, GDP was $2000, government purchases   were $550, and investment was $750. What were Macroland’s net exports in 2010? a. $200 b. -$200 c. $1800 d. Net exports cannot be calculated from the information given. 3. If the CPI was 90 in 1975 and is 225 today, then $100 today purchases the same amount of goods and   services as a. $25.00 purchased in 1975. b. $135.55 purchased in 1975. c. $33.33 purchased in 1975. d. $40.00 purchased in 1975. 4. Transfer payments a. are payments that flow from government to households. b. are not made in exchange for currently produced goods or services. c. alter household income, but they do not reflect the economy’s production. d. All of the above are correct. 5. A firm has an agreement with its workers to index their wages using the CPI. The firm currently pays its   production line workers $8.00 an hour and is scheduled to index their wages today. If the CPI is currently   160 and was 128 a year ago, the firm should increase the hourly wages of its workers by a. $2.56. b. $2.00. c. $0.25. d. $1.60.  6. The steps involved in calculating the consumer price index and the inflation rate, in order, are as follows:  a. Fix the basket, find the prices, compute the inflation rate, compute the basket’s cost, and   choose a base year and compute the index. b. Fix the basket, find the prices, compute the basket's cost, choose a base year and compute the   index, and compute the inflation rate. c. Choose a base year, fix the basket, find the prices, compute the inflation rate, compute the   basket's cost, and compute the index. d. Choose a base year, update the basket, find the prices, compute the index, estimate the basket’s   cost, and compute the inflation rate.7. If one wants to know how the material well-being of the average person has changed over time in a given   country, one should look at the a. level of real GDP. b. growth rate of nominal GDP. c. growth rate of real GDP. d. growth rate of real GDP per person. 8. Two alternative measures of the overall level of prices are a. the inflation rate and the consumer price index. b. the inflation rate and the GDP deflator. c. the GDP deflator and the consumer price index. d. the cost of living index and nominal GDP. 9. A country’s real GDP rose from 500 to 550 while its nominal GDP rose from 600 to 770. What was this   country’s inflation rate? a. 16.7% b. 20% c. -14.3% d. -20% 10. If the consumer price index was 88 in 2009, 95 in 2010, and 100 in 2011, then the base year must be a. 2009. b. 2010. c. 2011. d. The base year cannot be determined from the given information. 11. Which of the following is not correct? a. The consumer price index gives economists a way of turning dollar figures into meaningful  measures of purchasing power. b. The consumer price index is used to monitor changes in the cost of living over time. c. The consumer price index is used by economists to measure the inflation rate. d. The consumer price index is used to measure the quantity of goods and services that the economy  is producing. 12. Suppose that the prices of dairy products have risen relatively less than prices in general over the last   several years. To which problem in the construction of the CPI is this situation most relevant? a. unmeasured quality change b. substitution bias c. income bias d. introduction of new goods 13. The consumer price index was 225 in 2006 and 234 in 2007. The nominal interest rate during this period   was 6.5 percent. What was the real interest rate during this period? a. 4.0 percent b. 10.5 percent c. 6.76 percent d. 2.5 percent2 | Page 14. Other things equal, relatively poor countries tend to grow a. slower than relatively rich countries; this is called the poverty trap. b. slower than relatively rich countries; this is called the fall-behind effect. c. faster than relatively rich countries; this is called the catch-up effect. d. faster than relatively rich countries; this is called the constant-returns-to-scale effect. 15. A farmer sells $50,000 of apples to individuals who take them home to eat and $75,000 of apples to a   company that uses them all to produce cider. How much of the farmer’s sales will be included as apples   in GDP? a. $0 b. $50,000 c. $75,000 d. $125,000 16. Workland has a population of 10,000, of whom 7,000 work 8 hours a day to produce $224,000 worth of   final goods. Laborland has a population of 5,000, of whom 4,000 work 12 hours a day to produce  $120,000 worth of final goods. a. Workland has lower productivity and lower real GDP per person than Laborland. b. Workland has lower productivity but higher real GDP per person than Laborland. c. Workland has higher productivity and higher real GDP per person than Laborland. d. Workland has higher productivity but lower real GDP per person than Laborland. 17. The table below pertains to Napandsnack, an economy in which the typical consumer’s basket consists of   2 pillows and 15 hotdogs. Table 1 Year Price of a Pillow Price of a Hotdog 2009 $40 $3 2010 $45 $4 2011 $50 $3

What were Macroland’s net exports in 2010?

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Refer to Table 1. If the base year is 2010, then the economy’s inflation rate in 2010 was  a. 20.0 percent. b. 25.00 percent. c. 10.5 percent. d. 15.0 percent. 18. Transactions involving items produced in the past, such as the sale of a 5-year-old automobile by a used   car dealership or the purchase of an antique rocking chair by a person at a yard sale, are a. included in current GDP because GDP measures the value of all goods and services sold in the   current year. b. included in current GDP but valued at their original prices. c. not included in current GDP because it is difficult to determine their value. d. not included in current GDP because GDP only measures the value of goods and services produced   in the current year.3 | Page 19. Consider a small economy in which consumers buy only two goods: pretzels and cookies. In order to   compute the consumer price index for this economy for two or more consecutive years, we assume that a. the percentage change in the price of pretzels is equal to the percentage change in the price of   cookies from year to year. b. neither the number of pretzels nor the number of cookies bought by the typical consumer changes   from year to year. c. neither the price of pretzels nor the price of cookies changes from year to year. d. the number of pretzels bought by the typical consumer is equal to the number of cookies bought by   the typical consumer in each year. 20. If an economy’s GDP falls, then it must be the case that the economy’s a. income falls and expenditure remains the same. b. income falls and expenditure rises. c. income and expenditure both fall. d. income and saving both fall. 21. When looking at a graph of nominal and real interest rates you notice that nominal rates always lie above   real rates. From this you conclude a. GDP was always increasing for the time frame represented on the graph. b. consumer prices were always rising in the time frame represented on the graph. c. the economy never experienced a recession in the time frame represented on the graph. d. there were serious episodes of deflation in the time frame represented on the graph. 22. When economists talk about growth in the economy, they measure that growth as the a. absolute change in real GDP from one period to another. b. absolute change in nominal GDP from one period to another. c. percentage change in real GDP from one period to another. d. percentage change in nominal GDP from one period to another. 23. The table below contains data for the country of Crete for the year 2014. Table 2 Total income $5731 Household purchases of durable goods $1108 Household purchases of nondurable goods $702 Household purchases of non-education services $203 Household purchases of education services $302 Household purchases of new housing $816 Purchases of capital equipment $333 Inventory changes $75 Purchases of new structures $267 Local government spending on goods and services $236 State government spending on goods and services $419 Federal government spending on goods and services $1182

Transfer payments $707 Foreign purchases of domestically produced goods $217 Domestic purchases of foreign goods $129

What was this country’s inflation rate?

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4 | Page Refer to Table 2. What were Crete’s government purchases in 2014?  a. $1837 b. $1130 c. $2544 d. $1601 24. GDP is not a perfect measure of well-being; for example, a. GDP places too much emphasis on the value of leisure. b. GDP incorporates a large number of non-market goods and services that are of little value to  society. c. GDP fails to account for the quality of the environment. d. All of the above are correct. 25. The CPI differs from the GDP deflator in that a. the CPI is a price index, while the GDP deflator is an inflation index. b. increases in the prices of domestically produced goods that are sold to the U.S. government show   up in the CPI but not in the GDP deflator. c. substitution bias is not a problem with the CPI, but it is a problem with the GDP deflator. d. increases in the prices of foreign produced goods that are sold to U.S. consumers show up in the   CPI but not in the GDP deflator.5 | Page ECON 2301 – Macroeconomics Principles Practice Questions - Midterm 2  ANSWERS MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the  question. 1. For the purpose of calculating GDP, investment is spending on a. stocks, bonds, and other financial assets. b. real estate and financial assets such as stocks and bonds. c. capital equipment, inventories, and structures, including household purchases of new   housing. d. capital equipment, inventories, and structures, excluding household purchases of new housing. 2. In the economy of Macroland in 2010, consumption was $900, GDP was $2000, government purchases   were $550, and investment was $750. What were Macroland’s net exports in 2010? a. $200 b. -$200 c. $1800 d. Net exports cannot be calculated from the information given. ANSWER: Y = C + I + G + NX  2000 = 900 + 750 + 550 + NX  NX = -200 3. If the CPI was 90 in 1975 and is 225 today, then $100 today purchases the same amount of goods and   services as a. $25.00 purchased in 1975. b. $135.55 purchased in 1975. c. $33.33 purchased in 1975. d. $40.00 purchased in 1975. ANSWER: ⎛ ⎞ ( )CPI in year 1975 Equivalent $ Amount in year 1975 $ AmountCPI today xtoday = ⎜ ⎟ ⎝ ⎠ 90  $100225 = x  $40 = 4. Transfer payments a. are payments that flow from government to households. b. are not made in exchange for currently produced goods or services. c. alter household income, but they do not reflect the economy’s production. d. All of the above are correct.5. A firm has an agreement with its workers to index their wages using the CPI. The firm currently pays its   production line workers $8.00 an hour and is scheduled to index their wages today. If the CPI is currently   160 and was 128 a year ago, the firm should increase the hourly wages of its workers by a. $2.56. b. $2.00. c. $0.25. d. $1.60. ANSWER: New Wage = $8 x 160 / 128  = $10  Wage should increase by $10 -$8 = $2  6. The steps involved in calculating the consumer price index and the inflation rate, in order, are as follows:  a. Fix the basket, find the prices, compute the inflation rate, compute the basket’s cost, and   choose a base year and compute the index. b. Fix the basket, find the prices, compute the basket's cost, choose a base year and compute   the index, and compute the inflation rate. c. Choose a base year, fix the basket, find the prices, compute the inflation rate, compute the   basket's cost, and compute the index. d. Choose a base year, update the basket, find the prices, compute the index, estimate the basket’s   cost, and compute the inflation rate. 7. If one wants to know how the material well-being of the average person has changed over time in a given   country, one should look at the a. level of real GDP. b. growth rate of nominal GDP. c. growth rate of real GDP. d. growth rate of real GDP per person. 8. Two alternative measures of the overall level of prices are a. the inflation rate and the consumer price index. b. the inflation rate and the GDP deflator. c. the GDP deflator and the consumer price index. d. the cost of living index and nominal GDP. 9. A country’s real GDP rose from 500 to 550 while its nominal GDP rose from 600 to 770. What was this   country’s inflation rate? a. 16.7% b. 20% c. -14.3% d. -20%2 | P a g e ANSWER: GDP deflator = 100 x Nominal GDP / Real GDP  GDP deflator (Past) = 100 x 600 / 500 = 120  GDP deflator (New) = 100 x 770 / 550 = 140 Inflation rate = % change in GDP deflator    = (140 - 120) /120 x 100%     = 16.7%   10. If the consumer price index was 88 in 2009, 95 in 2010, and 100 in 2011, then the base year must be a. 2009. b. 2010. c. 2011. d. The base year cannot be determined from the given information. ANSWER: CPI = 100 in base year 11. Which of the following is not correct? a. The consumer price index gives economists a way of turning dollar figures into meaningful  measures of purchasing power. b. The consumer price index is used to monitor changes in the cost of living over time. c. The consumer price index is used by economists to measure the inflation rate. d. The consumer price index is used to measure the quantity of goods and services that the   economy is producing. 12. Suppose that the prices of dairy products have risen relatively less than prices in general over the last   several years. To which problem in the construction of the CPI is this situation most relevant? a. unmeasured quality change b. substitution bias c. income bias d. introduction of new goods 13. The consumer price index was 225 in 2006 and 234 in 2007. The nominal interest rate during this period   was 6.5 percent. What was the real interest rate during this period? a. 4.0 percent b. 10.5 percent c. 6.76 percent d. 2.5 percent3 | P a g e ANSWER: Inflation rate = % change in CPI  = (234 - 225)/225 x 100%    = 4% Real interest rate = Nominal Interest rate - Inflation rate  = 6.5% - 4% = 2.5% 14. Other things equal, relatively poor countries tend to grow a. slower than relatively rich countries; this is called the poverty trap. b. slower than relatively rich countries; this is called the fall-behind effect. c. faster than relatively rich countries; this is called the catch-up effect. d. faster than relatively rich countries; this is called the constant-returns-to-scale effect. 15. A farmer sells $50,000 of apples to individuals who take them home to eat and $75,000 of apples to a   company that uses them all to produce cider. How much of the farmer’s sales will be included as apples   in GDP? a. $0 b. $50,000 c. $75,000 d. $125,000 ANSWER:   GDP measures the value of final goods & services produced domestically in a given time period.  16. Workland has a population of 10,000, of whom 7,000 work 8 hours a day to produce $224,000 worth of   final goods. Laborland has a population of 5,000, of whom 4,000 work 12 hours a day to produce  $120,000 worth of final goods. a. Workland has lower productivity and lower real GDP per person than Laborland. b. Workland has lower productivity but higher real GDP per person than Laborland. c. Workland has higher productivity and higher real GDP per person than Laborland. d. Workland has higher productivity but lower real GDP per person than Laborland.4 | P a g e ANSWER: = = = productivityL x Y Workland 7,000 8 224,000 4 Workland = = = Workland productivityL x Y Laborland Laborland Laborland 4,000 12 120,000 2.5 Real GDP per PersonPopulation = = =   ( ) Y Workland 224,000 22.4 Real GDP per P Workland = = = 10,000 Workland Y ( )120,000 24 ersonPopulation Laborland Laborland Laborland 5,000 17. The table below pertains to Napandsnack, an economy in which the typical consumer’s basket consists of   2 pillows and 15 hotdogs. Table 1 Year Price of a Pillow Price of a Hotdog Cost of CPI basket 2009 $40 $3 $40 x 2 + $3 x 15 = $125 2010 $45 $4 $45 x 2 + $4 x 15 = $150 2011 $50 $3 $50 x 2 + $3 x 15 = $145

What was the real interest rate during this period?

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Refer to Table 1. If the base year is 2010, then the economy’s inflation rate in 2010 was  a. 20.0 percent. b. 25.00 percent. c. 10.5 percent. d. 15.0 percent. ANSWER:  CPI2009 = 100 x 125/150 = 83.33    CPI2010 = 100 (base year) Inflation rate in 2010 = % change in CPI between 2009 and 2010    = (100 - 83.33) / 83.33 x 100%    = 20%5 | P a g e 18. Transactions involving items produced in the past, such as the sale of a 5-year-old automobile by a used   car dealership or the purchase of an antique rocking chair by a person at a yard sale, are a. included in current GDP because GDP measures the value of all goods and services sold in the   current year. b. included in current GDP but valued at their original prices. c. not included in current GDP because it is difficult to determine their value. d. not included in current GDP because GDP only measures the value of goods and services   produced in the current year. 19. Consider a small economy in which consumers buy only two goods: pretzels and cookies. In order to   compute the consumer price index for this economy for two or more consecutive years, we assume that a. the percentage change in the price of pretzels is equal to the percentage change in the price of   cookies from year to year. b. neither the number of pretzels nor the number of cookies bought by the typical consumer   changes from year to year. c. neither the price of pretzels nor the price of cookies changes from year to year. d. the number of pretzels bought by the typical consumer is equal to the number of cookies bought by   the typical consumer in each year. 20. If an economy’s GDP falls, then it must be the case that the economy’s a. income falls and expenditure remains the same. b. income falls and expenditure rises. c. income and expenditure both fall. d. income and saving both fall. 21. When looking at a graph of nominal and real interest rates you notice that nominal rates always lie above   real rates. From this you conclude a. GDP was always increasing for the time frame represented on the graph. b. consumer prices were always rising in the time frame represented on the graph. c. the economy never experienced a recession in the time frame represented on the graph. d. there were serious episodes of deflation in the time frame represented on the graph. ANSWER:     “nominal interest rates > real interest rates” implies “inflation rate > 0”,  where inflation rate = % change in CPI   22. When economists talk about growth in the economy, they measure that growth as the a. absolute change in real GDP from one period to another. b. absolute change in nominal GDP from one period to another. c. percentage change in real GDP from one period to another. d. percentage change in nominal GDP from one period to another.6 | P a g e 23. The table below contains data for the country of Crete for the year 2014. Table 2 Total income $5731 Household purchases of durable goods $1108 Household purchases of nondurable goods $702 Household purchases of non-education services $203 Household purchases of education services $302 Household purchases of new housing $816 Purchases of capital equipment $333 Inventory changes $75 Purchases of new structures $267 Local government spending on goods and services $236 State government spending on goods and services $419 Federal government spending on goods and services $1182

Transfer payments $707 Foreign purchases of domestically produced goods $217 Domestic purchases of foreign goods $129

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Refer to Table 2. What were Crete’s government purchases in 2014?  a. $1837 b. $1130 c. $2544 d. $1601 24. GDP is not a perfect measure of well-being; for example, a. GDP places too much emphasis on the value of leisure. b. GDP incorporates a large number of non-market goods and services that are of little value to  society. c. GDP fails to account for the quality of the environment. d. All of the above are correct. 25. The CPI differs from the GDP deflator in that a. the CPI is a price index, while the GDP deflator is an inflation index. b. increases in the prices of domestically produced goods that are sold to the U.S. government show   up in the CPI but not in the GDP deflator. c. substitution bias is not a problem with the CPI, but it is a problem with the GDP deflator. d. increases in the prices of foreign produced goods that are sold to U.S. consumers show up in   the CPI but not in the GDP deflator.7 | P a g e Econ 2301 – Macroeconomics Principles Midterm 2 Review • Midterm 2 will be held on Wednesday, March 30th during regular  class time. • Arrive 5 minutes early. • 25 multiple-choice questions from Chapters 23, 24, and 25. • You can bring a cheat sheet (one page, double-sided OK, typed or  handwritten). • Bring a pencil & an eraser & a scantron (# 882-E). • Bring a calculator. • See pp. 2-5 for the midterm review and sample questions in  Blackboard.Chapter 23 – Measuring a Nation’s Income • Gross Domestic Product (GDP): The market value of all final goods & services produced  within a country in a given period of time. • According to the Circular-Flow Diagram, income must equal expenditure for an economy as a  whole. • Y = C + I + G + NX,  where  Y: GDP,  C: Consumption expenditures include spending by domestic households on durable goods,  nondurable goods, and services except purchases of new housing I: Investment expenditures include 1) spending by firms on capital equipment (e.g., machines, tools), structures (factories,  office buildings),  2) inventories (goods produced but not yet sold) 3) household purchases of new housing G: Government expenditures (excluding Transfer Payments) NX: Net Exports = Exports – Imports • Nominal GDP: value of GDP at current prices • Real GDP: value of GDP at base year prices • Growth rate of real output = % change in Real GDP  = Real GDPfinal year – Real GDP ( initial year ) Real GDPinitial yearx 100%   • For the base year, Nominal GDP = Real GDP • GDP deflator = 100 x Nominal GDP / Real GDP • For the base year, GDP deflator = 100.  • Inflation Rate  = % change in GDP deflator  = GDP Deflatorfinal year – GDP Deflator ( initial year ) GDP Deflatorinitial year x 100%2 Chapter 24 – Measuring the Cost of Living • Consumer Price Index (CPI) in year i  = 100 x Cost of CPI basket in year i / Cost of CPI basket in base year • Cost of CPI basket in year i  = Sum of (Price in year i x Quantity) for all items in CPI basket  • Inflation Rate = % change in CPI   = CPIfinal year – CPI ( initial year ) CPIinitial year x 100% • For the base year, CPI = 100.  • Problems with CPI: 1) Substitution bias 2) CPI excludes new goods & services since it uses a fixed basket. 3) Unmeasured quality change • Differences between GDP deflator and CPI: 1) Imports are included in CPI (excluded from GDP deflator) 2) Capital goods are included in GDP deflator (excluded from CPI) 3) CPI uses a fixed basket (GDP uses current production) • Measuring dollar values (purchasing value of dollars) from different years ⎛ ⎞ = ⎜ ⎟ ⎝ ⎠ ( ) CPI in year Equivalent $ Amount in year $ Amount in year CPI in yeara a bxb • Measuring dollar values (purchasing value of dollars) across different cities in a given year ⎛ ⎞ = ⎜ ⎟ ⎝ ⎠ ( ) CPI in city Equivalent $ Amount in city $ Amount in city CPI in citya a bxb • Indexation: A dollar amount (wages, social security payments, income tax brackets, etc.) is  indexed for inflation if it is automatically corrected for inflation by law or in a contract. • Nominal Interest Rate measures % change in dollar value (unadjusted for inflation) • Real Interest Rate measures % change in purchasing power of a dollar amount • Real Interest Rate = Nominal Interest Rate – Inflation Rate Real Interest Rate < Nominal Interest Rate if Inflation Rate > 0 Real Interest Rate > Nominal Interest Rate if Inflation Rate < 0 (which is called Deflation) Real Interest Rate = Nominal Interest Rate if Inflation Rate = 0 Real Interest Rate < 0 if Nominal Interest Rate < Inflation Rate3 Chapter 25 – Production and Growth • Real GDP per Person = Real GDP / Population • A nation's standard of living is best measured by its real GDP per Person • A nation’s economic progress is best measured by the Growth Rate of Real GDP per Person • Growth Rate of Real GDP per Person   = % change in Real GDP per person   = Real GDP per Personfinal year – Real GDP per Person ( initial year ) Real GDP per Personinitial yearx 100% • Productivity: quantity of goods and services produced per unit of labor input (an hour of labor). • Productivity = Y/L where Y: real GDP and L: amount of labor input (total hours worked) • The relationship between economy-wide inputs and output is given by Y A x F L,K,H,N = ( ), where F(.) is production function, K: physical capital stock, H: human capital stock, N: natural  resources, A: technological knowledge. • Assuming ‘constant returns to scale’ we can multiply all inputs by 1/L and obtain Y KHN A x F 1, , , L LLL ⎛ ⎞ = ⎜ ⎟ ⎝ ⎠ This implies that a nation’s productivity (Y/L) is positively correlated with physical capital per  worker (K/L), human capital per worker (H/L), natural resources per worker (N/L), and  technological knowledge (A). • Government policies to boost productivity: Encourage saving and investment to raise K/L Encourage investment from abroad (through Foreign Direct Investment and/or Foreign  Portfolio Investment) to raise K/L Control population growth to increase K/L Provide public education/health services to raise H/L Provide patent laws, grants, R&D funds to increase A • Diminishing Returns to Capital: As more K is used in production while holding L, H, N, A constant, extra output from an additional unit of K decreases. • The slope of the productivity function (Y/L) gets flatter as more K/L is used in production.4 • Catch-up (Convergence) Effect: Due to diminishing returns to capital, poor countries (that start  with low K/L) tend to grow faster than rich ones (that start with high K/L).5

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