Econ 425 – First Midterm Exam

Review Multiple Choice / True/False Questions

Pedro Elosegui

1. What are the three approaches to calculating GDP?

a) Income, expenditure, and value added by sectors’ approaches.

b) Income, savings, and investment approaches.

c) Production, consumption, and trade approaches.

d) Expenditure, savings, and trade approaches.

2. Which of the following is NOT a main expenditure component of GDP?

a) Private consumption.

b) Government spending.

c) Net exports.

d) Financial savings.

3. Indicate what is the difference between GDP and Net National Income (NNI)?

a) GDP includes income from abroad, while NNI does not.

b) NNI includes income from abroad, while GDP does not.

c) GDP measures production, while NNI measures consumption.

d) NNI measures production, while GDP measures consumption.

4. What does the Fisher Equation describe?

a) The relationship between nominal and real interest rates.

b) The relationship between GDP and NNI.

c) The relationship between consumption and savings.

d) The relationship between investment and capital.

5. What is the effect of perfect foresight on the Fisher Equation?

a) It eliminates the need for real interest rates.

b) It ensures that nominal and real interest rates are equal.

c) It makes the Fisher Equation irrelevant.

d) It simplifies the calculation of inflation expectations.

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6. What is the main component of aggregate expenditure modeled through a representative household
model?

a) Investment.

b) Private consumption.

c) Government spending.

d) Net exports.

7. What is the budget constraint for a representative household?

a) Consumption (uses) equals income minus savings (sources).

b) Consumption plus savings (uses) equals income (sources).

c) Consumption equals income plus savings (uses).

d) Consumption minus savings equals income (sources).

8. What is the net financial savings of a representative household?

a) Income minus consumption.

b) Income minus taxes.

c) Income minus investment.

d) Income minus government spending.

9. What is the relationship between nominal and real interest rates for an agent to be indifferent
between them?

a) Nominal interest rate equals real interest rate plus inflation.

b) Real interest rate equals nominal interest rate plus inflation.

c) Nominal interest rate equals real interest rate minus inflation.

d) Real interest rate equals nominal interest rate minus inflation.

10. What is the intertemporal budget constraint at period 2 for an agent living up to period 3?

a) Consumption in period 2 equals income in period 2.

b) Consumption in period 2 can be greater than income in period 2 if savings from period 1 are used.

c) Consumption in period 2 must be less than income in period 2.

d) Consumption in period 2 is independent of income in period 2.

11. What is the maximum amount of consumption for a household at period 1 if consumers only value
present consumption?

a) Income in period 1.

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 b) Income in period 1 plus savings from period 0.

c) Income in period 1 minus savings for period 2.

d) Income in period 1 plus income in period 2.

12. What happens to future consumption if a Ricardian household has an impatience rate above the real
interest rate?

a) Future consumption increases.

b) Future consumption decreases.

c) Future consumption remains unchanged.

d) Future consumption becomes zero.

13. What is the impact of a permanent increase in income on consumption compared to a transitory
increase?

a) Higher impact.

b) Lower impact.

c) Same impact.

d) No impact.

14. What is the effect of an increase in the real interest rate on Ricardian household consumption?

a) Increases consumption.

b) Decreases consumption.

c) No effect on consumption.

d) Makes consumption zero.

15. What happens to the debt constraint if the maximum amount of debt (D) increases?

a) The constraint becomes tighter.

b) The constraint becomes looser.

c) The constraint remains unchanged.

d) The constraint becomes irrelevant.

16. What is the optimal solution for a Keynesian household?

a) Maximize utility subject to the budget constraint.

b) Minimize consumption subject to the budget constraint.

c) Maximize savings subject to the budget constraint.

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 d) Minimize utility subject to the budget constraint.

17. What is the effect of an increase in the real interest rate on Keynesian households?

a) Increases consumption.

b) Decreases consumption.

c) No effect on consumption.

d) Makes consumption zero.

18. What is the definition of capital in the context of investment?

a) The stock of financial assets.

b) The stock of physical assets used in production.

c) The stock of human capital.

d) The stock of natural resources.

19. What is the relationship between the marginal productivity of labor and capital stock?

a) Independent.

b) Positively related.

c) Negatively related.

d) No relationship.

20. Why does Yt+1 depend on Kt?

a) Because capital accumulation affects future production.

b) Because labor productivity affects future production.

c) Because technology affects future production.

d) Because savings affect future production.

21. What is the profit maximization problem for a firm?

a) Maximize revenue minus costs.

b) Minimize costs subject to production constraints.

c) Maximize utility subject to budget constraints.

d) Minimize revenue minus costs.

22. What is the impact of an increase in the real exchange rate on domestic consumption of imported
goods?

a) Increases consumption.

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 b) Decreases consumption.

c) No effect on consumption.

d) Makes consumption zero.

23. What is the impact of a nominal exchange rate depreciation on net exports?

a) Increases net exports.

b) Decreases net exports.

c) No effect on net exports.

d) Makes net exports zero.

24. What is the implication of the Uncovered Interest Parity (UIP) for a foreign investor willing to invest in
the US?

a) The investor can earn risk-free profits.

b) The investor cannot earn risk-free profits.

c) The investor can earn profits only if the UIP is violated.

d) The investor can earn profits only if the UIP holds.

25. What is the effect of a domestic interest rate below the international interest rate on the real
exchange rate?

a) Positively affects net exports.

b) Negatively affects net exports.

c) No effect on net exports.

d) Makes net exports zero.

RBC Model

1. What are business cycles?

a) Long-term trends in economic growth and the covariance of the main non GDP variables.

b) Recurring fluctuations in real GDP over time and the covariance of the main macro variables.

c) Changes in inflation rates over time and the covariance of the main macro variables.

d) Government policies to stabilize the economy.

2. **Which of the following is an example of a technology shock?

a) A hurricane destroying crops.

b) A new invention increasing factory productivity.

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 c) The central bank is raising interest rates.

d) A change in consumer preferences for fashion.

3. What is the primary cause of business cycles in the RBC model?

a) Sticky prices and wages.

b) Financial frictions and bank failures.

c) Productivity shocks.

d) Government policy changes.

4. Which of the following is a propagation mechanism?

a) A sudden increase in money supply.

b) Intertemporal substitution of consumption.

c) A natural disaster destroying infrastructure.

d) A change in consumer tastes.

5. What happens in the RBC model when a positive technology shock occurs (remember it affects the
production function?

a) Output, wages, and investment decrease.

b) Output, wages, and investment increase.

c) Only consumption increases, while investment falls.

d) Prices become sticky, leading to unemployment.

8. In the RBC model seen in class, how much of their income do young consumers save? That depends
on….

a) One-third and depends on the production function.

b) Half and depends on the production function.

c) Two-thirds and depends on the production function.

d) Half and depends on the utility function.

10. Why is investment more volatile than consumption in response to shocks?

a) Consumers prefer to save rather than spend during shocks.

b) Investment decisions are more sensitive to changes in productivity and returns.

c) Government policies stabilize consumption but not investment.

d) Consumption is less affected by intertemporal substitution.

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11. A business cycle model is intended to model the evolution of the business cycle of GDP over time.
Which of the following are the two basic ingredients that such a model must include?

a) A maximizing utility household and an intertemporal budget constraint.

b) An optimizing firm deciding how much to produce in every period without any uncertainty.

c) An optimizing firm deciding how much to produce in every period with uncertainty about a possible
shock affecting productivity.

d) Both (a) and (b).

e) Both (a) and (c).

12. A result of a sound business cycle model would imply that:

a) Consumption overreacts to the shock, and investment is smoothed through the business cycle.

b) Consumption is smoothed after the shock (acting as a transmission mechanism).

c) Both consumption and investment are smoothed after the shock (acting as a transmission
mechanism).

d) Consumption is smooth, but investment usually overreacts to the GDP cycle.

13. The first-order condition of a household maximizing utility while optimally selecting intertemporal
consumption may be a key transmission mechanism for a business cycle model.

True/False

14. In a business cycle model (modeled as a deviation between actual and potential output), if there is
no uncertainty, what can we conclude about the economy's growth path?

a) The economy will experience fluctuations around the potential output due to random shocks.

b) The economy will grow smoothly at the potential (trend) output level.

c) The economy will grow faster than the potential output due to technological progress.

d) The economy will grow slower than the potential output due to inefficiencies.

15. The main difference between the representative agent model and the overlapping generations (OLG)
model is that:

a) In OLG, households have different utility functions.

b) In both cases, households may have the same utility function.

c) In both cases, households may have the same utility function, but OLG households overlap in at least
one generation.

d) The agents in both models live infinite periods.

16. What does the IS curve represent in the IS-LM model?

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 a) The relationship between money supply and interest rates.

b) The relationship between output and interest rates in the goods and services market equilibrium.

c) The relationship between output and money supply in equilibrium.

d) The relationship between inflation and output in equilibrium.

17. What does the LM curve represent in the IS-LM model?

a) The relationship between money supply and interest rates for the money demand.

b) The relationship between output and interest rates in the money market equilibrium.

c) The relationship between output and inflation in the money market.

d) The relationship between savings and investment in the goods and services market equilibrium.

18. What is the effect of an increase in money supply (dms >0) on output (y) in the IS-LM model?

a) Output increases.

b) Output decreases.

c) Output remains unchanged.

d) Output becomes zero.

19. What is the effect of an increase in money supply (dms >0) on the interest rate (i) in the IS-LM model?

a) Interest rate increases.

b) Interest rate decreases.

c) Interest rate remains unchanged.

d) Interest rate becomes zero.

20. How does an increase in money supply (dms >0) shift the LM curve?

a) The LM curve shifts upwards.

b) The LM curve shifts downwards.

c) The LM curve does not shift.

d) The LM curve becomes vertical.

21. What is the mathematical expression for the change in output (dy) due to a money-supply shock
(dms )?

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22. What is the mathematical expression for the change in the interest rate (di) due to a money-supply
shock (dms)?

23. In the IS-LM model, what happens to equilibrium output and interest rates when the LM curve shifts
downwards?

a) Output increases, and interest rates increase.

b) Output decreases, and interest rates decrease.

c) Output increases, and interest rates decrease.

d) Output decreases, and interest rates increase.

24. What is the role of the parameter (σ) in the IS curve equation?

a) It represents the sensitivity of investment to changes in the interest rate.

b) It represents the sensitivity of money demand to changes in output.

c) It represents the sensitivity of money demand to changes in the interest rate.

d) It represents the sensitivity of consumption to changes in income.

25. What is the role of the parameter (b) in the LM curve equation?

a) It represents the sensitivity of investment to changes in the interest rate.

b) It represents the sensitivity of money demand to changes in output.

c) It represents the sensitivity of money demand to changes in the interest rate.

d) It represents the sensitivity of consumption to changes in income.

26. The time t budget constraint for the Keynesian consumer is giving by

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Showing that:

a) Keynesian consumer is affected by financial constraints and consumption depends on present

27. The following equation shows:

a) There is a relationship between the domestic and foreign interest rate that always hold and is
covered.
b) There is a relationship between the domestic and foreign interest rate that is affected by the
expected depreciation rate between the domestic and foreign currency.
c) There is a relationship between the domestic and foreign interest rate that not always when
there is arbitrage.
d) There is a relationship between the domestic and foreign interest rate that is not use in
analyzing small open economic models.

28. From totally differentiation Aggregate demand we can get to the following relationship:

a) The first term indicates the MPC and reflects the Keynesian multiplier. True/False
b) The first term indicates the MPC and reflects the Keynesian multiplier that is negatively affected
by the fact that net exports are reduced when domestic output increases. True/False
c) The relationship allows us to write the implicit equation showing the negative relationship
between the aggregate demand and the real interest rate as well as the potential impact of the
exogenous variables. True/False
d) Log linearizing the equation above we can get the LM curve showing the equilibrium in the bond
market. True/False

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