ECO 2040 Exam 2

Suppose real GDP growth is expected to be 3% per year and the velocity of money is expected to remain constant. To achieve zero inflation, the growth rate of the money supply should be:

3%. For this question, use the "Quantity Equation" given in class: money growth + velocity growth = inflation + real GDP growth. With velocity growth equal to zero and real GDP growth equal to 3% (as given in the question), the quantity equation will be: money growth + 0% = inflation + 3%. In order for inflation to be zero, money growth will have to be 3%, so that the equation will be: 3% + 0% = 0% + 3%. Thus, the answer is money growth equal to 3%.

The Federal Open Market Committee (FOMC) is made up of:

5 of the 12 presidents of the regional Federal Reserve Banks and the 7 members of the Board of Governors.

If the reserve ratio (rr) is currently 20% in a banking system with a required reserve ratio (rrr) of 10%, then the money multiplier is currently:

5. The money multiplier is 1/rr = 1/0.2 = 5. Note that it is the actual reserve ratio (rr) within the banking system that is used to calculate the money multiplier, not the required reserve ratio (rrr).

China's economy has grown at about 10% per year, on average, in recent years. If China's growth continues at this rate, about how long will it take for China to double its living standard?

7 years According to the "rule of 70", 70/10 = 7 years to double living standards.

Which of the following strategies should the Fed use to accomplish a decrease in the Fed Funds Rate?

A decrease in the discount rate In general, to decrease the Fed Funds Rate the Fed would need to increase the money supply. The only choice that results in an increase in the money supply is a decrease in the discount rate. All other choice would decrease the money supply.

How much can a commercial bank legally loan out?

An amount equal to its excess reserves. Commercial banks are legally required to hold a certain amount of reserves which are called "required reserves." Any reserves a bank has in excess of its required reserves, called "excess reserves," are available for loans.

Thinking about the growth process from its ultimate to its immediate causes, where would "investment, education, and R&D" appear in this process?

Between "incentives" and the "factors of production". Investment, education, and R&D are the activities that create the factors of production, so they would appear between incentives and the factors of production.

Which of the following is a "factor of production" that is important in determining an economy's living standard?

Human capital, Physical capital, Technology

Which of the following best describes what economists mean by the "institutions" of an economy?

Institutions refer to both the formal and informal rules and customs of a society that affect the incentives for firms and individuals to behave in a productive manner.

Which of the following is an important "institution" for promoting economic growth in a country?

Private property rights, Political stability, An efficient and dependable legal system, Honest government

Which of the following would NOT be included in the M1 money supply?

Savings deposits M1 includes currency (paper money and coins), checking deposits, and traveler's checks.

A key reason South Korea has enjoyed far more economic progress than North Korea over the last 50 years is:

South Korea has institutions that are more conducive to growth than North Korea. North and South Korea started from the same point when the country was divided. South Korea's success and North Korea's failure is attributable to the different institutions they adopted following the division.

Most people in the world live in poverty today.

TRUE The only true statement is that most people in the world live in poverty today. This was discussed in class using the fact that 80% of the world's population lives below the world average income level of $9,133 (measured in 2000 dollars). This is also discussed in Figure 7.2 and discussed on p. 117 in the text.

Which of the following plays a role in determining the money supply in the economy?

The Fed, Commercial banks, The public. The Fed, the commercial banking system, and the public all play a role in determining the money supply.

According to the model of money demand and money supply, an increase in the money supply by the Fed will cause:

a decrease in the value of money, an increase in the price level, inflation.

In a 100% reserve banking system:

banks hold all of their customers' deposits in reserves. In a 100% reserve banking system, banks hold all of their customers' deposits in reserves, which means no loans are made by banks.

To increase the money supply, the Fed could:

decrease the discount rate. Selling bonds and increasing the reserve requirement would decrease the money supply. Decreasing the discount rate would increase bank borrowing from the Fed, thus increasing the monetary base and the money supply.

Which of the following is the best measure of how much living standards have improved in an economy over time?

growth in real GDP per capita Growth rates are the best measure of progress or improvement over time and real GDP per capita is the best measure of living standards.

China's economic growth in recent years is largely attributable to:

improved economic institutions. Adoption of more favorable institutions has improved economic incentives and allowed more growth in China. Population growth, communist rule, and an abundance of natural resources are generally not important in the growth process of any country.

If the Fed wishes to increase the money supply by $1 million and the money multiplier is 10, they would need to conduct:

open market purchases of $100,000. An increase in the money supply requires open market purchases, not sales. With a money multiplier of 10, it would only take $100,000 worth of open market purchases to increase the money supply by $1 million, since 10 x $100,000 = $1 million.

Which of the following moves by the Fed would increase the Federal Funds rate?

open market sales, an increase in the discount rate, an increase in the interest rate paid on bank reserves Any Fed action (that is, any of the Fed's three "tools") that decreases the money supply would increase the Fed Funds rate by decreasing the supply of Federal Funds (and also possibly increasing the demand for Federal Funds). All of the answers here would have this effect because they all ultimately decrease the money supply.

One way to promote growth and, in the long run, raise an economy's standard of living is to encourage

saving and investment. Saving and investment are necessary to build the factors of production that an economy needs for production now and in the long run. Consumption diverts resources away from this use. Population growth decreases growth in real GDP per capita and therefore living standards.

To decrease the money supply, the Fed could

sell government bonds, increase the discount rate, increase the reserve requirement.

The Federal Funds Rate is:

the interest rate on overnight loans between commercial banks.

Human capital is:

the knowledge and skills that workers acquire through education, training, and experience.

As the reserve ratio (rr) increases:

the money multiplier decreases, the amount of loans banks can make decreases, the amount of money generated by loans in the banking system decreases.

Physical capital is:

the stock of structures and equipment that workers use to produce goods and services.