Section A- Short Answer Questions - 60 Marks

1.(i) If there was no item in the economy widely accepted in return for goods and services, how would transactions be made? How efficient would such a system be? (1 Mark)

(ii) What is the difference between a medium of exchange and a store of value?

(1 Mark)

(iii) What is the difference between commodity money and fiat money?

(1 Mark)

(iv) Are credit cards money? (1 Mark)

(v) Under what circumstance can banks not influence the supply of money?

(1 Mark)

1b. If Coke sells for $1.20 Canadian and for .75 pounds in the U.K., determine what the exchange rate should be if purchasing power parity holds. (2.5 Marks)

1c. What are the two problems facing the Bank of Canada in trying to control the money supply precisely? (2.5 Marks)

2a If the chartered banks decide to maintain an average reserve ratio of zero, what would be the size of money multiplier? Explain why. (2 Marks)

2b Suppose that the Bank of Canada sells 100 million pounds sterling from its foreign exchange reserves, and that the exchange rate is $2.40 Canadian per pound sterling.

(i) Explain what happens to the Canadian money supply. (2 Marks)

(ii) Now suppose that the Bank of Canada does not want the money supply to change. What would it need to do to sterilize its foreign exchange market operation?

(3 Marks)

2c. (i) Paper currency is the most easily recognized form of money. How well does paper currency serve the functions of money if we have an inflation rate of

50-percent per year? (1.5 Marks)

(ii) Gold is also recognized as a form of money. How well does gold serve the functions of money if we have an inflation rate of 50-percent? (1.5 Marks)

3. Assume that the banking system has no excess reserves. The combined balance sheet of all chartered banks is (inmillion of dollars)

ASSETS	LIABILITIES
Reserves $15,000 Securities and loans $135,000	$150,000 Deposits
$150,000	$150,000

Suppose the general public purchase $500 million in government bonds and pay for them by drawing cheques on their chartered bank deposits.

(i) Calculate the (target) reserve requirement. (1 Mark)

(ii) What is the immediate effect on chartered bank reserves and deposits? Provide the balance sheet. (3 Marks)

What is the ultimate effect on chartered bank reserves, deposits, and loans? Provide the final balance sheet. (6 Marks)

4a. It is often suggested that the Bank of Canada try to reduce the inflation rate to zero. If we assume that velocity is constant, does this zero-inflation goal require that the rate of money growth equal zero? If yes, explain why. If no, explain what the rate of money growth should equal. (2 Marks)

4b. Explain whether the following statements are true, false, or uncertain.

(6 Marks - 2 marks each).

(i) "Inflation hurts borrowers and helps lenders, because borrowers must pay a higher rate of interest.

(ii) "If prices change in a way that leaves the overall price level unchanged, then no one is made better or worse off."

(iii) "Inflation does not reduce the purchasing power of most workers."

4c. If there was a decline in price over time (deflation), why would this be a concern to workers, consumers, and retailers? (2 Marks)

5a. Explain the difference between the real exchange rate and the nominal exchange rate. (2 Marks)

5b. If a Japanese car costs 500 000 yen, if a similar Canadian- produced car costs $10,000, and if a dollar can buy 100 yen, what are the nominal and real exchange rates? (4 Marks)

5c. Explain the relationship among saving, investment, and net foreign investment.

What is happening to Canada's real exchange rate in each of the following situations? Explain. (4 Marks - 1 mark each)

(i) The Canadian nominal exchange rate is unchanged, but prices rise faster in Canada than abroad.

(ii) The Canadian nominal exchange rate is unchanged, but prices rise faster abroad than in Canada.

(iii) The Canadian nominal exchange rate declines and prices are unchanged in Canada and abroad.

(iv) The Canadian nominal exchange rate declines and prices rise faster abroad than in Canada.

6a. How would a fall in U.S. interest rates affect Canadian investment, saving, net foreign investment, and the Canadian real exchange rate? (5 Marks)

6b. The federal government has made significant efforts to turn the federal deficit into a surplus over the last few years. Explain how this is likely to impact on domestic investment, private saving, the trade balance, and net foreign investment for Canada. (5 Marks)

Section B - 40 Multiple Choice Questions - 40 marks

1. Negative net exports signal that

A. the country sells more goods abroad than it buys from other countries.

B. the country buys more goods from other countries than it sells to other countries.

C. the country has a closed economy.

D. the country's tariffs are too high.

2. Arnie is the owner of a firm that produces bottled water in British Columbia. There are many such firms in the area. Arnie decides that if he pays his workers a wage higher than the going market wage, his profits will increase. Which of the following is a likely explanation for his decision?

A. The higher the wage, the more he can charge for his water.

B. The higher the wage, the less often his workers will choose to leave his firm.

C. The higher the wage, the lower will be the cost of obtaining needed supplies.

D. All of the above are likely explanations for Arnie's decision.

3. If today the economy produces a large quantity of new capital goods, then

A. tomorrow it will have a smaller stock of capital and not be able to produce as many goods and services as today.

B. tomorrow it will have a larger stock of capital and be able to produce more of all types of goods and services.

C. natural resources will be completely depleted faster.

D. future productivity will be reduced.

4. In a small open economy with perfect capital mobility, if the Bank of Canada chooses to fix the value of the Canadian dollar, aggregate demand could be increased by

A. increasing government expenditures.

B. decreasing tax rates.

C. increasing the money supply.

D. All of the above are correct.

E. Only a and b are correct.

As the price level increases, the value of money __________ and the demand for money __________.

A. increases, increases

B. increases, decreases

C. decreases, decreases

D. decreases, increases

The real exchange rate is

A. the nominal price of domestic goods.

B. the absolute price of foreign goods.

C. the relative price of domestic and foreign goods.

D. none of the above.

The Bank of Canada's most important job is to

A. regulate banks.

B. control the supply of money.

C. act as a lender of last resort.

D. print currency.

Some frictional unemployment is inevitable because

A. of government labour market policies.

B. unions push the wage above its equilibrium value.

C. in a well-functioning economy, some firms are expanding while others are contracting.

D. All of the above are reasons why frictional unemployment exists.

In an open economy,

A. Saving = Foreign Saving + Net Foreign Investment.

B. Saving = Domestic Saving + Foreign Saving.

C. Saving = Domestic Investment + Net Foreign Investment.

D. Saving = Domestic Saving + Net Foreign Investment.

According to the theory of efficiency wages,

A. firms may choose to pay a wage above the competitive equilibrium level to reduce worker turnover.

B. firms will pay a higher wage to impose a cost on shirking.

C. firms will pay a high wage to provide an incentive to work hard.

D. All of the above are true.

Which of the following equations represents national saving in a closed economy?

A. Y - I - G

B. Y - I - C

C. G + C - Y

D. Y - C - G

Canada_40_160
Japan_50_150

Net foreign investment refers to

A. the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreign residents.

B. the purchase of domestic assets by domestic residents minus the purchase of foreign assets by foreign residents.

C. investment plus saving.

D. none of the above.

Suppose the banking system has $10 million in reserves, the reserve requirement is 20 percent, and there are no excess reserves. The public holds $10 million in cash. Then bankers decide that it is prudent to hold some excess reserves, and so begin to hold 25 percent of deposits in the form of reserves. Other things the same, what will this action cause the money supply to do?

A. to change forms, but not size

B. to fall by $10 million

C. to fall by $5 million

D. to fall by $0.5 million

Firms worry about worker turnover because

A. it is costly to hire and train new workers.

B. newly trained workers are not as productive as experienced workers.

C. firms with higher worker turnover tend to have higher production costs.

D. a and b are correct

E. a, b, and c are correct

The theory of efficiency wages explains

A. why firms must pay workers more than the competitive equilibrium level.

B. how a wage above the competitive equilibrium level may reduce costs of production.

C. how a wage below the competitive equilibrium level may reduce the costs of production.

D. None of the above are correct.

All of the following are functions of money except

A. medium of exchange.

B. unit of account.

C. a transfer payment.

D. store of value.

The value of money

A. increases when prices rise.

B. increases when the price of bonds falls.

C. increases when prices fall.

D. decreases when prices fall.

The process of taking advantage of different prices for a good in different markets is called

A. comparative advantage.

B. capitalism.

C. arbitrage.

D. the law of one price.

An open-market operation is where the Bank of Canada

A. issues new currency.

B. buys government bonds from the public.

C. sells government bonds to the public.

D. Both b and c are open market operations.

If the Bank of Canada buys 100 million in the foreign exchange market for $150 million Canadian, the Canadian money supply will

A. increase by $150 million.

B. decrease by $150 million.

C. be unaffected by this transaction.

D. decrease by the same amount the money supply in the UK increases.

"Sterilization" is a process by which the Bank of Canada

A. prevents foreign exchange market operations from taking place.

B. causes the money supply to increase.

C. offsets the effects of foreign exchange market operations with open-market operations.

D. causes the money supply to decrease.

Under a fractional reserve banking system, banks

A. hold only a fraction of their deposits as reserves.

B. generally lend out a majority of their deposits.

C. can create money by lending out reserves.

D. All of the above are correct.

The Bank of Canada can increase the price level by

A. conducting open-market sales.

B. conducting open-market purchases.

C. decreasing the bank rate.

D. increasing the bank rate.

E. b and c

If $500 is deposited into the First Bank of Oz, (see table below)

A. the bank will be able to make additional loans totalling $425.

B. excess reserves initially increase by $75.

C. required reserves increase by $75.

D. total reserves initially increase by $425.

First bank of Oz
Assets	Liabilities
Required Reserves $15.00	Deposits $100
Loans $85.00

If the reserve requirement is 25 percent, this bank (see table below)

A. can create money by making a new loan.

B. is holding no excess reserves.

C. cannot make a new loan.

D. Both b and c are correct.

Last Bank of Springfield
Assets	Liabilities
Required Reserves $250	Deposits $1000
Loans $750

If P is the price level,

A. P measures the number of dollars needed to buy a basket of goods and services.

B. 1/P measures the quantity of goods and services that can be bought with $1.

C. 1/P measures the number of dollars needed to buy a basket of goods and services.

D. both a and b are correct

The most important variable affecting the demand for money in the long run is

A. the nominal interest rate.

B. the real interest rate.

C. the price level.

D. the velocity of money.

According to the Fisher effect, an increase in the rate of inflation from 3 percent to 6 percent will __________ the __________ interest rate by __________ percentage points.

A. increase, nominal, 3

B. increase, real, 3

C. decrease, nominal, 3

D. increase, nominal, less than 3

If the exchange rate is 110 yen = $1, a radio that costs 2750 yen in Japan will cost

A. $20 in Canada.

B. $25 in Canada.

C. $22 in Canada.

D. $27 in Canada.

If the reserve ratio is 20 percent, and banks do not hold excess reserves, when the Bank of Canada sells $100,000 of government securities to the public, bank reserves will _____ and the money supply will _____:

A. increase by $100,000, increase by $500,000

B. increase by $100,000, increase by $2000,000

C. decrease by $100,000, decrease by $2,000,000

D. decrease by $100,000, decrease by $500,000

Use the following information to answer questions 31-32.

At point C,

A. the money supply is greater than money demand.

B. the value of money is greater than its equilibrium level.

C. the price level is lower than its equilibrium level.

D. money demand is greater than the money supply.

A shift in the money supply curve from MS2to MS1will cause a(n) __________ in the equilibrium price level, a(n) __________ in the equilibrium value of money, and an immediate excess of __________ of size CD for money.

A. increase, increase, supply

B. decrease, increase, demand

C. increase, decrease, supply

D. decrease, decrease, demand

Which of the following is correct?

A. Economic variables measured in physical units are real variables, and economic variables measured in monetary units are nominal variables.

B. Economic variables measured in physical units are nominal variables, and economic variables measured in monetary units are real variables.

C. Economic variables measured in physical units are actual variables, and economic variables measured in monetary units are nominal variables.

D. Economic variables measured in physical units are real variables, and economic variables measured in monetary units are actual variables.

According to the quantity equation, if M increases and V and P are constant,

A. Y will remain constant.

B. Y will decrease.

C. Y will decrease by the same percentage change in M.

D. Y will increase by the same percentage change in M.

Printing money to finance government expenditures

A. imposes a tax on every person in the economy.

B. is an inexpensive way to finance government.

C. imposes a tax on everyone who holds money.

D. is the principal method by which the Canadian government finances its expenditures.

Net foreign investment refers to

A. the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreign residents.

B. the purchase of domestic assets by domestic residents minus the purchase of foreign assets by foreign residents.

C. investment plus saving.

D. none of the above.

If the nominal exchange rate is e, the domestic price is P, and the foreign price is P*, the real exchange rate is defined as

A. e(P/P*).

B. e(P*/P).

C. e + P/P.

D. e - P/P*.

A depreciation of the dollar implies

A. Canadian consumers will buy more domestic goods and fewer foreign goods.

B. Canadian consumers will buy fewer domestic goods and more foreign goods.

C. Canadian consumers will buy more domestic goods and more foreign goods.

D. Canadian consumers will buy fewer domestic goods and fewer foreign goods.

According to the purchasing power parity theory,

A. a currency cannot have the same purchasing power in all countries.

B. a currency must always have less purchasing power in foreign countries.

C. a currency must always have the same real purchasing power in all countries.

D. a currency must always have more purchasing power in foreign countries.

Canada is said to be a 'small' open economy because

A. an increase in the domestic demand or supply of internationally traded goods has no effect on world prices.

B. Canada is just one member of the North American Free Trade Agreement (NAFTA).

C. Canada's GDP is small relative to U.S. GDP.

D. of recent cutbacks to federal government expenditures.