ECON 102 REVIEW SESSION

SPRING 2015 MIDTERM 2 BY BENJI HUANG

HOW TO PASS GATEMAN’S EXAMS:

Assume nothing! If you have to assume, state your assumptions clearly. WHEN YOU READ THE QUESTION: Don’t panic. Take a deep breath. Start by defining the question. WHEN YOU ARE STUCK: Move on! The test is long. Prioritize strengths. HOW WOULD I KNOW? I got 100% in his course last year :)

Did I get perfect on every single question? No. Did I do better than most other people? You bet.

TABLE OF CONTENTS

Part 1 – Terms Part 2 – Chapter 24/25 Part 3 – Chapter 26 Part 4 – Chapter 27 Part 5 – Chapter 28/29

DON’T ASSUME

YOU’LL FAIL

PART 1 – TERMS (BOLDED WORDS IN THE GBOOK) Know them ALL. Here are a few to practise: Automatic stabilizer: Gross tuning: Human capital: Law of diminishing marginal returns:

Embodied technological change: Commercial bank: Bank run: Present value: Classical Dichotomy: Hysteresis: * the above definitions are taken from Macroeconomics, Thirteenth Canadian Edition by Ragan and Lipsey

PART 2 – CHAPTER 24/25 1) After learning about the adjustment process, Tony reasons that following an AD or AS shock, actual GDP will eventually return to its potential level. He wonders if GDP always returns back to the level it was at before, how can economic growth possibly occur? 2) Sally wants to know how the Philips Curve reflects the second asymmetry of the aggregate supply curve. Explain to Sally using a diagram showing the Philips Curve in its original form.

3) Peter was astonished to learn that even without government intervention, an economy in recession will fix itself back to its original state. Using the after-effect of a negative supply shock caused by an increase in oil prices to illustrate to Peter how he is only partially correct. Hint: why wouldn’t the economy be back to exactly the original state? 4) Wages are often slow to decrease following a negative supply shock. Without government intervention, what is another natural mechanism that might help to move GDP back to its potential level? 5) The housing market is heating up in the city where Tom lives. From what he learned in Econ 102 Tom expects that the government will implement a contractionary fiscal policy soon to counter the possibility of an inflationary gap. Assuming that the housing bubble is not expected to persist for too long, explain why it is not likely that the government would intervene.

6) Mary is very puzzled when the president advises the people to increase spending when the country is in a recession. Mary thinks that when the economy is down, it is best to save to protect against hard times to come. Explain to Mary why although saving might be a wise decision for one, it is not a wise decision for an entire country in recession. 7) Mary has understood your explanation above, but she becomes confused once again after reading a study showing how countries that embrace greater savings generate greater economic growth over time. Why does this study seem contradictory to what the president was trying to do to increase GDP during the recession? 8) Explain the basic idea behind the accounting for GDP growth using the three components of GDP that we learned in Econ 102 and illustrate how each of the three components affect GDP in the short run or long run.

PART 3 – CHAPTER 26 1) Tally is a staunch supporter of economic growth (her father is a successful banker and her mother is in the show business). Down the street from her lives Jack who completely disagrees with Tally. He thinks that economic growth has done nothing good to his life (both his parents are recently laid off after their employers bought new machines to automate the assembly line in response to increased product demand). What are the arguments that Tally and Jack would most likely use if they were to debate with each other about the pros/cons of economic growth? 2) Tally is deciding who to vote for in an upcoming presidential election. She has decided that long term economic growth is her first political priority. Explain to Tally using the long run model for interest rates what her ideal political candidate would advocate for?

3) Sam wants to know the different effects of (a) labour-force growth without capital accumulation, (b) capital accumulation without labour-force growth, and (c) simultaneous growth in both labour-force and capital on the material standard of living of an economy? 4) Betty keeps hearing Professor Gateman talking about “too many people.” Explain to Betty using the Solow model in the G-book why a decrease in population growth rate is favorable for increasing the material standard of living of a country.

PART 4 – CHAPTER 27 1) What is milling, and why was it once a wide-spread practice? Was it able to cure all problems that could lead to the debasement of a coin currency in the past? If no, explain why not. 2) Using examples from your daily life, illustrate the three functions of money. 3) What are the major roles performed by Bank of Canada? Explain the significance of each role.

4) What are the three distinct types of commercial banks in Canada? 5) Paul wants to know how the fractional reserve system adopted by commercial banks creates money. Explain, using terms learned in Econ 102, the process of money recreation following an inflow of $100 brought into Canada by a new immigrant. 6) Three economists disagree over their estimates of Canada’s total money supply but then quickly realized that they are using different definitions of money supply. Economist A, B and C, follow the M1, M2 and M2+ definitions respectively. Whose estimate is likely the largest, and whose is likely the smallest? 7) Kelvin received a scholarship from UBC paid to him in the form of a cheque. While sitting through Professor Gateman’s lecture, Kelvin wonders if that cheque should be classified as near money or money substitute. Explain to Kelvin which classification is correct.

PART 5 – CHAPTER 28/29 1) Jenny bought a Government of Canada Bond a face value of a $1000 5 years ago at par. The bond has a maturity of 10 years and makes annual interest payments of $100 at the end of every year starting from the purchase date. Today, Jenny checks the bond listing and sees that the same bond is now selling at a yield of 6%. On the spur of the moment, she calls her broker to sell the bond immediately. Did she make a wise decision? Why or why not? What would have happened instead if she were to hold the bond until maturity? 2) Jacob needs some help valuing a bond (i.e. determining the worth of bond). A private company started by his relative plans to issue a new 10-year bond very soon with a face value of $1000 and yearly coupon payments of $170. The company, called Tate Ltd is planning to sell the bond at par. Jacob knows little about the company but he is able to find out about another bond issued by the same company a while back and its current market price along with the pricing information for 2 types of Government of Canada Bonds as they are listed on a financial newspaper today: Issuer Coupon(%) Maturity Price Yield(%) Canada 5 in 3 yrs 973 6 Canada 16 in 10 yrs 1023 15 Tate 10 in 3 yrs 952 12 Are there good reasons for whether Jacob should or should not buy Tate Ltd’s soon to be issued bond?

3) Julia avidly reads the economics news. Since she started following Bank of Canada’s policy decisions she has become very confused (she didn’t take Econ 102 with Professor Gateman). Explain to Julia the main idea behind why Bank of Canada choses to control the interest rate instead of the money supply, and finally what Bank of Canada uses as a target to guide its decisions. 4) Bank of Canada wants to increase interest rate. Which type of monetary policy will the Bank consider? What will happen to the economy? Use a nicely labeled diagram to illustrate your answers. Assume that the economy was originally at its long run equilibrium (label that as A). Label the new equilibrium as B.

P

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Special question: if you can get this, you are more than ready! 5) Bank of Canada has traditionally set a target inflation rate at 2%. What are the arguments for systematically targeting inflation rate? During the 2009 worldwide recession, Bank of Canada took some drastic actions and for a period of time brought the ONR rate to near 0%. However the effects were mild. The economy did get a boost but not as much as many would have liked there to have been. Following the recession, some critics argued that the issue laid in the Bank’s low inflation target of just 2%. They suggested that the inflation target should be higher in order for monetary policies to be more effective in the future against recessions. Why?

__________________________________________________________________________________ DISCLAIMERS: The above questions are only meant to help you solidify your Econ 102 understanding and to help you get a feel for the level of difficulty that you might be reasonably expected to encounter on an actual Gateman exam. However the real exam might take any format and might include: T/F, multiple choice, short answers, calculations, problems, articles, etc. As always, knowledge comes first. Exam-taking finesse comes second.