University of the Philippines

SCHOOL OF ECONOMICS
Economics 100.1: Introduction to Macroeconomic Theory and Policy
Problem Set #3
S. A. Quimbo

Feliciano/ Inocencio / Mendoza / Pormon

Name: ___________________________________
Student No.: _____________________

Discussion Class Section: _________

Deadline: March 22, 2015, 5PM, Room 229

1. What is the marginal propensity to import in an economy with no foreign trade?

a. equal to its marginal propensity to consume (MPC)
b. equal to its marginal propensity to save (MPS=1-MPC)
c. equal to zero
d. equal to the ratio of one over the sum of MPC and MPm
e. (None of the above)
MPm = change in Import due to change in GDP, since there is no trade, imports = 0
2. When world interest rates increase, a small open economy would tend to experience ___.
a. an increase in exchange rates, an increase in investment, and an increase in net exports
b. an increase in exchange rates, a decrease in investment, and an increase in net exports
c. a decrease in exchange rates, an increase in investment, and an increase in net exports
d. a decrease in exchange rates, a decrease in investment, and an increase in net exports
e. a decrease in exchange rates, a decrease in investment, and a decrease in net exports
Increase in world interest rates would drive investment out of the small open economy (decrease
in investment). Decrease in demand for their currency leads to decrease in exchange rates. This
decrease in exchange rates make domestic goods cheaper (compared to the rest of the world),
resulting to an increase in exports.
For numbers 3 to 4, use the following table:
GDP
C
I
G
5,000
3,000
2,000
200
4,500
2,650
2,000
200
3,300
1,810
2,000
200
3,000
1,600
2,000
200

Exports
300

Imports
500
450
330
300

X
-200

C+I+G+X
5,000

3. On the basis of the Keynesian model of output determination, using the table above, if MPC=0.6,
MPm=0.1, and the government increases its spending by $200 billion,
a. GDP will increase by $400 billion
b. GDP will increase by $666 billion
c. GDP will decrease by $400 billion
d. the government will run a deficit
e. (None of the above).

Recall: Open economy multiplier (OEM) =

1
MPm+ MPS , where MPS = 1-MPC = 0.4

So, OEM = 1/ (0.1+0.4) = 1/0.5 = 2.

Since government increased spending by $200 billion and multiplier is 2, increase in GDP is
$400 billion.
4. On the basis of the simple Keynesian model of output determination and using the table above,
a. when GDP is less than 5,000 there is inventory decumulation
b. when GDP is 5,000, planned investment=actual investment
c. when GDP is greater than 5,000, inflation will rise
d. (All of the above).
e. (None of the above).
It is implied in the choices that 5,000 is the equilibrium point where planned investment = actual
investment. When GDP is below 5,000, the economy will tend to expand to address the inventory
decumulation. When GDP is above 5,000 (producing too much output, so actual GDP is greater than
potential GDP), prices will begin to rise in response to demand pressure in key markets. To return to the
equilibrium, the economy will tend to contract (reduce production) to address the inventory accumulation.
5. An open economy is one that ____
a. has a high level of inflation.
d. experiences budget deficit
b. has a high level of economic growth. e. (All of the above)
c. engages in international trade.
(Definition of an open economy)
6. All of the purchases and sales of financial assets and liabilities will appear on a nations ____
a. Balance of international transactions d. financial account
b. Trade balance
e. (None of the above)
c. Foreign exchange rate
Recall: 2 main components of Balance of International Payments, the Current Account
(includes trade balance) and the Financial Account.
7. In the foreign exchange market, Filipinos ____ peso in order to obtain ____ to buy foreign goods,
services, or assets. Foreigners ____ peso in order to buy Philippine goods, services or assets.
a. Demand; peso; demand
b. Demand; foreign currency; supply
c. Supply; peso; demand
d. Supply; foreign currency; demand
e. Supply; dollar; supply
This explains the upward sloping supply and downward sloping demand curves for foreign
exchange
8. Suppose the Banko Sentral ng Pilipinas adopted a fixed exchange rate system. In order to
maintain a fixed currency against peso appreciation, the central bank should ____.
a. Buy dollars from the exhange market
d. Buy bonds from the public
b. Sell dollars to the exchange market
e. (None of the above)
c. Print peso

Note: Peso appreciation means that the exchange rate ($/Php) is increasing, or that the value
of the peso is increasing. To offset this or to decrease the value of the peso, we need to
demand less of the Peso (depreciation of the peso) or more of the dollars.
Suppose exchange rate is fixed at $1=Php45. Let the peso appreciate, such that new rate
might go to $1=Php44. (Definition of fixed exchange rate system)To maintain a fixed
currency, the BSP whould buy dollars or sell peso to the foreign exchange market.
For items 9-10. Given the following information:

C=500+0.5 Yd

T =200,G=200,Tr =0
I =300

Imports=40+ 0.2Y

Exports=400

9. Determine the level of income/output of the country

a. 1750
d. 1500
b. 1260
e. 2520
c. 1800
Recall:

GDP=Y =C+ I +G+ X ;

Yd (Disposable Income)=Income (Y )Taxes(T )

400(40+0.2 Y )
GDP=Y =[500+0.5( Y 200)]+[300]+[200]+

Y = +[300]+[200]+[400400.2 Y ]
Y =[400+0.5 Y ]+[500 ]+[3600.2Y ]
Y 0.5 Y +0.2 Y =400+500+360
0.7 Y =1,260

( Output ) Y =1,800
10. Given the level of income at number 6, the country is running a ___
a. Balance of trade
d. Budget deficit
b. Trade deficit
e. (None of the above)
c. Trade surplus
Since

Y =1,800 , Imports = 40+ 0.2 ( 1,800 ) =40+360=400

Note that Exports=400=Impors, so we have Balance of Trade

11. In an open economy under flexible exchange rates, a reduction in the money supply will
cause___. (Recall Quantity Theory of Prices/Money)

a.
b.
c.
d.
e.

An increase in the exchange rate, E Since reduction in money supply causes appreciation
An increase in the interest rate (see money market: shifting money supply curve to the left)
A reduction in output Appreciation causes reduction in exports.
All of the above
Only A and B

12. Assume a country in a a fixed exchange rate regime decided to peg the exchange rate at a lower
level. This is called ____
a. A revaluation
d. an appreciation
b. A devaluation
e. (None of the above)
c. A depreciation
(Definition of devaluation)
13. Based on the supply and demand model of the exchange rate, which of the following should
cause the Philippine peso to appreciate?
a. Concern abroad over the safety of Philippine toy exports.
b. An increase in remittances from Philippine workers abroad to their families at home.
c. Repayment by the Philippine government of its debt to the IMF.
d. Increased imports by Philippine consumers of electronics made in Taiwan.
e. An increase in Philippine savings that is used to purchase financial assets in Europe.

For item number 14.

14. Using figure the figure above, the S+T-G line is drawn with a relatively steep slope because:
a. government borrowing decreases with the interest rate
b. higher interest rates choke off investment spending
c. taxes tend to increase with interest rates
d. domestic savings responds positively, but only slightly, to higher interest rates
e. government spending does not vary much from year to year
15. With no technological advance, the growth rate of output would:
a. equal the growth rate of capital
b. equal the growth rate of labor

c. equal the growth rate of labor plus the growth rate of capital
d. equal the weighted average of labor and capital growth rates, with each factor's weight equal to
its share of national income
e. equal none of the above, generally
16. According to the Solow growth model, capital deepening refers to:
a. the process by which the capital-labor ratio increases over time
b. technological advances in capital equipment over time
c. the decline in economic growth resulting from the displacement of workers by capital equipment
d. the self-perpetuating cycle of growth between technological advances and capital equipment
e. (None of the above).
(Definition of capital deepening)
17. Which of the following statements is not true?
a. Improvements in literacy, health, discipline, and the ability to use computers add greatly to
productivity of labor
b. Roads, irrigation and water projects, and public-health measures are examples of social overhead
capital
c. Adam Smith stressed the importance of technology in economic growth. (Smith's classical model
talked about the relationship between the population and economic growth and land. It was Solow
who stressed the importance of technology on growth.)
d. The fundamental equation of growth accounting includes a measurement of technological change
e. The real wage can increase because of capital-deepening, technological change, or both
18. If the growth of labor, of capital, and of output were always 1%, 6%, and 2%, respectively with no
technological change, then labor's share of output in the neoclassical growth model would be:
a. 1/3 -> =

2
1
1
( 6 )+ (1 )=4 2
3
3
3

b. 1/2 -> =

1
1
( 6 ) + ( 1 )=4 2
2
2

c. 2/3 -> =

1
2
2
( 6 )+ (1 )=2 2
3
3
3

d. 1/4 -> =

3
1
3
( 6 ) + ( 1 )=4 2
4
4
4

e. 4/5 -> =

1
4
10
( 6 )+ ( 1 )= =2
5
5
5

(By trial and error), Recall formula for Growth accounting,

%changeGrowth=share of Labor output(Growth of labor )+ share of capital output(Growth of capital)

19. Which of the following occurs in the long run neoclassical growth model without technological
change?

a.
b.
c.
d.
e.

capital deepening ceases

real wages stop growing
the return to capital is constant
real interest rates are constant
(All of the above)
The above are implications of Solow's growth model without technological change. With
technological change, output is allowed to grow, thus the above can grow much more.

20. All other things held equal, an increase in the money supply will___.
a. Decrease the interest rate
d. Increase spending
b. Increase GDP
e. (All of the above)
c. Increase the price level
Recall the Quantity Theory of Prices, MV = PY, change in money supply must result to the same direction
of change in prices. Thus, the increase in Ms results to an increase in prices.
Increase in money supply will depreciate the currency, resulting to lower interest rates, higher exports,
leading to an increase in GDP or Income, which allows us to increase spending.