ECMC61 Sample Midterm Questions
The followings are collections of part midterm questions. These questions are
compiled from different midterms (the total marks do not add up to 100) and are
for your practice only. You should also practice the review questions and
Answer all questions.
Point form is acceptable.
Re-grade will not be done for penciled answer.
You must submit this question sheet with your examination booklet(s) in order to
receive the grade.
If the question has more than one part, label each part of your answer. Latter
part(s) of the question will not be graded if you failed to label your answer.
Do not write E/q/E increases/decreases in your answer, you have to answer
whether the currency appreciates/depreciates. POINTS WILL BE
SUBTRACTED IF YOU DO NOT FOLLOW THIS INSTRUCTION.
Label your graph; otherwise, marks will be subtracted.
No credit will be given if you do not show your work.
Your answer should be structured in a way such that those know little about
economics will have no difficulty understanding your argument/answer.
Question 1 (15 points)
The world consists of two open economies only, FinCity and TradeTown. The following
table provides some macroeconomic data for these countries.
Gross domestic products 7500
Government spending 3000
Non-reserve portion of financial account
Official reserve transactions 300
Capital account 0 0
Note: Empty cell only means the data is not given in the question.
Additional information given about both economies:
In FinCity, consumption, investment, and government spending represent 75%, 15%,
and 20% of the economy’s output respectively.
The level of GDP in TradeTown is two times of FinCity’s GDP.
The level of investment in TradeTown equals to 15% of its GDP.
The stock of official reserves of TradeTown increase by 300.
1 a) Fill in the empty cells of the above table (The table is reproduced in the answer
sheets). No need to show your work. (10 points)
b) Which economy runs a current account deficit? Is running a current account deficit a
problem? Explain. (5 points)
Question 2 (10 points)
a) Is it possible for a country to have a current account deficit and at the same time it has
a surplus in its balance of payments? Explain (Hint: you don’t have to answer what
happens to the official reserve transactions). (4 points)
b) What are the implications of current account deficit? Is it a problem if a country runs
a CA deficit? Explain. (6 points)
Question 3 (10 points)
“An increase in national saving leads to a current account improvement.”
Question 4 (15 points)
Suppose there are only two countries, Home and Foreign, in the world. Owing to a very
cold winter, Foreign experiences a major crop failure. As a result, the Foreign output
level drops. Fortunately, the bad weather only affects the country temporarily, so the
market participants do not change their expectations on the exchange rate between
domestic currency and foreign currency. However, this reduction in the foreign output
causes the spot exchange rate to change immediately. The Home country’s central bank
does not want the spot exchange rate to change, what action should the Home central
bank take to stabilize movements in the spot exchange rate in the short run?
Answer this question in the context of the asset approach to the exchange rate and
support your answer by a set of appropriate diagrams (i.e., the one that has foreign
exchange market on the top and the domestic money market at the bottom).
Question 5 (15 points)
Suppose the Canadian and British money markets are in equilibrium and the Canadian
dollar/British pound (CAD/£) exchange rate is at its equilibrium level. With the aid of a
diagram that shows the foreign exchange market and the Canadian money market, briefly
explain the immediate and long-run effects of a permanent decrease in the Canadian real
money demand on the Canadian price level, the interest rate in Canada, and the CAD/£
exchange rate. (Compare your results to initial equilibrium)
Note: Quote the exchange rate as E In your diagrams and written explanation, use
the subscripts “CAN” and “UK” to denote all the variables and terms used for Canada
and Britain respectively. You must follow this notation; otherwise, you will receive a
grade of ZERO for the whole question.
2 Question 6 (15 points)
Suppose there is a permanent decrease in the level of foreign money supply. In the
context of the asset approach to the exchange rate, explain the short-run and long-run
effects of this change in foreign money supply on EDC/FC
Support your answer in a diagram that shows the foreign exchange market only (Hint:
you must put E DC/FC on the vertical axis and draw the diagram like what we did in class.
In other words, you cannot treat Foreign as domestic country; otherwise, no credits will
be given to the whole question).
Question 7 (15 points)
Consider two open economies, Cardland and Paperland, the exchange rate between
Paperland’s currency (P$) and Cardland’s currency (C$) is determined by the asset
approach to the exchange rate. Besides, the following equations can be used to describe
Cardland: Money supply: MS C 27000
Real money demand: L (RC, YC) =C0.5Y – 2C00R C
Output: Y C 10000
Paperland: Money supply: MS P 12000
Real money demand: L (RP, YP) =P0.8Y – 5P0R P
Output: Y P 5250
Note: Quote the exchange rate as E C$/P$ and interest rates are expressed in decimal
points (i.e., if R = 0.1, then R = 10%). In your written explanation, use the subscripts “C”
and “P” to denote all the variables and terms used for Cardland and Paperland
respectively. You must follow these notations; otherwise, you will receive a grade of
ZERO for the whole question. Keep your answer in 4 decimal points if necessary.
a) Initially, both economies are in their respective long-run equilibrium and the long-run
nominal interest rate in Cardland and Paperland are equal to 25% and 40%
respectively. Beside, the expected exchange rate is 2C$ per P$. Find the long-run
levels of C$/P$ exchange rate and prices in both countries. (5 points)
Now, suppose the central bank of Cardl