ECMC61 Sample Midterm

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Economics for Management Studies
Iris Au

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 assignment. Instructions:  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. e  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. FinCity TradeTown Gross domestic products 7500 Consumption 9000 Investment Government spending 3000 Current Account 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.” True/False/Uncertain, explain. 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 CAD/£. 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 these economies: 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
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