Indian School of Business

PGP Pro: Global Economics

Final Sample Questions: ANSWERS

Professor: Krishna B. Kumar

For each of the following questions, select an answer that is the best available response.
In the final exam, you will have 30 multiple choice questions to be answered in two hours.

1 Topic 3 (Labor Market)

1. L.Z. Bones works fewer hours when the wage rate increases. For him it can be said that:

(a) The income effect of a wage increase is stronger than the

substitution effect
(b) The income and substitution effects are equally strong
(c) The substitution effect of a wage increase is stronger than the income effect
(d) The individual labor demand curve is upward sloping

2. Which of the following could PREVENT an equilibrium from being attained?

I. Consumers maximizing their utility
II. Firms maximizing profits
III. Prices being fixed by the government
(a) I only
(b) II only

(c) III only

(d) I and III

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3. Suppose a competitive firm is operating at a region where P < M P L. To move to an optimum,
the firm has to:

(a) Increase the labor employed

(b) Decrease the labor employed
(c) Keep the labor as it is
(d) Decrease its output

4. When the firm in the previous question makes the appropriate move toward its optimum:

(a) Its total profits increase

(b) Its marginal profit increases
(c) Its total profits decrease
(d) Its total profits stay the same

5. An unexpected influx of women into the labor force of an economy will, at least in the short run,
most likely:

(a) Increase the current wage rate of men already in the labor force

(b) Decrease the current wage rate of men already in the

labor force
(c) Leave the current wage rate of men already in the labor force unchanged
(d) Decrease the equilibrium interest rate
In the labor market picture, the supply curve shifts right, decreasing equilibrium wages.

6. An unexpected invention that increases economywide productivity will:

(a) Shift the aggregate labor supply curve outward (to the right), decreasing the equilibrium
wage rate
(b) Shift the aggregate labor supply curve inward (to the left), increasing the equilibrium wage
rate

(c) Shift the aggregate labor demand curve outward (to the
right), increasing the equilibrium wage rate
(d) Shift the aggregate labor demand curve inward (to the left), decreasing the equilibrium wage
rate

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7. Suppose an economy has a total population of 100 Million people, out of which 20 Million are
under sixteen years of age. 50 Million people are employed. This economy’s unemployment rate,
assuming that it is calculated the way it is done in the US, is:

(a) 30/80
(b) 30/100
(c) 50/100
(d) It cannot be determined with the information given
You need to know the size of the labor force, which cannot be calculated with the given
information.

8. Keynesians are more inclined to recommend that the unemployed people be given unemployment
benefits because in their model:

(a) Unemployment is voluntary

(b) Wages drop whenever there is a negative productivity shock

(c) Jobs are rationed

(d) A negative productivity shock shifts the labor supply curve downward
Unemployment is involuntary for Keynesians.

9. One channel through which college education subsidies reduce inequality is by:

(a) Increasing demand for skilled labor

(b) Decreasing demand for skilled labor

(c) Increasing the supply of skilled labor

(d) Decreasing the supply of skilled labor
Refer to the graphs for skill-biased technical change.

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2 Topic 4 (Capital Market)
1. If the depreciation rate (d) is held constant, as the market real interest rate (r) increases, you
should expect the real rental price of a unit of capital (R/P ) to:

(a) Decrease

(b) Increase
(c) Stay the same
(d) Cannot tell with the information given
Since R/P=r+d

2. The real interest rate is the cost of capital when:

(a) A firm borrows to invest

(b) A firm uses retained earnings to invest

(c) In both cases

(d) In neither case

3. An increase in the government expenditure (G) and a positive productivity shock both increase
the equilibrium real interest rate. What is the difference between the two?

(a) The equilibrium amount of saving is larger when G increases

(b) The equilibrium amount of investment is smaller when

G increases
(c) The equilibrium amount of investment is smaller with the positive productivity shock
(d) The equilibrium wage rate is higher when G increases

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3 Topic 5 (Money)
1. What is true about the rate of return on fiat money in an inflating economy?

(a) Its nominal and real return are both positive

(b) Its nominal and real return are both negative
(c) Its nominal return is negative and real return is zero
(d) Its nominal return is zero and real return is negative
2. Which of the following is TRUE about a fiat money?
I. Its purchasing power stays the same always

II. It is not backed by any commodity

III. It suffers from the same problems as bartering
(a) I only

(b) II only
(c) I and III only
(d) II and III only
Inflation implies I is false. And money avoids the matching problem that barter suffers from.

3. The money demand function M P = L (i, Y ) implies that an expected increase in the future money
supply will increase the current price level P because:
M
(a) π e decreases, i decreases, P decreases, and for a given current money supply M , this implies
that P increases
M
(b) π e increases, i decreases, P decreases, and for a given current money supply M , this implies
that P increases
M
(c) π e increases, i increases, P increases, and for a given current money supply M , this implies
that P increases
(d) π e increases, i increases, MP decreases, and for a given cur-
rent money supply M , this implies that P increases
Exactly the mechanism that was described in class.

4. Which of the following events is MOST likely to affect the velocity of money?

(a) An increase in the currency-to-deposit ratio of households.

(b) An increase of the discount rate by the Fed.

(c) A financial innovation that makes it easier to access ac-

counts and withdraw money.
(d) An open market operation by the Fed.

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4 Topic 6 (Monetary Policy & Fluctuations)
1. Keynesians are led to believe in the principle of short-run non-neutrality of money because they
believe in the Phillips curve which shows a negative connection between:

(a) Inflation, a real variable, and unemployment, also a real variable

(b) Inflation, a nominal variable, and unemployment, also a nominal variable

(c) Inflation, a nominal variable, and unemployment, a real

variable
(d) Inflation, a real variable, and unemployment, a nominal variable

2. Which of the following statements about short run non-neutrality is TRUE?

I. The US experience in the 70s and 90s provide evidence in favor of the Phillips curve
II. Keynesian economists do not believe in short run non-neutrality

Keynesian models to explain short run non-neutrality

III.

typically feature rigidity of nominal wage or price

(a) I only
(b) II only

(c) III only

(d) I and III only

3. One of the Keynesian theories of non-neutrality is that nominal wages are rigid, and an increase
in money supply would increase prices and therefore reduce real wages, which in turn would cause
firms to increase the labor employed and increase output. Milton Friedman and Edmund Phelps
argued against this theory by stating that there is no “money illusion”. By this they meant:

(a) Workers would be willing to work at the same nominal wage no matter what the price level;
so the output will stay the same instead of increasing
(b) Workers would demand lower nominal wages and nullify any drop in real wages firms might
experience

(c) Workers would demand higher nominal wages to counter

inflation and nullify any drop in real wages firms might
experience
(d) The experience of the 70s and 90s have cast suspicions on the validity of the Phillips curve

4. Which of the following statements about long run neutrality is TRUE?

I. There is evidence to support it

II. Both Classical and Keynesian economists believe in
it
III. One policy recommendation that is based on long run neutrality is for poor countries
to increase growth in money supply in order to increase growth in output

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(a) I and II only
(b) I and III only
(c) II and III only
(d) I, II, and III
Neutrality by definition involves no output growth so III is wrong.

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5. Which of the following is the correct ordering in terms of volatility, lowest to highest?

(a) C, I, Y
(b) I, C, Y

(c) C, Y, I
(d) Y, I, C

6. If a productivity shock is serially correlated:

(a) The likelihood the productivity is higher than normal this quarter is independent of its value
in the previous quarter
(b) Higher than normal productivity this quarter is likely to be followed by lower than normal
productivity next quarter

(c) Higher than normal productivity this quarter is likely

to be followed by higher than normal productivity next
quarter also
(d) Higher than normal productivity this quarter is certain to cause no productivity change
next quarter

7. If the assumption that prices and wages are fully flexible is not valid, which of the following
features of the Real Business Cycle (RBC) model would break down?

(a) Money is irrelevant to studying business cycles

(b) There is intertemporal substitution of labor
(c) Technology shocks are responsible for output fluctuation
(d) All markets clear

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 8. Classical economists would argue for a non-activistic policy toward economic fluctuations, since:

(a) In RBC theory, fluctuations in Y, C, I, and L, are all natural and desirable responses of
individuals and firms to inevitable changes in the environment.
(b) The long lags between the time a stimulating policy is instituted and the time its effect is
felt on the economy might cause the stimulus to arrive at the wrong time.

(c) Both reasons apply.

(d) Neither reason applies.

9. The cyclicality of an economic variable, to study its role in business cycles, is measured by:

(a) The standard deviation of that variable

(b) The percentage deviation of that variable from its trend
(c) The correlation coefficient of the variable with respect to national investment
(d) The correlation coefficient of the variable with respect to
GDP
10. In the RBC model, when there is a negative productivity shock, consumption:

(a) Decreases heavily

(b) Decreases slightly

(c) Stays the same
(d) Increases slightly

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5 Topic 7 (Fiscal Policy)
1. The least distortionary type of tax is:

(a) A flat rate tax

(b) A lumpsum tax

(c) A progressive tax
(d) A regressive tax

2. Suppose a government’s revenues are 500 Billion in dollar terms in a year. In the same year
government outlays excluding interest payments are 500 Billion $ and interest payments on
outstanding debt are 75 Billion $. In that year:

(a) Total deficit = 0, and Primary deficit = 75 Billion $

(b) Total deficit = 75 Billion $, and Primary deficit = 0

(c) Total deficit = 0, and Primary deficit = 425 Billion $
(d) Total deficit = 425 Billion $, and Primary deficit = 0

3. Which of the following (is) are TRUE about the traditional view of the government financing a
tax cut by running budget deficits?
I. The government saving decreases but private saving increases by the same amount,
leaving national saving unchanged

Persistent deficits negatively affect capital accumu-

II.

lation; the steady state capital stock decreases

III. The equilibrium real interest rate increases
(a) I only
(b) I and III only

(c) II and III only

(d) I, II, and III

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6 Topic 8 (Open economy capital markets)
1. The increased trade deficit of an economy is not bad news for a country if:

(a) Its investment curve shifts leftward because of a negative productivity shock

(b) Its investment curve shifts rightward because of a posi-

tive productivity shock
(c) Its saving curve shifts leftward
(d) The world interest rate rises
(a) and (d) will not even increase the trade deficit and (c) will increase it but could be bad
news.

2. The global capital market will allocate more capital to a country with:

(a) High TFP

(b) Low risk premium

(c) Both (a) and (b)

(d) Neither (a) and (b)
Both will cause the interest rate line to intersect MPK curve at a higher level of capital.

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 (e)

7 Topic 9 (International Trade)

Consider the following production technology (unit labor requirements) for Eurasia and Oceania:
Eurasia Oceania
Onions 2 8
Garlic 5 10
Use this information to answer the following four questions.
1. Which of the following is TRUE?

(a) Eurasia has a comparative advantage in the production of both goods

(b) Eurasia has an absolute advantage in the production of

both goods
(c) Oceania has a comparative advantage in the production of both goods
(d) Oceania has an absolute advantage in the production of both goods

2. Oceania has a comparative advantage in the production of:

(a) Onions

(b) Garlic
(c) Both onions and garlic
(d) It cannot be determined without the knowledge of the world relative price of garlic
The opportunity cost of producing garlic in Eurasia is 5/2 = 2.5 units of onion, while in
Oceania it is 10/8 = 1.25 units of onion. Therefore Oceania has comparative advantage in
the production of garlic.

3. Under which of the following equilibrium relative price of garlic (in terms of onions) would you
observe complete specialization if Eurasia and Oceania trade:

(a) 0.5
(b) 1

(c) 1.5
(d) 3
This is the only price that lies in between the 1.25 and 2.5 figures derived above and corre-
sponds to the prices that yield the vertical segment in the relative supply curve.

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 4. Which of the following countries would be worse off if both open up to international trade?

(a) Eurasia
(b) Oceania

(c) Neither
(d) It cannot be determined without the knowledge of the world relative price of garlic
The CPF lies beyond the PPF for both countries. Therefore, both countries will be better
off.

8 Topic 10 (Exchange rates)

1. The exchange rate system that gives a country the MOST freedom with its monetary policy is:

(a) A currency board, as was followed in Argentina

(b) A fixed exchange rate system
(c) Using the US dollars as currency, as followed in Panama
(d) A floating exchange rate, as followed in Brazil
2. If two countries, A and B, agree to fix their nominal exchange rates with respect to each other’s
currency. Suppose country A wants to expand its money supply suddenly. Which of the following
statements is TRUE?

(a) The exchange rate cannot be maintained at the old level, since country A’s currency will
appreciate

(b) The exchange rate cannot be maintained at the old level,

since country A’s currency will depreciate
(c) The exchange rate can be maintained at the old level, since the nominal exchange rate has
nothing to do with the money supply
(d) The exchange rate can be maintained at the old level, since the real exchange rate will
adjust immediately
πwill increase, cause enom to decrease in the relative PPP
equation.
3. Which of the following ways of dealing with an overvalued currency would decrease the official
exchange rate?

Devaluation to set the official exchange rate to its

I.

fundamental value
II. Instituting capital controls
III. Contracting the money supply

(a) I only
(b) II only
(c) I & II only

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 (d) II & III only
II and III will both increase the fundamental value of the exchange rate.

4. Speculative attacks are possible in:

(a) A dollarized economy

(b) An economy with a currency board
(c) A currency union
(d) A fixed exchange rate system with overvalued currency
5. When absolute PPP holds between two countries:

(a) The nominal exchange rate between their currencies is guaranteed to be 1

(b) Identical goods can cost different amounts in the two countries

(c) The real exchange rate between the two countries is 1

(d) The real exchange rate can be 1 only if the rate of inflation is the same in both countries

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9 Articles
1. The article A Computer Would Do Better Than the Fed argues that if a computer controls the
discount rate, it would:

(a) Prevent economic downturns

(b) Predict events that are likely to alter the economy
(c) Promote speculative stock trading
(d) Prevent the discount rate from becoming an extra source
of economic uncertainty
The article says “d” is the best we can hope for, because even the Fed cannot do “a” and “b”.
According to the article, “c” would actually be avoided.

2. China approaching the turning point explains the Lewis turning point thus: “When an economy
first becomes industrialsied it grows very fast by importing foreign technology and employing
capital and plentiful, cheap unskilled labour from the farm. But after a while the extra agricul-
tural labour is put to work and wages start to rise.” Which of the following shifts in the labor
market equilibrium graph for industries would be consistent with this hypothesis?

(a) The labor demand curve shifts to the right, more than
any shift to the right of the labor supply curve
(b) The labor demand curve shifts to the left, more than any shift to the right of the labor
supply curve
(c) The labor supply curve shifts to the right, more than any shift to the right of the labor
demand curve
(d) The labor supply curve shifts to the left
(a) is by far the best answer as it captures the net shift in demand from increased industri-
alization. (b) and (c) would imply wages decrease. If anything labor in industries increases,
so (d) cannot be right.

3. The article Inside the Hottest Job Market in Half a Century notes: “Economic theory holds
that when unemployment is very low, it stirs inflation, which causes the Federal Reserve to raise
short-term interest rates and short-circuit growth and hiring.” The principle underlying the belief
monetary actions can affect the real economy is called:

(a) Money neutrality

(b) Money non-neutrality

(c) Inflation
(d) Ricardian equivalence

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