Practice Questions on Chapter 3 ECO62 Spring 2011 Udayan Roy

Name: __________________________ Date: _____________

A)
B)
C)
D)

1.In the long run, what determines the gross domestic product in an economy?
the interest rate and the amount of national saving
the quantities of capital and labor, and the production technology
consumption, investment, and government spending
the marginal products of capital and labor, constant returns to scale, and competition

A)
B)
C)
D)

2.Unlike the real world, the classical long-run macroeconomic model (as in chapter 3)
assumes that:
all capital and labor is fully utilized.
all capital is fully utilized but some labor is unemployed.
all labor is fully employed but some capital lies idle.
some capital lies idle and some labor is unemployed.

A)
B)
C)
D)

A)
B)
C)
D)

A)
B)
C)
D)

A)

3.When a production function satisfies constant returns to scale, if we:

multiply capital by z1 and labor by z2, we multiply output by z3.
increase capital and labor by 10 percent each, we increase output by 10 percent.
increase capital and labor by 5 percent each, we increase output by 10 percent.
increase capital by 10 percent and increase labor by 5 percent, we increase output by
7.5 percent.
4.If an increase of an equal percentage in all factors of production results in an increase in
output by the same percentage, then a production function has the property called:
constant marginal product of labor.
increasing marginal product of labor.
constant returns to scale.
increasing returns to scale.
5.According to the classical long-run macroeconomic model, at any particular point in
time, the output of the economy:
is fixed because the supplies of capital and labor and the technology are fixed.
is fixed because the demand for goods and services is fixed.
varies because the supplies of capital and labor vary.
varies because the technology for turning capital and labor into goods and services
varies.
6.If output is produced according to the production function Y = AK0.2L0.8, then the
production function has:
constant returns to scale.
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B)
C)
D)

diminishing returns to scale.

increasing returns to scale.
a degree of returns to scale that cannot be determined from the information given.

A)
B)
C)
D)

7.A consumption function shows the relationship between consumption and:

income.
personal income.
disposable income.
taxes.

A)
B)
C)
D)

8.The demand for output in a closed economy is the sum of:

public saving and private saving.
the quantity of capital and labor and production technology.
consumption, investment, and government spending.
government purchases and transfer payments minus tax receipts.

A)
B)
C)
D)

9.Assume that Y denotes gross domestic product, T denotes the net tax revenue of the
government, and C denotes total consumption spending. If the consumption function is C
= 500 + 0.5(Y T), and Y is 6,000 and T is given by T = 200 + 0.2Y, then C equals:
2,500.
2,800.
3,500.
4,200.

A)
B)
C)
D)

10.If the consumption function is given by the equation C = 500 + 0.5Y, the production
function is Y = 50K0.5L0.5, where K = 100 is the total stock of capital and L = 100 is the
amount of labor, then C equals:
1,000.
2,500.
3,000.
5,000.

A)
B)
C)
D)

11.If the consumption function is given by C = 150 + 0.85Y and Y increases by 1 unit, then
C increases by:
0.15 unit.
0.5 unit.
0.85 unit.
1 unit.
12.If the consumption function is given by C = 150 + 0.85Y and Y increases by 1 unit, then

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A)
B)
C)
D)

savings:
decreases by 0.85 unit.
decreases by 0.15 unit.
increases by 0.15 unit.
increases by 0.85 unit.

A)
B)
C)
D)

13.If the consumption function is given by C = 150 + 0.85(Y T) and T increases by 1 unit,
then private savings:
decreases by 0.85 unit.
decreases by 0.15 unit.
increases by 0.15 unit.
increases by 0.85 unit.

A)
B)
C)
D)

14.The nominal interest rate is the:

rate of interest that investors pay to borrow money.
same as the real interest rate.
rate of inflation minus the real rate of interest.
real rate of interest minus the rate of inflation.

A)
B)
C)
D)

15.The real interest rate is the:

rate of interest actually paid by consumers.
rate of interest actually paid by banks.
rate of expected inflation minus the nominal interest rate.
nominal interest rate minus the rate of expected inflation.

A)
B)
C)
D)

16.Assume that the investment function is given by I = 1,000 30r, where I is investment
spending and r is the real rate of interest (in percent: that is, if the real interest rate is 6
percent, then r = 6). Assume further that the nominal rate of interest is 10 percent and the
expected inflation rate is 2 percent. According to the investment function, investment will
be:
240.
700.
760.
970.

A)
B)
C)
D)

17.If government purchases (G) exceed net taxes (that is, T or taxes minus transfer
payments), then the government budget is:
balanced.
in deficit.
in surplus.
endogenous.

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A)
B)
C)
D)

18.According to the classical long-run macroeconomic model, the equation Y = C(Y T) +

I(r) + G may be solved for the equilibrium level of:
income.
consumption.
government purchases.
the real interest rate.

A)
B)
C)
D)

19.National saving refers to:

disposable income minus consumption.
taxes minus government spending.
income minus consumption minus government spending.
income minus investment.

A)
B)
C)
D)

20.Y C G equals:
national saving.
private saving.
public saving.
financial saving.

A)
B)
C)
D)

21.Private saving equals:

Y C G.
Y T C.
Y I C.
Y T.

A)
B)
C)
D)

22.Private saving is:

income minus consumption minus government spending.
disposable income minus consumption.
disposable income minus government spending.
taxes minus government spending.

A)
B)
C)
D)

23.Public saving is:

income minus consumption minus government spending.
disposable income minus consumption.
disposable income minus government spending.
government revenue minus government spending.
24.If income is 4,800, consumption is 3,500, government spending is 1,000, and net tax

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A)
B)
C)
D)

revenues are 800, private saving is:

300.
500.
1,000.
1,300.

A)
B)
C)
D)

25.If income is 4,800, consumption is 3,500, government spending is 1,000, and net tax
revenues are 800, public saving is:
200.
200.
500.
1,800.

A)
B)
C)
D)

26.Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C =
500 + 0.6Y. No government exists (G = T = 0). In this case, equilibrium investment (I) is:
1,500.
2,000.
2,500.
3,000.

A)
B)
C)
D)

27.Assume that equilibrium GDP (Y) is 5,000. Consumption is given by the equation C =
500 + 0.6(Y T). Net taxes (T) are equal to 1,000. Government spending is 600. In this
case, equilibrium investment (I) is:
600.
1,100.
1,500.
2,200.

A)
B)
C)
D)

28.Assume that equilibrium GDP (Y) is 5,000. Consumption is given by the equation C =
500 + 0.6Y. Investment (I) is given by the equation I = 2,000 100r, where r is the real
interest rate in percent. No government exists (G = T = 0). In this case, the equilibrium
real interest rate is:
2 percent.
5 percent.
10 percent.
20 percent.

29.According to the classical long-run macroeconomic model developed in Chapter 3, when

government spending increases and taxes remain unchanged:
A)
consumption increases.
B)
consumption decreases.

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C)
D)

investment increases.
investment decreases.

A)
B)
C)
D)

30.According to the model developed in Chapter 3, when taxes decrease and government
spending is unchanged:
consumption and investment both increase.
consumption and investment both decrease.
consumption increases and investment decreases.
consumption decreases and investment increases.

A)
B)
C)
D)

31.According to the model developed in Chapter 3, when government spending increases

and taxes increase by an equal amount:
consumption and investment both increase.
consumption and investment both decrease.
consumption increases and investment decreases.
consumption decreases and investment increases.

A)
B)
C)
D)

32.According to the model developed in Chapter 3, when government spending increases

but taxes are not raised, interest rates:
increase.
are unchanged.
decrease.
can vary.

A)
B)
C)
D)

33.According to the model developed in Chapter 3, when taxes are increased but
government spending is unchanged, interest rates:
increase.
are unchanged.
decrease.
can vary wildly.

A)
B)
C)
D)

34.If there is a decrease in government spending and taxes are unchanged, then public
saving ______ and private saving ______.
increases; increases
increases; does not change
decreases; increases
decreases; does not change
35.According to the classical long-run macroeconomic model, a reduction in the government
budget deficit will lead to a:

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A)
B)
C)
D)

higher real interest rate.

lower real interest rate.
higher level of output.
lower level of output.

A)
B)
C)
D)

36.When government spending increases and taxes are increased by an equal amount,
interest rates:
increase.
remain the same.
decrease.
can vary wildly.

A)
B)
C)
D)

37.When there is a technological advance (such as the invention of the Internet) that leads to
an increase in businesses' desire to invest in new productive capacity, the equilibrium
level of investment:
increases and the interest rate rises.
is unchanged and the interest rate rises.
and the interest rate are both unchanged.
increases and the interest rate falls.

A)
B)
C)
D)

38.When the government lowers taxes on business investment, thus increasing desired
investment, but does not change government spending or taxes, the equilibrium level of
investment spending (I):
increases and the interest rate rises.
is unchanged and the interest rate rises.
and the interest rate are both unchanged.
decreases and the interest rate rises.

A)
B)
C)
D)

39.Suppose that GDP (Y) is 5,000. Consumption is given by the equation C = 500 + 0.5(Y
T). Investment (I) is given by the equation I = 2,000 100r, where r is the real interest
rate in percent. Government spending (G) is 1,000 and net taxes (T) is also 1,000. When a
technological innovation boosts the investment function to I = 3,000 100r:
I rises by 1,000 and r rises by 10 percentage points.
I rises by 1,000 and r is unchanged.
I is unchanged and r rises by 10 percentage points.
I is unchanged and r rises by 15 percentage points.

40.Assume that an increase in consumer confidence raises consumers' expectations of future

income and thus the amount they want to consume today for any given income. This will:
A)
lower investment and raise the interest rate.
B)
raise investment and lower the interest rate.

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C)
D)

lower both investment and the interest rate.

raise both investment and the interest rate.

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Answer Key
1.B
2.A
3.B
4.C
5.A
6.A
7.C
8.C
9.B
10.C
11.C
12.C
13.B
14.A
15.D
16.C
17.B
18.D
19.C
20.A
21.B
22.B
23.D
24.B
25.A
26.A
27.C
28.B
29.D
30.C
31.B
32.A
33.C
34.B
35.B
36.A
37.B
38.B
39.C
40.A

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