Practice question for Chapter 3.

ECON2102A

1. In the long run, the level of national income in an economy is determined by its:
A) factors of production and production function.
B) real and nominal interest rate.
C) government budget surplus or deficit.
D) rate of economic and accounting profit.

2. A production function is a technological relationship between:

A) factor prices and the marginal product of factors.
B) factors of production and factor prices.
C) factors of production and the quantity of output produced.
D) factor prices and the quantity of output produced.

3. The production function feature called ìconstant returns to scaleî means that if we:
A) multiply capital by z1 and labour by z2, we multiply output by z3.
B) increase capital and labour by 10 percent each, we increase output by 10 percent.
C) increase capital and labour by 5 percent each, we increase output by 10 percent.
D) increase capital by 10 percent and increase labour by 5 percent, we increase output
by 7.5 percent.

4. The price received by each factor of production for its services is determined by:
A) demand for output and supply of factors.
B) demand for factors and supply of output.
C) demand and supply of output.
D) demand and supply of factors.

5. When factor supply is fixed and quantity of the factor is graphed on the horizontal axis
while factor price is graphed on the vertical axis, the factor:
A) supply curve is horizontal.
B) supply curve is vertical.
C) supply curve slopes up to the right.
D) demand curve slopes up to the right.

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 6. The marginal product of labour is:
A) output divided by labour input.
B) additional output produced when one additional unit of labour is added.
C) additional output produced when one additional unit of labour and one additional
unit of capital are added.
D) value of additional output when one dollar's worth of additional labour is added.

7. The property of diminishing marginal product means that, after a point, when additional
quantities of:
A) a factor are added, output diminishes.
B) both labour and capital are added, output diminishes.
C) both labour and capital are added, the marginal product of labour diminishes.
D) a factor are added when another factor remains fixed, the marginal product of that
factor diminishes.

8. A competitive, profit-maximizing firm hires labour until the:

A) marginal product of labour equals the wage.
B) price of output multiplied by the marginal product of labour equals the wage.
C) real wage equals the real rental price of capital.
D) wage equals the rental price of capital.

9. The real wage is the return to labour measured in:

A) dollars.
B) units of output.
C) units of labour.
D) units of capital.

10. An increase in the supply of capital will:

A) increase the real rental price of capital.
B) decrease the real rental price of capital.
C) increase the productivity of capital.
D) increase the real interest rate.

11. According to the neoclassical theory of distribution, total output is divided between
payments to capital and payments to labour depending on their:
A) supply.
B) equilibrium growth rates.
C) relative political power.
D) marginal productivities.

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12. If Y = AK0.5L0.5 and A, K, and L are all 100, the marginal product of capital is:
A) 50.
B) 100.
C) 200.
D) 1,000.

13. If output is described by the production function Y = AK 0.2L0.8, then the production
function has:
A) constant returns to scale.
B) diminishing returns to scale.
C) increasing returns to scale.
D) a degree of returns to scale that cannot be determined from the information given.

14. If the production function describing an economy is Y = 100 K.25L.75, then the share of
output going to labour:
A) is 25 percent.
B) is 75 percent.
C) depends on the quantities of labour and capital.
D) depends on the state of technology.

15. In a CobbñDouglas production function, the marginal product of capital will increase if:
A) the quantity of labour increases.
B) the quantity of capital increases.
C) labour's share of output increases.
D) average capital productivity decreases.

16. In a closed economy, the components of GDP are:

A) consumption, investment, government purchases, and exports.
B) consumption, investment, government purchases, and net exports.
C) consumption, investment, and government purchases.
D) consumption and investment.

17. If the consumption function is given by C = 500 + 0.5(Y ñ T), and Y is 6,000 and T is
given by T = 200 + 0.2Y, then C equals:
A) 2,500.
B) 2,800.
C) 3,500.
D) 4,200.

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18. If the consumption function is given by C = 150 + 0.85Y and Y increases by 1 unit, then
savings:
A) decreases by 0.85 unit.
B) decreases by 0.15 unit.
C) increases by 0.15 unit.
D) increases by 0.85 unit.

19. Assume that the consumption function is given by C = 150 + 0.85(Y ñ T) and the tax
function is given by T = t0 + t1Y. If t0 increases by 1 unit, then consumption:
A) decreases by 0.85 units.
B) decreases by 0.15 units.
C) increases by 0.15 units.
D) increases by 0.85 units.

20. Assume that the consumption function is given by C = 200 + 0.7(Y ñ T), the tax function
is given by T = 100 + 0.2Y, and Y = 50K0.5L0.5, where K = 100. If L increases from 100
to 144, then consumption increases by:
A) 560.
B) 840.
C) 1,120.
D) 2,120.

21. Assume that the investment function is given by I = 1,000 ñ 30r, where r is the real rate
of interest (in percent). Assume further that the nominal rate of interest is 10 percent and
the inflation rate is 2 percent. According to the investment function, investment will be:
A) 240.
B) 700.
C) 760.
D) 970.

22. The investment function slopes ______ because there are ______ investment projects
that are profitable as the interest rate decreases.
A) upward; fewer
B) upward; more
C) downward; fewer
D) downward; more

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23. The government spending component of GDP includes all of the following except:
A) federal spending on goods.
B) provincial and municipal spending on goods.
C) federal spending on transfer payments.
D) federal spending on services.

24. In a classical model with fixed factors of production and flexible prices, the amount of
consumption spending depends on _____ , the amount of investment spending depends
on _____, and the amount of government spending is determined _____.
A) the interest rate; disposable income; by tax revenue
B) the real wage; the real rental price of capital; by factor prices
C) labor's share of output; capital's share of output; by the interest rate
D) disposable income; the interest rate; exogenously

25. In the classical model with fixed output, the supply and demand for goods and services
are balanced by:
A) government spending.
B) taxes.
C) fiscal policy.
D) the interest rate.

26. In the classical model with fixed income, if the demand for goods and services is less
than the supply, the interest rate will:
A) increase.
B) decrease.
C) remain unchanged.
D) either increase or decrease, depending on whether consumption is greater or less
than investment.

27. If disposable income is 4,000, consumption is 3,500, government spending is 1,000, and
tax revenues are 800, national saving is equal to:
A) 300.
B) 500.
C) 700.
D) 1,000.

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28. If income is 4,800, consumption is 3,500, government spending is 1,000, and tax
revenues are 800, private saving is:
A) 300.
B) 500.
C) 1,000.
D) 1,300.

29. If income is 4,800, consumption is 3,500, government spending is 1,000, and tax
revenues are 800, public saving is:
A) ñ200.
B) 200.
C) 500.
D) 1,800.

30. In equilibrium, total investment equals:

A) private saving.
B) public saving.
C) national saving.
D) household saving.

31. The demand for loanable funds is equivalent to:

A) national saving.
B) private saving.
C) public saving.
D) investment.

32. The supply of loanable funds is equivalent to:

A) national saving.
B) private saving.
C) public saving.
D) investment.

33. The supply and demand for loanable funds determine the:
A) real wage.
B) real rental price of capital.
C) real interest rate.
D) nominal interest rate.

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34. If saving exceeds investment demand and consumption is not a function of the interest
rate:
A) the demand for loans exceeds the supply of loans.
B) the interest rate will fall.
C) the interest rate will rise.
D) saving will fall.

35. Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C
= 500 + 0.6Y. No government exists. In this case, equilibrium investment is:
A) 1,500.
B) 2,000.
C) 2,500.
D) 3,000.

36. In the classical model with fixed income, a reduction in the government budget deficit
will lead to a:
A) higher real interest rate.
B) lower real interest rate.
C) higher level of output.
D) lower level of output.

37. According to the model developed in Chapter 3, when taxes decrease without a change
in government spending:
A) consumption and investment both increase.
B) consumption and investment both decrease.
C) consumption increases and investment decreases.
D) consumption decreases and investment increases.

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Use the following to answer questions 38-39:

Exhibit: Saving, Investment, and the Interest Rate 1

38. (Exhibit: Saving, Investment, and the Interest Rate 1) The economy begins in
equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals
desired investment, I1. What will be the new equilibrium combination of real interest
rate, saving, and investment if the government cuts spending, holding other factors
constant?
A) Point A
B) Point B
C) Point C
D) Point D

39. (Exhibit: Saving, Investment, and the Interest Rate 1) The economy begins in
equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals
desired investment, I1. What will be the new equilibrium combination of real interest
rate, saving, and investment if the government cuts taxes, holding other factors
constant?
A) Point A
B) Point B
C) Point C
D) Point D

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Use the following to answer questions 40-41:

Exhibit: Saving, Investment, and the Interest Rate 2

40. (Exhibit: Saving, Investment, and the Interest Rate 2) The economy begins in
equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals
desired investment, I1. What will be the new equilibrium combination of real interest
rate, saving, and investment if there is a technological innovation that increases the
demand for investment goods?
A) Point A
B) Point B
C) Point C
D) Point D

41. (Exhibit: Saving, Investment, and the Interest Rate 2) The economy begins in
equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals
desired investment, I1. What will be the new equilibrium combination of real interest
rate, saving, and investment if there is a tax law change that makes investment projects
less profitable and decreases the demand for investment goods (but does not change the
amount of taxes collected in the economy)?
A) Point A
B) Point B
C) Point C
D) Point D

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42. When saving (the supply of loanable funds) increases as the interest rate increases, an
increase in investment demand results in a ______ interest rate and ______ in the
quantity of investment.
A) higher; no change
B) higher; an increase
C) lower; no change
D) lower; an increase

43. The government raises lump-sum taxes on income by $100 billion, and the neoclassical
economy adjusts so that output does not change. If the marginal propensity to consume
is 0.6, national saving:
A) rises by $100 billion.
B) rises by $60 billion.
C) falls by $60 billion.
D) falls by $100 billion.

44. In a neoclassical economy, assume that the government lowers both government
spending and taxes by the same amount. By doing so:
A) investment falls and the interest rate rises.
B) investment rises and the interest rate falls.
C) investment and the interest rate both fall.
D) investment and the interest rate both rise.

45. In a neoclassical economy, assume that the government lowers both government
spending and taxes by $100 billion. If the marginal propensity to consume is 0.6,
investment will:
A) rise by $100 billion.
B) rise by $60 billion.
C) rise by $40 billion.
D) not change.

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Answer Key

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

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45. C

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