Principles of Economics Practice Exam
Course Introduction
Principles of Economics introduces students to the fundamental concepts and analytical tools used in microeconomics and macroeconomics. The course explores how individuals, firms, and governments make choices about allocating limited resources, examines the forces of supply and demand, and analyzes market structures and the role of competition. Students also learn about key macroeconomic topics such as inflation, unemployment, economic growth, and fiscal and monetary policy. Through real-world examples, the course aims to provide a solid foundation for understanding how economic principles apply to everyday life and inform policy decisions.
Recommended Textbook Money Banking and the Financial System 3rd Edition by R. Glenn Hubbard
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Page 2
Chapter 1: Introducing Money and the Financial System
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Q1) Fannie Mae and Freddie Mac both
A) sell bonds to investors and use the funds to purchase mortgages.
B) help regulate the banking system.
C) directly lend funds to people seeking mortgages.
D) reduce access to funds for mortgages by purchasing existing mortgages.
Answer: A
Q2) All of the following are true regarding securitized loans EXCEPT
A) they provide risk sharing.
B) they provide information.
C) they provide liquidity.
D) they cannot be resold.
Answer: D
Q3) Alt-A borrowers were those who
A) used mortgages to purchase apartments.
B) chose adjustable-rate mortgages instead of fixed-rate mortgages.
C) borrowed using "interest-only" mortgages.
D) did not provide documentation of their income when applying for a mortgage.
Answer: D
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3
Chapter 2: Money and the Payments System
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Q1) By "specialization" economists mean a situation where
A) individuals produce the goods or services for which they have relatively the best ability.
B) goods are traded directly for goods and money is not used.
C) individuals who produce goods do not also produce services and individuals who produce services do not also produce goods.
D) individuals are assigned to occupations on the basis of tests that gauge their relative abilities.
Answer: A
Q2) Commodity money can best be described as
A) money used to purchase agricultural products.
B) a good used as money that also has value independent of its use as money.
C) standardized goods like gold that trade in a financial market.
D) the form of money used in a barter system.
Answer: B
Q3) What is the difference between money,income,and wealth?
Answer: Income is equal to a person's earnings over a period of time.Wealth is the sum of a person's assets minus the sum of a person's liabilities.Money is a medium of exchange and one component of a person's wealth.
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Page 4
Chapter 3: Interest Rates and Rates of Return
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Q1) Which of the following is the correct expression for the approximate expected real interest rate?
A) r = i + <sup>e</sup>
B) r = i - <sup>e</sup>
C) r = i/ <sup>e</sup>
D) r = i <sup>e</sup>
Answer: B
Q2) The expected real interest rate approximately equals
A) the nominal interest rate minus the tax rate.
B) the nominal interest rate minus the expected rate of inflation.
C) the nominal interest rate plus the expected rate of inflation.
D) the yield to maturity on a coupon bond held to maturity.
Answer: B
Q3) Suppose a firm receives $975 for a discount bond with a face value of $1,000 to be repaid in one year.What is the amount of interest on the bond? What is the interest rate on the bond? Report a percentage with two decimal places.
Answer: The amount of interest is $1,000 - $975 or $25.the interest rate is $25 / $975 which equals 2.56%.
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Page 5
Chapter 4: Determining Interest Rates
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Q1) If there is an excess demand for bonds at a given price of bonds,then
A) the interest rate will fall.
B) the interest rate will rise.
C) the price of bonds will fall.
D) the interest rate may rise or the interest rate may fall depending upon the reasons for the excess demand for bonds.
Q2) The expected change in the supply and demand for bonds due to an increase in expected inflation will definitely result in
A) an increase in the equilibrium price of bonds.
B) an increase in the equilibrium quantity of bonds.
C) a decrease in the equilibrium price of bonds.
D) a decrease in the equilibrium quantity of bonds.
Q3) The Federal Reserve issues a report indicating that future inflation will be higher than had previously seemed likely.As a result
A) the supply curve for bonds shifts to the right.
B) the demand curve for loanable funds shifts to the left.
C) the equilibrium interest rate falls.
D) the equilibrium price of bonds rises.
Q4) Explain why the nominal interest rate is the opportunity cost of holding money.
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Chapter 5: The Risk Structure and Term Structure of Interest
Rates
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Q1) U)S.Treasury securities
A) are considered risk free because their prices never change.
B) have been defaulted on several time in U.S. history.
C) are considered default-risk-free instruments.
D) have a large default risk premium.
Q2) The risk structure of interest rates refers to
A) the amount of additional interest necessary to compensate savers for the greater risk of default on some bonds.
B) the relationship among the interest rates on similar bonds with different maturities.
C) the relationship among the interest rates on bonds with the same maturity.
D) the amount of additional yield necessary to compensate savers for the lesser liquidity of some bonds.
Q3) According to the liquidity premium theory,the yield curve normally has a positive slope because
A) short-term interest rates are expected to rise.
B) term premiums rise as the time to maturity increases.
C) risk premiums rise over time.
D) long-term bonds are more liquid than short-term bonds.
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Chapter 6: The Stock Market, information, and Financial
Market Efficiency
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Q1) Behavioral economics can best be described as
A) the study of situations in which people's choices do not appear to be economically rational.
B) the study of human economic behavior.
C) the basis for efficient markets.
D) the study of how the economy affects human behavior.
Q2) Momentum investing can be described as
A) consistent with the efficient markets hypothesis.
B) similar to mean reversion.
C) follow the picks of investors who have been successful in the past.
D) the trend is your friend.
Q3) Explain what is meant by the "double taxation of dividends"?
Q4) Rising stock prices ________ household wealth,which ________ consumption spending.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
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Q5) Why do some economists think that taxing capital gains results in a locked-in effect?
Chapter 7: Derivatives and Derivative Markets
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Q1) The role of the Commodity Futures Trading Commission is to
A) set the prices of futures contracts.
B) operate the Chicago Mercantile Exchange.
C) operate the Chicago Board of Trade.
D) monitor potential price manipulation in futures trading.
Q2) Explain how each of the following might make use of the futures market:
(a)A lender who is worried that its cost of funds might rise during the term of a loan it has made.
(b)A speculator who believes strongly that interest rates will rise.
Q3) Southwest Airlines relies on jet fuel to operate its planes.If it chooses to hedge against future changes in fuel prices,what positions (long or short)will it take in the spot and futures markets?
Q4) The most important derivative instruments are
A) futures, options, and swaps.
B) common and preferred stocks.
C) corporate bonds.
D) government bonds.
Q5) What are the steps involved in using options for a short sale of a stock?
Q6) Why are forward contracts typically illiquid?
Q7) Explain the difference between a credit swap and a credit default swap.
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Chapter 8: The Market for Foreign Exchange
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Q1) Which of the following will take place in the foreign exchange market if there is an increase in the demand for products made in the United States?
A) The supply of dollars will decrease.
B) The demand for dollars will decrease.
C) The demand for dollars will increase.
D) The dollar will decrease in value.
Q2) If the interest rate in the United States rises
A) investors increase their demand for dollars and the U.S. exchange rate appreciates.
B) investors increase their demand for dollars and the U.S. exchange rate depreciates.
C) investors decrease their demand for dollars and the U.S. exchange rate appreciates.
D) investors decrease their demand for dollars and the U.S. exchange rate depreciates.
Q3) Suppose that the one-year Treasury bill rate in the United States is 6%,the one-year government bond rate in Canada is 4%,and investors expect the U.S.dollar to depreciate against the Canadian dollar by 4% over the coming year.Is the nominal interest rate parity condition violated?
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Chapter 9: Transactions Costs, asymmetric Information, and the Structure of the Financial System
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Q1) All of the following are consequences of adverse selection on good firms EXCEPT A) the cost of external financing increases.
B) firms need to rely more on internal funds.
C) firms need to rely more on accumulated profits.
D) firms will only be able to attain financing from the government.
Q2) To help offset the costs from loan defaults,the First National Bank of Gotham decides to increase the interest rate it charges on its business loans.As a result of this increase in the interest rate,the creditworthiness of Gotham's loan applicants is likely to A) improve.
B) deteriorate.
C) be unchanged.
D) be unchanged, unless the economy enters a recession at the same time as the interest rate is increased.
Q3) What are the reasons why disclosure by the SEC does not eliminate the information costs of adverse selection?
Q4) What are the various ways that financial intermediaries can take advantage of economies of scale?
Q5) How does the principal-agent problem increase the possibility of moral hazard?
Page 11
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Chapter 10: The Economics of Banking
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Q1) The process by which banks screen potential applicants by eliminating bad risks and to obtain a pool of creditworthy borrowers is called
A) gap analysis.
B) duration analysis.
C) credit-risk analysis.
D) liquidity analysis.
Q2) What are the different forms of bank borrowings?
Q3) Customers who have long-term relationships with banks
A) pose particular problems with respect to adverse selection.
B) pose particular problems with respect to moral hazard.
C) often obtain credit at a lower rate or with fewer restrictions.
D) are more likely to default or violate restrictive covenants.
Q4) Banks use repurchase agreements to
A) ensure that payments on consumer loans are made on time.
B) borrow funds from business firms or other banks.
C) guard against price fluctuations on long-term bonds.
D) ensure that they always have enough funds on hand to meet their federal tax liabilities.
Q5) What steps can a bank take to deal with a significant outflow of deposits?
Q6) What is a repurchase agreement?
Page 12
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Chapter 11: Beyond Commercial Banks: Shadow Banks and
Nonbank Financial Institutions
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Q1) Which of the following is NOT a form of a short-term loan in the shadow banking system?
A) repurchase agreements
B) commercial paper
C) money market mutual fund shares
D) bank deposits
Q2) Suppose an investment bank is buying $50 million in long-term mortgage-backed securities,and finances the investment by borrowing 80% and paying for the other 20% out of equity.What is the bank's return on its equity investment if the value of the mortgage-backed securities decreases by 20% during the year after they are purchased?
A) -25%
B) -40%
C) -50%
D) -100%
Q3) Which of the following is an investment institution?
A) The New York Stock Exchange
B) Greater Illinois Savings and Loan
C) Prudential Insurance Company
D) Fidelity Magellan Mutual Fund
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Chapter 12: Financial Crises and Financial Regulation
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Q1) What actions must a central bank take if it is trying to maintain a pegged exchange rate,but there's downward pressure on the value of its currency.
Q2) Which investment caused the Reserve Primary Fund to incur heavy losses?
A) mortgage-backed securities
B) real estate investment trusts
C) commercial paper issued by Bear Stearns
D) commercial paper issued by Lehman Brothers
Q3) In what ways did the stock market crash of 1929 increase the severity of the downturn?
Q4) The original intention of the Fed's role as lender of last resort was to make loans to banks that were
A) not illiquid nor insolvent.
B) illiquid, but not insolvent.
C) insolvent, but not illiquid.
D) both illiquid and insolvent.
Q5) How does the relationship between housing prices and rental rates provide evidence for or against the existence of a housing bubble?
Q6) What are two ways that governments can prevent bank panics?
Q7) What are the primary reasons for and against a policy of "too big to fail."
Page 14
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Chapter 13: The Federal Reserve and Central Banking
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Q1) The national economic forecast for the next two years prepared by the staff of the Board of Governors is published in the
A) Green Book.
B) Beige Book.
C) Blue Book.
D) Fed Book.
Q2) What is the length of a term for the Chairman of the Board of Governors?
A) one year
B) four years
C) 14 years
D) 28 years
Q3) The European Central Bank is responsible for the monetary policy of
A) the 5 largest European economies.
B) all countries on the continent of Europe.
C) all 28 countries in the European Union.
D) the 19 sovereign countries that use the euro as their currency.
Q4) What are the three books to which the FOMC has access and what information is included in each?
Q5) What are the limitations to the Fed's independence?
Q6) What constitutes meaningful independence of a central bank?
Page 15
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Chapter 14: The Federal Reserves Balance Sheet and the Money
Supply Process
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Q1) If C represents currency,D represents checkable deposits,N represents savings accounts,and MM represents money market mutual funds,which of the following equations is correct?
A) M2 = N + MM
B) M2 = D + N + MM
C) M2 = C + D + N + MM
D) M2 = C + D
Q2) If the required reserve ratio is 10% and the Fed purchases $20 million worth of securities,what is the simple deposit multiplier and what happens to the amount of deposits in the banking system? Assume that banks do not hold excess reserves and the public does not change its currency holdings.
Q3) Reserve deposits are
A) assets for financial institutions, but liabilities for the Fed.
B) liabilities for financial institutions, but assets for the Fed.
C) assets for both financial institutions and the Fed.
D) liabilities for both financial institutions and the Fed.
Q4) Suppose the required reserve ratio is 8% and that banks hold no excess reserves and the public does not change its currency holdings.If the Fed sells $5 million worth of securities,what happens to the amount of deposits in the banking system?
Page 16
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Chapter 15: Monetary Policy
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Q1) Which of the following is considered to be a goal of monetary policy?
A) a low federal budget deficit
B) fair wages
C) price stability
D) an end to poverty
Q2) Which of the following statements is correct?
A) The volume of open market operations is determined jointly by the actions of the public, banks, and the Fed.
B) The volume of open market operations is determined jointly by the actions of banks and the Fed.
C) The volume of open market operations is determined jointly by the actions of the public and the Fed.
D) The volume of open market operations is determined solely by the Fed.
Q3) Jow does the interest paid on reserves set a floor for the federal funds rate?
Q4) A matched sale-purchase transaction is also known as a
A) reverse repo.
B) discount loan.
C) put option.
D) federal funds loan.
Q5) On which type of unemployment can monetary policy have the most effect? Why?
Page 17
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Chapter 16: The International Financial System and Monetary Policy
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Q1) If the Fed sells foreign assets,the monetary base will
A) fall by the amount of the sale, only if the Fed buys domestic bank deposits with the proceeds.
B) fall by the amount of the sale, only if the Fed buys domestic currency with the proceeds.
C) fall by the amount of the sale, whether the Fed buys domestic bank deposits or domestic currency with the proceeds.
D) rise by the amount of the sale.
Q2) An unsterilized foreign-exchange intervention occurs
A) whenever a central bank purchases or sells domestic currency.
B) whenever a central bank purchases or sells foreign currency.
C) whenever a central bank allows the monetary base to respond to the sale or purchase of domestic currency.
D) whenever a central bank fails to reduce its holdings of gold by the amount of a foreign-exchange purchase.
Q3) Briefly describe how the Bretton Woods system worked.What advantages did it have over the gold standard? What problems did the Bretton Woods system eventually encounter?
Q4) Discuss the problems associated with the imposition of capital controls.
Page 18
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Chapter 17: Monetary Theory I- the Aggregate Demand and Aggregate Supply Model
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Q1) In the new Keynesian view,the larger the proportion of firms in the economy with sticky prices
A) the steeper the SRAS curve will be.
B) the flatter the SRAS curve will be.
C) the greater the increase in the price level for a given shift in the AD curve.
D) the less effective is fiscal policy in increasing output.
Q2) The new classical explanation of aggregate supply in the short run builds on research by
A) Irving Fisher.
B) John Maynard Keynes.
C) Robert Lucas.
D) Robert Solow.
Q3) An increase in all of the following will increase aggregate demand EXCEPT
A) investment.
B) savings.
C) exports.
D) government spending.
Q4) Explain what happens to the short-run aggregate supply curve when output exceeds its potential.
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Chapter 18: Monetary Theory Ii: the Is-Mp Model
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Q1) All of the following tend to occur when unemployment is above the natural rate EXCEPT
A) wage increases will be limited.
B) inflation will rise.
C) increases in the cost of production will be limited.
D) there is slack in the labor market.
Q2) Which interest rate is most relevant in determining aggregate expenditures?
A) federal funds rate
B) short-term real interest rate
C) long-term nominal interest rate
D) long-term real interest rate
Q3) What is the multiplier? If MPC = 0.75,what is the value of the multiplier in the simple model of the economy?
Q4) The marginal propensity to consume can best be described as A) consumption / income.
B) the impact of a change in income on GDP.
C) the change in income divided by the change in consumption.
D) the change in consumption divided by the change in income.
Q5) What is the difference between an autonomous change in spending and an induced change in spending?
Page 20
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