Download Queens College, ECO 101, 2 Mid-Term Exam Prof. Dohan, Fall 2012

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Queens College, ECO 101,
2 Mid-Term Exam
Prof. Dohan,
Fall 2012
Last Name (Print)_________________________, First _________________ Student ID ____________________
Phone Number ___________________ Year____ Major _______ College e-mail___________________________
Language spoken at home____________________Country of birth _______________________________
Part I Some basic vocabulary and concepts (2 pt each)
Select the best answer for phrase in Column A from the phrases given in Column B. * means “carful”.
Put letter
(Abbreviations/symbols used frequently in class are on “Hint Sheet”.)
here
Column A
Column B.
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2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
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A Taxes- (gov’t spending +gov’t transfers) >0
B All people with any amount of paid work + people actively looking for
work
real interest rate
C Imports, income taxes, unemployment payment => ↓value of multiplier
Multiplier effect (cause of)
D Taxes- (gov’t spending – gov’t transfers) <0
Standard Income Tax multiplier
E Nominal GDP adjusted for net foreign income earned by US firms
Balanced budget multiplier
F Nominal GDP corrected for price changes by the GDP deflator
Real GDP
G Income taxes reduces the multiplier effect by reducing income available to
consumers
Marginal propensity to consume
H Adjustment to multiplier because taxes are paid partly from savings.
Cost of inflation to society
I The APR or interest rate actually paid on consumer debt
Demand-pull (Keynesian) inflation J Nominal interest rates minus inflation rate
Lump sum tax
K Firms demanding higher prices for their excess inventory
Value-added
L Demand is greater than potential GDP including net imports
Potential GDP
M Taxes that don’t vary with income or sales such as property tax
Induced investment caused by
N Excise taxes on cigarettes, alcohol, perfume, tires, phone service
higher output (crowding in)
Automatic stabilizers of Ya* from O Caused by the spending and re-spending of a primary shift in ∆Yd
external shocks.
(aggregate demand).
Equilibrium only if Ia = Id=Sd
P Caused by spending and taxing of the same amount by government
Measure of the labor force
Q Sales – cost of goods and services bought from other firms.
The interest determined
R A gross investment in physical, new homes, changes inventory minus
component of investment
depreciation.
How to estimate the doubling time S Increase in C from each additional dollar of Ydi.
Net growth of real private capital
T Distorts peoples’ and producers’ investment & purchase decisions
U * Hurts debtors and helps creditors if unexpectedly high.
V Level of GDP which fully employs labor force
W Investment caused by increased need for capacity as output rises; therefore,
leaving a larger real capital stock for future generations despite an increase
in public debt.
X Business order/invest more, same or less depending on Ia <, = or > Id
Y 70 divided by growth rate per period = approximate doubling time
Z People who do not want to work
aa People changing jobs, frictional, structural and, Keynesian unemployment
bb Net investment of money in the stock market by investors
cc Causes public debt to rise creating a potential burden on future
generations
dd Actual desired investment rises as interest rates fall
Types of unemployment
Federal government deficit
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Part II Multiple Choice and Simple Questions: (2 pts each unless otherwise specified)
____1. What determines the actual rate of investment in the economy? (Careful, not the demand rate)
a. The need to replace sold inventories and depreciated capital.
b. The desired rate of investment.
c. The desired rate of savings which also determines the actual rate of saving.
d. The interest rate.
e. The profitability of new investment.
____2. Which one of the following resources of an economy is not “scarce” in the sense that if the resource is made
available to one producer, other producers could (theoretically) also use it at the same time at little or no social cost
(if not prohibited legally)?
a. Capital
d. Labor
b. Human Capital.
e. Natural Resources
c. Existing Production Technology.
3. The multiplier is defined as the increase in the equilibrium level of income resulting from a shift in the aggregate
demand for final goods and services (∆Yd) and is usually between 2 ½ and 6. Two factors change the size of the
multiplier: the secondary expansion of demand which causes the multiplier effect and the automatic stabilizers
which reduce the impact of a shift in aggregate demand. Using up  or down  arrows or zero for no change, show
what impact each of the following events has on the size of the multiplier. (1 pt each)
_____a. the marginal propensity to consume goes down
_____b. the income tax rate “tx” is lowered
_____c. the marginal propensity to invest rises to = 0.25Ya*
_____d. the marginal propensity to import Chinese goods rises because the $ rises against the Yuan.
_____e. *unemployment payments rise as income falls (careful)
4. How are these items counted in gross domestic product (GDP)? Put an “X if counted in the EXpenditure
approach, E if in Earnings approach, B if appear in both expenditures and earnings approach (yes), DI if only in
disposable income, Not if not included at all. Careful (1 pt each = 18 pts)
____a. New computer bought for use at home
___j. New computer bought by accountant for doing taxes
____b. Gardening done by a landscape company.
___k. Gardening done by the homeowner
____c. Building a new home.
___l. Purchase of the Plaza Hotel by an investment group.
____d. Fall in business inventories caused by a recession.
___m. Net bond interest paid by Federal government to households.
____e. Net interest paid by businesses to households. ___n. Wages paid to CUNY professors.
____f. Social Security payments paid to professors.
___o. Wages paid to TSA personnel by the Federal Government.
____g. Indirect business taxes paid by business
___p. Building of a new smart grid by the government.
____h. Net gambling winnings or losses in Atlantic City.
___q. The purchase of cigarettes by a person under 21.
____i. Net profit of casinos
___r. Scholarships received by students.
5. Calculate the percentage change in real GDP given the following data. (3 pts)
Year Nominal
% Increase in GDP 2009
Real GDP
Real GDP
GDP billions Nominal GDP Price Index 2009 prices (% increase)
2009 14,000
100.
14,000
-------------------2010 14,560
%
About
Set up formula here
6. Watch out! Which policies would lead to a higher growth rate of labor productivity over the next ten years?
Label as T for TRUE or F for FALSE. For these questions, assume that “Investment” = I + bYa (where bYa equals
induced investment). Hints: growth and labor productivity, look at these functions HC/L,
Q/L = ft(K/L, N/L), K=∑(It – depreciationt). Children don’t work. (1 pt each = 7 pts)
_____A. The Chinese policy of restricting the number of children in a family.
_____B. Reducing taxes on new investment using investment tax credits and accelerated depreciation.
_____C. In a full employment economy, the government lowers interest rates and raises income taxes on households.
_____D. In an economy with unemployment, the government lowers household taxes to increase output and
consumption, thereby encouraging businesses to invest.
_____E. In today’s economy with unemployment at 8%, the government should cut the large deficit by raising
income taxes and cutting government spending. This will increase business confidence (Sound familiar?)
_____________F. Corporate retained earnings are savings (non-spending on other inputs, taxes and dividends). Thus they are
actual savings available to finance new investment. Reducing taxes on corporate profits would increase
corporations’ ability to finance investment.
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______G. Even if we must raise taxes to prevent inflation, the government should increase human capital through
research grants and scholarships to Engineering, Science, and Social Sciences at the university level and give
tax credits to encourage research at the corporate level.
7. Gross Domestic Production Basics Using Two Approaches
List The Category of Items Included in GDP by two approaches (2 pts each item)
A Expenditure Approach
B. Earnings Approach
1. Consumption
1. Wages
2. _________________
2.
3. __
3.
4.
4.
5.
5.
.
6.
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7.
PART III TRUE AND FALSE (2 PTS EACH)
(The whole statement must be true for it to be true; only part false to be false
____A. Since the price of computers and clothing has fallen over the past few years, we can reliably conclude that we
do not have inflation as is measured by the CPI (consumer Price Index).____
B. The primary cost of unemployment to society as measured by economists is lost output.
____C. If the GDP price deflator rises from 200 to 220 (10%) and the nominal GDP rises from $10 trillion to $12
trillion, then the real GDP has risen.
____ D. Nominal GDP measures the output of all final goods and services for this year as evaluated at the market price in
the base year.
____E. Despite the large increase in tax rates that may be necessary to fund payments to retirees in future years, and
despite the fact that we have a smaller labor force to support EACH retiree, it is possible that the standard of
living of both groups could rise. (Hint: Look at labor productivity function in Part I, Question 6.)
____F. If imports and taxes rise with income, this could potentially reduce the impact on output that otherwise would be
caused by a sudden upward shift in investment or government spending (e.g. upward shift in aggregate demand).
____G. If we are in the middle of a recession with high unemployment, falling prices and a large deficit, a sudden increase
in spending by the government on 1) grants to states to hire more workers and 2) infrastructure projects (smart
grid) in fact could increase investment and capital stock so that future generations could be left economically
better off despite making the deficit larger.
____H. At the national level, taxes should always be raised and government spending should always be cut whenever we
have a deficit in the Federal budget. (Tx – G – Tr < 0); otherwise the resulting higher national debt will become a
higher debt burden on future generations.
____I. Adding an income tax rate of tx% to our tax equation ( Tx= Tx +txYa) makes the multiplier larger.
____J. Ceteris paribus, if Id is determined in part by induced investment (marginal propensity to invest = mpi) which
gives us an investment function, Id = I +mpiYa*. This is called “crowding in” which makes the multiplier larger.
____K. A permanent increase in disposable income Ydi resulting from a reduction in weekly payroll taxes withheld will
probably have a larger impact on the consumption function than if the same annual amount is sent out in a check
once per year as a lump sum distribution.
____L. Raising taxes on the rich (income over $1 million) will probably have a relatively small impact on consumption.
____M. A permanent policy of lower taxes will probably shift the consumption function upward even though it might
increase the deficit and the national debt over the next decade.
____N. People will probably consume more when their personal wealth (net assets) goes up at any given level of
disposable income.
____O. People consume more as the federal debt goes down because there is less burden of the federal debt per capita.
____P. The primary purpose of savings from disposable income by households is to earn interest and profits on their
“investments” . Thus the interest rate plays an important decision in how much they save.
____Q. The primary purpose of savings from disposable income by households is to redistribute consumption over time.
____R. Households which consume more than their disposable income are dissaving, and therefore have an MPS< 0.
____S. Households which consume more than their disposable income are dissaving, but nevertheless have an MPS>0 .
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____T. *In a simple model, assume we have unemployment and the equilibrium is where Sd = Id (desired savings equals
desired investment). Assume also that the Id curve slopes upward (induced investment) when plotted as a function
of output Ya. If households are optimistic about the future and decide to save less for a rainy day, paradoxically
then, the overall level of actual investment and savings may go up at the new equilibrium (paradox of thrift).
____ U. If there is full employment, and the federal government is running a surplus, then the government should pay back
this surplus to the taxpayers because the taxpayers’ hard earned money paid the taxes to create these surpluses.
____ V. The MPS + MPC always equals 1. Therefore, if I know the MPC, we always know the MPS.
4 pts
____ W. Ya* (the equilibrium level of output) is always considered by economists to be good for society because at this
level the demand for goods equals the supply of goods. This always implies that there is no demand-pull inflation
from excess demand and no Keynesian-type unemployment from too little demand for goods and services.
____ X. One problem in reducing unemployment in a slow-growing economy is that the continuous increase in labor
productivity resulting from growing capital stock and technological progress reduces the need for more labor.
____ Y. A decrease in imports will shift the Yd upward, (or in the language of the textbook, “shifts AE upwards”) and
increases the equilibrium level of GDP.
____ Z. A policy of taxing higher incomes more and giving the tax proceeds to the lower income families will not have an
impact on the AE (Yd) curve because this policy merely redistributes the same amount of income.
_ __ AA. If imports and income taxes rise with income, that is, IM=IM+impYa and Tx=Tx+txYa, these are types of
“automatic stabilizers” that make the multiplier larger.
____ BB. It is possible that even though measured real GDP per capita in $ grows, the overall wellbeing of society can
fall over time because of environmental damage and global warming.
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PART IV. MACRO ECONOMIC FISCAL POLICY PROBLEM (no algebraic problem) (40 points)
All Symbols are on your “Symbols and Hints Page No credit will be given for just a number!
2 pts
A small European industrial economy such as Spain, hard hit by the world financial crisis, has the goal of FEWPS (fullemployment with price stability). You have just a few pieces of data about them.
Ya = actual GDP,
Ydi = Ya-Tx + Tr, Disposable Income
Yd = aggregate demand (in lecture or “aggregate expenditure” or AE in text) and is defined as Yd = C+I+G+X–M,
Ya* is where Ya = Yd where aggregate demand equals actual GDP output. Equilibrium Condition
$
Initial Condition of Economy in constant dollars
You do not need to solve algebraic equations to find the answers!
The equilibrium level of GDP output is currently:
Ya* = 11,000
Full employment level of GDP output
Yfe = 15,000
Marginal propensity to consume = MPC=∆C/∆Ydi
MPC = 0.8
Interest-determined component of investment I(i)
Part of firms’ planned investment I(i) is determined
by a comparison of the profitability of their various
projects with the relevant interest rate. If the profit
per year is higher than the interest rate, they invest.
The interest rate can be influenced by the size of
the current money supply Ms
Table I.
Money Interest I(i)
Supply Rates
12%
100
600
10%
200
700
8%
300
800
6%
500
1,000
5%
800
1,200
4%
1,000
1,500
3%
2,000
2,000
2%
25,000
Two point each unless otherwise noted.
Ya
Yd = C+I+G+X-M
Ms = 700
11,000
Ya*
15,000
YFE
$Ya
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Each question is 2 pts plus the gray boxes unless otherwise noted. Be sure to use graph on previous page for answers.
______1. What is the one basic economic problem in this economy?
# 2 Multiplier equation
a. high rate of inflation, b. slow growth, c. deep recession
_______ 2 Calculate the simple multiplier (show equation) 2 pts
________ 3. In Spain, they initially felt that their large deficit was the cause of their
2 pts for work economic problems and their massive borrowing. Thus, they cut
________
#3 Show your work
government spending by 1 billion Euros. Let’s assume their
multiplier is 3. Calculate the amount of the impact you predict such a
cut had on equilibrium GDP (Ya*), using modern economic theory. Be
sure to specify the direction and types of changes (up or down).
_____2 pts 4. Using post-Keynesian macro theory, what basic fiscal policy strategy are you going to recommend to achieve
these goals?
#5a Income Gap Ya* (for question 5a
a. simply change the equilibrium level of GDP
below)
b. cut the deficit first and then see what else needs to be done.
c. raise or lower Yd (aggregate demand) by the amount of the demand gap
d. raise or lower Yd (aggregate demand) by the amount of the income gap
e. lower the full employment level of income
Watch your signs & show equations and calculations. Mark your answers above on graph.
33pts
5a. Mark the amount of YFE on the Ya axis and draw a vertical line from YFE to the 45o line (Use your school ID as a ruler)
pts
5b. Calculate the income or output gap: Ya* = YFE -Ya. That is, what change in Ya* do you want to
make Ya* equal to YFE? That change is called Ya* Show your work in box above.
3 pts 5c Now mark the income or output gap Y * by drawing an arrow in the correct direction and label it “income gap”
a
3 pts
with the amount.
4 pts 5d. Calculate the shift in aggregate demand (Yd ) or the aggregate demand gap with the correct sign.
Yd times the multiplier = Ya. which plus Ya will move Ya* to potential GDP (YFE). Show work in box
below. #5b Aggregate Demand Gap so that Yd * M = Ya* (put numbers in equation)
4 pts
4 pts 5d. Mark the “demand gap”Yd by drawing an arrow in the correct direction of desired change, and label it
4 pts
“demand gap” with the amount.
6. Draw the “new” Yd curve so the new Yd crosses the Ya line at YFE, based on your calculations of the demand gap.
V. Required algebraic GDP problem. (2 pts each unless noted)
Assume that we have estimated or determined the following functions and or data for an economy in dollars.
Yd = C + I + G + X – IM
Interest determined component of
C = 400 + .75 * Ydi
investment demand I(i)
I = 400 + I(i)
Ms=Money i=interest
I(i)
supply
rate in %
G = 400
100
12%
50
Tx = 800
Money
200
10%
100
Tr = 600
supply
8%
300
300
Ydi = Ya – Tx + Tr
=
500
6%
400
X = 400
$300
800
5%
600
IM= 300
2 pts
8
1200
$1800
4%
3%
1000
1200
1a. What is the equilibrium level of output? (6 pt)
1b. Show your work to the right. Be sure to keep all the
numbers separate and variables separate even though you were taught
in high school to combine them all. Remember that each number
represents a possible policy variable.
_______2a What is the multiplier? a) .75 b) 1.33 c) 5 d) 4
_______2b What is the multiplier formula in this simple case? a) M=.75*Yd b) M= 1.33*Yd c) M = 1/(1-.75)
_______3. What is the marginal propensity to consume?
a. 400
b. 0.2
c. 0.75
d. 0.25
e. 0.8
_______4. What is the status of the government budget? T-G-Tr > 0 = surplus, , <0 = deficit, = 0 is balanced.
a. surplus b. deficit c. balanced
d. not enough info
e. 0
_______5. If full employment YFE is at 4800, what is the major problem that we are having in the economy?
a. stagflation b. inflation c. unemployment
d. slow growth e. slow per capita growth
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∆____6. What is Ya, the inflationary or recessionary (∆ income) gap as used in the book?
2
6b. Label Ya on the graph above with arrows (← →) pointing in the direction of change.
∆____7a. What shift in aggregate demand (∆Yd) or autonomous spending (AE) will correct our economic problem?
7b. Label this demand gap (∆Yd) on the above graph with arrows (↑↓) pointing in the direction of change.
POLICY TO IMPROVE THE ECONOMY: FISCAL AND A LITTLE BIT OF MONETARY (“x” = times)
2 pts
∆_________8a. If possible, what could the government do to government spending to correct our economic problems?
3 8b. Prove: _________∆G of _____ x multiplier of ___ = ______ which closes the income gap.
9. If possible, what could the government do to consumer spending to correct the economic problems?
2 pts______________ C by ____________. Proof:
2 pts ∆C=______
9a Want ∆C (consumer spending) to go________ by $_______. (Put in the correct sign)
4 pts∆Y =______ 9b. Want Y
di
di (disposable income) to go ________ by $_________ which x MPC of .75 =∆C =_____.
4 pts ∆ TX ______ 9c Since Ydi = Ya-Tx+Tr, we want to ____ taxes by ____ which x (-1) will______Y by ______.?
di
6pts In sum: ∆TX ____ x (-1) = Ydi___x MPC of .75 _____ C by $ _____ x multiplier of ___ = $______ which closes the income gap
2 pts _______10.Why is there a difference between the change in taxes and the change in government spending?
a. There is none. b. Some taxes come from savings c. Taxes are fixed d. Govt spending is wasteful.
2 pts ∆______11.What $ change could the government do with political difficulty to ∆TRansfer payments?
Intro to monetary policy:
3 pts _____by _____ What change do we want in investment from the current $200? _________by ______
3pts______ ___% We get this change by ________ interest rate from 8% to ____% by changing the money supply.
4pt ______ $____ ____% We ______ Ms (money supply) from 300 to ______ so the interest rate _____from 8% to___%
As a result, the interest-determined component of investment goes __ by $______
which x multiplier of 4 = $_______ which closes the gap! Hurrah!
A few more questions based on the original problem before policy: Remember Ya = equilibrium level of income.
2 pts _______
______12.1/ 12.2 If the demand for exports goes up by 100, what impact will this have on Ya?
Ya will ____ by $_______. Don’t forget the multiplier
2 pts_______
______13.1/ 13.2 If more Americans decide to import and buy $100 more cell phones and tablets from foreign
country, ceteris paribus, Ya will _____ by $_______. Don’t forget the multiplier and the sign on imports.
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2 pt each unless noted
VI The Twin Functions of Consumption & Savings New Problem
In a simple economy, with no I, G, or Tx or Tr, or X & M, consumption equals C= 1200 plus .8Ya
________1a. What is the multiplier? It will help you answer the questions below.
________2. What consumption graph below best plots this C-function.
$
AE or Yd
Aggregate
A
Ya
C
$
_____3.
Ya
C
D
$
Ya
C
Expenditure
200
B
1200
C
$
Ya
C
GDP
1200
Output
2222
GDP
Ya
Ya
.8Y
1200 GDP
GDP 2222
6000
Output
4800
Output
Output2222
2222
2222
Based on your choice above, or a calculation, at what output level Ya* will
the people be spending exactly as
2222
*
much as is being produced at Ya assuming no government spending, no
taxes, no transfer payments, etc?
2222
A. +.8Y
B. 800
C. 4800
D. 6000
2200
Ya
Ya
1200
7
S=I equilibrium
____1. Which function is the numerical savings function that is the twin of the consumption function above?
a S=Ya-C b. S=Ya-1200 c. S= -1200 +.2Ya d. S=-1200 + .8 Ya
2. Assuming that Id =0 and Yd = 1200+.8Ya, at what level of Ya* does Sd = 0. Calculate & enter on left.
______3. Based on your choice above, or a calculation, which saving graph best represents the savings function corresponding to (or
derived from) the consumption problem in the above problem Think about which graph represents the actual savings function, such that
Sd = 0 at the output level where C equals Ya. Remember that where the consumption function intersects the 45 degree Ya line, consumption exactly equals
output and that level of output is called the “breakeven point”. The slopes of these graphs below are representational and not realistic.
Saving-Investment Graphs
Saving $
Graphs
A
Sd=+200
Sd=0
Sd=-200
.8Y
$
Sd
Ya
B
Sd=+200
0
Sd=0
$
Sd
C
Sd=+400
Sd=+400
Sd=+200
Ya
Sd=1200
Ya
5000
Sd=-200
D
Sd
Sd=+200
Sd=0
1200
Sd=-200
Sd=-1200
$
Sd
6000
Sd=0
Ya
Sd=-200
7000
Sd=-1200
5000 6000 7000
Sd=-1200
4a. Now assume that firms raise their Id from 0 to 200. Since Id = Sd for a simple economy to be in
equilibrium, and since Id = 200, at what Ya* does Sd rise to 200. Remember Sd = -1200 + .2Ya. Solve this
algebraically
4b. After desired investment Id goes up to 200, what principle of business behavior makes the economy and savings
move up or down?
a. Sd=Sa=Ia > Id, so orders & output fall, b. Sd=Sa=Ia < Id, so orders & output rise
3 pts
c. Sd=Sa=Ia = Id, no change
4c. On the same saving-investment chart below copied from Question 3, draw a horizontal line
that
represents Id= 200. Now draw a vertical line from the intersection point with the horizontal axis at the new Ya*
where desired savings equals desired investment (Sd = Id).
Saving-Investment Graphs
Saving $
Graphs
A
Sd=+20
0
Sd=0
Sd=-200
Sd=-1200
.8Y
$
Sd
Ya
B
Sd=+200
0
Sd=0
Sd=-200
Sd=1200
$
Sd
Sd=+400
$
Sd
C
Sd=+400
Sd=+200
Ya
1200
Sd
Sd=+200
Sd=0
Sd=-200
D
Ya
5000 6000 7000
Sd=-1200
Sd=0
Sd=-200
Ya
5000 6000 7000
Sd=-1200
*
4d. At what level of output Ya does Sd intersect the Id line. It should be the same as your answer in 6a.
4e. What is savings at this level of output. Remember this.
The Paradox of Thrift
5. Let us assume that savers want to save 200 more (in addition to the 200 they are already saving) to rebuild their
retirement fund destroyed by the recession. So they don’t buy as much at any given level of output and disposable
income. Remember that desired investment Id still equals 200.
The new savings function is: Sd = -1200+.2Ya + 200. The old investment function is still Id = 200
4 pts
5a. Solve algebraically for the new equilibrium level of income Ya* such that Id = Sd =where Id still equals 200
Show work
4 pts
4 pts
4 pts
5b. Chose which savings-investment graph above, that shows the correct level of Ya* and draw the new savings
line on top of the old saving line. Determine where it intersects the Id=200 line. Enter that number to the left.
.
5c What is the new equilibrium output, investment, and saving after people all try to save more?
A. I =400, S =400, Ya = 7000 B. I =200, S =400, Ya = 7000 C. I =200, S = 200, Ya = 5000 D. No equilibrium
5d. How much more is saved at the new equilibrium? That’s the paradox
4 pts
of thrift:
A fallacy of composition.
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