Download Answers to First Midterm

Economics 302
Answers to First Midterm
June 7, 2007
Name ________________________________
Student ID Number _____________________
Version 2
This midterm consists of 28 multiple choice questions (some with just two answers and some with up to
five answers) worth 2 points each for a total of 56 points and 3 problems worth 10 points each for a total of
44 points. Please answer all multiple choice questions on the scantron provided.
Pleases show all your work on the exam booklet: if any questions arise
as to the integrity of your exam, we will NOT give full credit unless
suitable work is shown in the exam booklet.
For all questions please pick the BEST answer.
SCANTRON DIRECTIONS
Please fill out your scantron sheet carefully. You need to use a number 2 pencil and you need to bubble in
your
 Name
 Student Identification Number (and NOT your social security number)
 Your exam version number in special codes column “A”
PROBLEM DIRECTIONS:
Please answer these questions on your test booklet. Please write legibly and please take some time to
organize your answer before your write it.
If you have questions about any question on the exam please make a note of that question on your exam
booklet and then draw the proctor’s attention to this question at the end of the exam. Please do not ask the
proctor any questions during the exam: no questions will be answered during the exam period.
You have 75 minutes to complete the exam. Please use your exam booklet margins for any calculations you
need to do.
Calculators are fine to use.
Problem #1 (12 points) _____________________
Problem #2 (12 Points) ______________________
Problem #3 (20 Points) ______________________
TOTAL
_______________________
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Multiple Choice Questions:
1. Real GDP in year 3 is calculated by
a. Summing together the product of the base year’s prices times the year 3
quantities of production.
b. Summing together the product of year 3’s prices times the year 3
quantities of production.
c. Summing together the product of year 3’s prices times the base year
quantities of production.
Answer: A.
2. In the classical model, an increase in the level of the money supply
I. Has no effect on nominal variables
II. Has no effect on real variables
III. Will result in an increase in the price level, holding everything else
constant
a.
b.
c.
d.
e.
Statements I, II and III are true.
Statements I and III are true.
Statements II and III are true.
Statement I is true.
Statement III is true.
Answer: C.
3. Economists build models and then use these models to test hypotheses. Variables
explained by the models are called
a. Endogenous variables.
b. Exogenous variables.
Answer: A
4. Depreciation is an example of a
a. Stock.
b. Flow.
Answer: B.
5. Positive increases in inventories cause
a. GDP for that period to increase.
b. No change in the level of GDP computed for that period.
Answer: A.
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6. Income is an example of a
a. Stock.
b. Flow.
Answer: B.
7. Computing GDP using the value added approach can also be referred to as double
counting.
a. True
b. False
Answer: B.
8. Reductions in inventories from the beginning level of inventories to the final level
of inventories during the period under consideration cause
a. GDP for that period to decrease.
b. No change in the level of GDP computed for that period.
Answer: B.
9. Sue, a U.S. resident, purchases Italian wine twice a month at her local grocery
store. Holding everything else constant, this purchase
1. Increases the level of U.S. consumption spending.
2. Decreases the level of net exports.
a.
b.
c.
d.
Statements (1) and (2) are correct.
Statement (1) is correct.
Statement (2) is correct.
Neither statement (1) nor (2) is correct.
Answer: A.
10. Real GDP is measured using
a. Constant dollars.
b. Current dollars.
Answer: A.
11. Suppose an economy’s production is described by a Cobb-Douglas production
function. If the amount of labor used increases, holding everything else constant,
this will
I. Increase the value of the MPL for this economy
II. Decrease the value of the MPL for this economy
III. Decrease the value of the MPK for this economy
IV. Cause labor productivity to decrease
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a.
b.
c.
d.
e.
Statements I, III and IV are correct.
Statements II, III and IV are correct.
Statements I and III are correct.
Statements II and III are correct.
Statements II and IV are correct.
Answer: E. An increase in the amount of labor used, holding everything else
constant, will cause labor productivity to fall as the additional labor has less
capital per unit of labor to work with. An increase in the amount of labor used,
holding everything else constant, will cause the MPK to increase since the
capital can now be used more intensively.
12. An increase in the GDP deflator may be due to
1. An increase in nominal GDP holding everything else constant.
2. An increase in real GDP holding everything else constant.
3. A decrease in real GDP holding everything else constant.
a.
b.
c.
d.
e.
Statements (1) and (2) are true.
Statements (1) and (3) are true.
Statement (1) is true.
Statement (2) is true.
Statement (3) is true.
Answer: B.
13. The CPI holds constant prices in its calculation, using prices defined at the level
they are at during the base year, while allowing quantities to vary from year to
year.
a. True
b. False
Answer: B. The CPI holds quantities constant at a predetermined level (this is
the idea of a fixed “market basket”) while utilizing the price level for each
particular year. Hence, prices vary from year to year in the calculation of the
CPI while quantities are fixed in its calculation.
14. An increase in the number of discouraged workers in an economy will, holding
everything else constant,
I. cause the unemployment rate to fall
II. cause the unemployment rate to rise
III. cause the labor force participation rate to rise
a.
b.
c.
d.
Statements I and III are correct.
Statements I and II are correct.
Statement I is correct.
Statement II is correct.
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e. Statement III is correct.
Answer: C. An increase in the number of discouraged workers will reduce the
unemployment rate since the unemployment rate is defined as the (number of
unemployed divided by the number in the labor force)*100: when discouraged
workers increase this causes both the denominator and the numerator to
change, but the decrease in the numerator has a larger impact than the
decrease in the denominator resulting in the overall ratio falling. The labor
force participation rate decreases when the number of discouraged workers
increases because the measure of the labor force is smaller (recall that the
measure of the labor force is the sum of the employed plus the unemployed)
while the total adult civilian population is unchanged. Hence, the labor force
participation rate = (labor force/total adult civilian population)*100 is now
smaller.
15. Suppose that the MPL for the next additional unit of labor is $35 while the
prevailing wage rate is $30. If you are a profit maximizing firm, you will
a. Hire more labor since the value of the production of another unit of labor
exceeds the cost of that unit of labor.
b. Hire less labor since you already have the profit maximizing amount of
labor employed at your factory.
c. Make no changes in the amount of labor you hire since more labor will
only reduce your level of labor productivity at your factory.
Answer: A.
16. Joe, a U.S. resident, purchased a brand-new Ford in 2002 for $22,000. This year
he sold the Ford for $8000. U. S. GDP for this year
a. Decreased by $14,000.
b. Increased by $8,000.
c. Was unaffected by this transaction.
d. Was affected by this transaction, but insufficient information is provided
to measure the effect of the transaction on U.S. GDP for this year.
Answer: C.
17. The number of employed people in an economy is an example of a
a. Stock.
b. Flow.
Answer: A.
18. When the central bank purchases treasury bills on the open market this
a. Increases the money supply and therefore raises the market interest rate.
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b. Decreases the money supply and therefore raises the market interest rate.
c. Increases the money supply and therefore lowers the market interest rate.
d. Decreases the money supply and therefore lowers the market interest rate.
Answer: C.
19. When k, the constant that tells us how much money people want to hold for every
dollar of income, has a relatively large value then
a. Money in this economy changes hands infrequently.
b. Money in this economy changes hands frequently.
Answer: A. Since v = 1/k, then when k is relatively large then v is relatively
small and that implies that the velocity of money is low and therefore money
changes hands infrequently.
20. Use the following table to answer this question.
Year
Money Supply Velocity Real GDP
2006
10,000
2.5
125
2007
11,000
3.0
132
Using the arithmetic tricks for estimating percentage changes in a variable and
the above information, estimate the percentage change in the price level from
2006 to 2007. The percentage change in the price level is approximately
a. 24.70%
b. 20.46%
c. 23.84%
d. 24.40%
Answer: D.
21. Joe lends $1000 to Sue for the year. Sue promises to repay Joe the $1000 plus 8%
interest on the loan at the end of the year. Joe figures that the inflation rate for the
year will be 4%. The actual inflation rate for the year is 5%. Which of the
following statements is true?
I. The ex ante real interest rate for Joe is 4%.
II. The ex post real interest rate for Joe is 5%.
III. Joe ends up worse off than he expected when he agreed to make the loan.
a.
b.
c.
d.
e.
Statements I, II and III are true.
Statements I and II are true.
Statements I and III are true.
Statements II and III are true.
Statement III is true.
Answer: C. The ex post real interest rate is 3%.
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22. Suppose that the money supply increases by 1 percent in one year and then
remains constant at this higher level thereafter. According to the quantity theory
of money, the inflation rate
a. Is 1 percent in the first year and thereafter.
b. Increases by 1 percent in the first year and remains constant at the higher
level thereafter.
c. Increases by 1 percent in the first year and returns to its former value
thereafter.
d. Is unaffected.
Answer: C. The key thing here is to remember that the question is asking
about what is happening to the inflation rate and not the aggregate price level.
23. When the government spends more than it receives in tax revenue, holding
everything else constant, we know that
I. Public Saving is positive
II. The government is running a deficit
III. The government is running a surplus
a.
b.
c.
d.
e.
Statements I and II are correct.
Statements I and III are correct.
Statement I is correct.
Statement II is correct.
Statement III is correct.
Answer: D. When G is greater than T, then G – T > 0 and this implies that the
government is running a deficit. When the government runs a deficit, holding
everything else constant, it must be a situation where public saving (the saving
the government does) is negative.
24. Suppose nominal GDP is $150 in 2002 and $300 in 2003. Furthermore, you know
real GDP in 2002 was $200 and that real GDP increased by 50% in 2003. With
certainty you know
a. The GDP deflator decreased between 2002 and 2003.
b. The GDP deflator increased between 2002 and 2003.
Answer: B.
25. During periods of unexpected inflation, lenders are hurt while borrowers gain
because the
a. Ex post real interest rate exceeds the ex ante real interest rate.
b. Ex post real interest rate is lower than the ex ante real interest rate.
c. Real interest rate rises.
d. Nominal interest rate falls.
Answer: B.
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26. The GDP deflator is calculated using a pre-determined “market basket” of goods
and services that includes particular amounts of all goods and services produced
in an economy.
a. True
b. False
Answer: B. The GDP deflator is calculated using each year’s level of
production of all goods and services produced in an economy rather than
specific amounts of all goods and services (this would be similar to how the
CPI is calculated).
27. Constant returns to scale occurs when
a. Output doubles when the amounts of all factor inputs double.
b. Output remains constant over time.
c. The marginal productivity of labor equals the marginal productivity of
capital.
d. The marginal products of capital and labor do not change.
Answer: A.
28. Suppose, k, the constant that tells us how much money people want to hold for
every dollar of income, has a value of .2. If the money supply is equal to $1000,
then what is the value of nominal GDP?
a. $5000
b. $500
c. $50,000
d. The value of nominal GDP cannot be determined without information
about the aggregate price level.
Answer: A.
Short Essays/Problems:
1. (12 points total)
Use the following information about an economy that produces three goods – books,
socks, and pizzas – to answer this set of questions.
Books
Pairs of Socks
Pizzas
Prices in Year 1 Quantities in
Year 1
10
100
2
50
4
200
Prices in Year 2 Quantities in
Year 2
12
120
1
200
3
250
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a. (2 points) Using year 1 as the base year, what is the value of real GDP in year
1? Show your work and provide the base formula you are using. (An answer
without any indication of how you got the answer will not receive full credit.)
Answer: Real GDP in Year 1 = (10)(100) + (2)(50) + (4)(200) = $1900
b. (2 points) Using year 1 as the base year, what is the value of nominal GDP in
year 2?
Answer: Nominal GDP in Year 2 = (12)(120) + (1)(200) + (3)(250) = $2390
c. (2 points) Using Year 1 as the base year, what is the value of the GDP
deflator for this economy in year 2? Assume the GDP deflator is being
measured on a 1 point scale.
Answer: GDP deflator for Year 2 = (Nominal GDP for Year 2)/(Real GDP for
Year 2) = ($2390)/($2600) = .919 = .92
d. (2 points) Using Year 1 as the base year and defining the consumer market
basket as 50 books, 20 pairs of socks, and 100 pizzas, calculate the CPI for
Year 2. What is the value of the CPI for year 2? Assume the CPI is being
measured on a 100 point scale.
Answer: CPI = [(Cost of market basket in year 2)/(Cost of market basket in base
year) ]* 100 = [(920)/(940)]*100 = 97.87
e. (2 points) Given the market basket defined in part (d) and this economy’s CPI
figures, what is the rate of inflation between Year 1 and Year 2?
Answer: Inflation Rate = [(97.87 – 100)/(100)]*100 = -2.13%
f. (2 points) Suppose a particular good in this economy cost $1200 in year 1 and
its price precisely adjusts to the rate of inflation in this economy. What will
its price be in year 2?
Answer: $1174.44. This just requires you to utilize the calculation you made in
part (e).
2. (12 points total) The economy of your country can be described using a CobbDouglas production function where A is a measure of the available technology, L is
the amount of labor available, K is the amount of capital available, and Y is the level
of aggregate real output. Capital’s share of output is 50%. You also know that this
country has 625 units of labor available this year and 900 units of capital. Its level of
available technology has a value of 2.
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a. (2 points) What is the level of aggregate real output in this country for this
year? Show your work.
Y = AK.5L.5 = 2(30)(25) = 1500
b. (2 points) What is labor’s income in this economy during the current year?
Show your work.
Labor receives 50% of income or .5(1500) = 750.
c. (2 points) What is the value of labor productivity for this year? Show your
work.
Labor productivity equals Y/L = 1500 units of output/625 units of labor = 2.4
units of output per unit of labor
d. (2 points) What is the ratio of labor income to capital income equal to in this
economy?
Ratio of labor income to capital income equals (labor’s share of
income)/(capital’s share of income) = 750/750 = 1.
e. (2 points) Suppose that the unemployment rate in this economy during this
year is 4% (resulting in 625 units of labor being utilized in this economy).
This economy has no discouraged workers. What is the size of the labor force
in this economy during this year? (Hint: round to the nearest whole number.)
Answer: to find the labor force recall that the unemployment rate is equal to (the
number of unemployed/labor force )* 100 and therefore the employment rate is
equal to (the number of employed/labor force)*100. In this case we have
(625/LF) *100 = 96 or LF = 651.
f. (2 points) Suppose there is no change in the labor force in this economy and
no change in the level of employment, but that productivity changes in the
economy are such that Okun’s Law holds. If Okun’s Law holds, what is your
prediction as to the level of real output in the next year for this economy?
(Assume that labor and capital are unchanged, but that productivity does
change in such a way that Okun’s Law precisely captures the predicted change
in real GDP.)
Okun’s Law states that the percentage change in real GDP = 3% - 2(the change in
the unemployment rate). In this example there is no change in the unemployment
rate so the second term on the right hand side of the equation has a value of zero.
Thus, the percentage change in real GDP = 3%. So, if real GDP equals 1500
initially, then it will equal 1500(1.03) = 1545.
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3. (20 points) For this problem carry all calculations out to two places past the decimal.
Use the following information to answer this question. A closed economy can be
described by the standard Cobb-Douglas production function. Furthermore, all firms
in this economy are competitive firms with constant returns to scale and they all are
profit maximizing firms. Technology in this economy can be measured as having a
value of 15, while capital’s share of aggregate income is 70%. There are initially 100
units of capital and 100 units of labor.
Furthermore, this economy can be described using the Classical Model where
Y = C + SP + T
Y = C + I + G in equilibrium
C = a + b(Y – T) = 10 + .6(Y – T)
I = I(r)
G is a constant and is equal to 100
T is a constant and is equal to 200
Where
Y is real GDP
C is consumption spending
SP is private saving
T is net taxes
I is investment
G is government spending
r is the real interest rate
SG is government saving
a. (2 points) What is the initial value of private saving, SP , in this economy?
Show your work. Answers without supporting work cannot receive full
credit.
First, you need to find Y:
Y = AK.7L.3
Y = (15)(100).7(100).3
Y = (15)(25.12)(3.98)
Y = 1499.66
Then, you need to find C:
C = a + b(Y – T) = 10 + .6(Y – T) = 10 + .6(1499.66 – 200)
C = 10 + .6(1299.66)
C = 789.80
Then, use the equation Y = C + SP + T to find SP:
1499.66 = 789.80 + SP + 200
SP = 1499.66 – 989.80
SP = 509.86
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b. (2 points) What is the initial value of government saving, SG , in this
economy? Show your work. Answers without supporting work cannot receive
full credit.
Government saving = SG = T – G = 200 – 100 = 100
c. (2 points) Describe the government’s initial budget situation. In your answer
be sure to relate the budget situation to the level of government saving.
Since net taxes are greater than government expenditure on goods and services,
the government is running a budget surplus and therefore has positive
government saving.
d. (2 points) In this economy, what is the initial equilibrium value for
investment? Show your work. Answers without supporting work cannot
receive full credit.
To find the level of investment use the equation Y = C + I + G:
1499.66 = 789.8 + I + 100
I = 609.86
Now, suppose net taxes are reduced by 100. Use this information to compute the
answers for the rest of the questions in this problem.
e. (2 points) What is the new value of private saving, SP , in this economy?
Show your work. Answers without supporting work cannot receive full
credit.
First, you need to find Y. But, since nothing has changed in the variables
determining Y, you already know that Y’s value is the same as it was initially, or
Y = 1499.66.
Then, you need to find C:
C = a + b(Y – T) = 10 + .6(Y – T) = 10 + .6(1499.66 – 100)
C = 10 + .6(1399.66)
C = 849.80
Then, use the equation Y = C + SP + T to find SP:
1499.66 = 849.80 + SP + 100
SP = 1499.66 – 949.80
SP = 549.86
f. (2 points) What is the value of government saving, SG , in this economy?
Show your work. Answers without supporting work cannot receive full
credit.
Government saving = SG = T – G = 100 – 100 = 0
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g. (2 points) Describe the government’s budget situation now that the level of
net taxes has changed.
Since net taxes are equal to government expenditure on goods and services, the
government is running a balanced budget and therefore government saving
equals zero.
h. (2 points) In this economy, what is the new equilibrium level of investment?
Show your work. Answers without supporting work cannot receive full
credit.
To find the level of investment use the equation Y = C + I + G:
1499.66 = 849.80 + I + 100
I = 549.86
i. (2 points) What is the effect on the real interest rate of this change in fiscal
policy? Explain your answer, making note of any shifts of curves or
movements along curves.
The effect of this change in fiscal policy on the real interest rate is to raise the
real interest rate. The change in fiscal policy causes the national savings curve to
shift to the left and this causes a movement along the investment demand
schedule. This movement along the investment demand curve is due to the
increase in the level of the real interest rate.
j. (2 points) Now, draw a well-labeled graph of the loanable funds market to
illustrate your answer.
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