Econ 2610



Econ 2630

STUDY GUIDE FOR MIDTERM 1*

* The study guide is not intended to be exhaustive. It is intended to give you direction as to what you should focus on understanding given your limited study time.

Fundamentals

-The definition of economics

-Economic Decision Rule

-Marginal benefits, marginal costs and sunk costs

-Opportunity costs

-Production possibilities curve

-Supply and Demand Curves

-How we reach equilibrium in a market

-How changes in supply and/or demand affect equilibrium price and quantity

-Sticky Prices

Gross Domestic Product

-What it measures

-What it includes and what it excludes

-Components (C + I + G + X – M)

-Real GDP and Nominal GDP

-Real GDP and its relationship with quality of life

Economic Growth

-The change in living standards in the U.S. since 1810

-Why small differences in growth rates matter

-Compound interest

-Average labor productivity and real GDP per capita

-The determinants of average labor productivity

-What the government can do to facilitate growth.

-The business cycle

-The stages: recession, trough, expansion, and peak

Unemployment

-The Unemployment Rate

-Who is included and who is excluded

-Underemployment Rate (True Unemployment)

-Types of Unemployment

-Frictional, Structural, and Cyclical

-The Full Employment Rate

-Recessions and cyclical unemployment

-Potential output and actual output

-Recessionary and expansionary gaps

-Okun’s law

-Changes in unemployment and how it’s tied to output

Inflation and the Price Level

-The Consumer Price Index

-How it’s measured, interpreted, and using it to calculate inflation and real prices

-Using CPI to calculate to real prices and real income

-True Costs of Inflation

-How it redistributes wealth between borrowers and lenders, workers and employers

-Real and Nominal Interest Rates

-Deflation and its impact to the economy

PRACTICE PROBLEMS:

Note: The exam is Tuesday, 2/18. I will post the answers to these problems on my website by Friday (2/18). It is also necessary to review quizzes, assignments, the book, and your notes in addition to these (they are complements to this study guide, not substitutes). Enjoy the questions!

1. Use the following table to answer the following question.

Q Marginal Benefit Total Cost

0 -- 30.00

1 40.00 50.00

2 25.00 70.00

3 15.00 90.00

4 10.00 110.00

5 5.00 130.00

The table above represents the marginal benefits and total costs associated with a government program (in millions).

a. What is the optimal quantity of this program?

b. Suppose the total costs at Q=0 are $50.00 instead of $30.00, but everything else remains the same. What is the optimal quantity of this program?

c. If marginal costs increased from $20.00 to $26.00 per unit, what is the new optimal quantity?

2. Suppose the government invests in a policy which results in $45 million in net benefits. They faced two alternatives, one which would have resulted in $20 million in net benefits and another which would have resulted in $30 million. What is the opportunity cost of the chosen policy?

3. What would the following changes cause to the equilibrium price and the equilibrium quantity in a market?

a. An increase in demand.

b. A decrease in demand.

c. An increase in supply.

d. A decrease in supply.

4. What is the definition of GDP?

5. Bob owns a lawn mowing company. On Monday he mows 6 customers lawns and chargers them each $30. He also mows his own lawn and his neighbor’s lawn for free later in the day. How much was contributed to GDP?

6. What is the expenditure formula for GDP?

7. Which of the expenditure components of GDP can be negative? 

8. Which of the following is excluded from GDP calculations? 

A. capital goods

B. services

C. leisure

D. new home sales

E. used good sales

F. government interest payments

G. government expenditures on goods and services

H. exports

I. nonmarket transactions

9. Here are some data for an economy.

|  Consumption expenditures |$600.00   |

|  Exports |120.00   |

|  Government purchases of goods and services |200.00   |

|  Construction of new homes and apartments | 200.00   |

|  Sales of existing homes and apartments |200.00   |

|  Imports | 150.00|

|  Business investment |100.00   |

|  Government payments to retirees |100.00   |

| Used Goods | 80.00 |

|  Intermediate Goods | 60.00 |

Use the information to calculate the following:

Consumption Component of GDP = _________

Investment Component of GDP = _________

Government Purchases Component of GDP = ___________

Net Exports Component of GDP = ___________

GDP = ________________

10. Suppose nominal GDP increases by 3% in a year and inflation equals 4%. What happens to real GDP?

11. Suppose an economy is made up of two goods: books and pretzels.

| |Price 2000 |Quantity 2000 |Price 2007 |Quantity 2007 |

|pretzels |$2.00 |5 |$4.00 |5 |

|books |$50.00 |2 |$75.00 |3 |

12. Assuming a base year of 2000, what is real GDP in 2007? What is the percent change in real GDP from 2000 – 2007?

13. What is not included in real GDP that affects overall well-being in society?

14. What is real GDP per capita in the U.S.? How has it changed over the last 200 years? What is the historical rate of growth? What is the average real GDP per capita in the world?

15. Suppose a country (Cowistan) produces only three goods, beef, milk, and leather. Use the following information on their production and prices to answer the following questions.

Q2010 Q2011 P2010 P2011

Beef 800 860 $90 $95

Milk 1,000 1,200 $15 $15

Leather 70 75 $50 $52

Calculate Cowistan’s nominal GDP in 2010 and 2011.

Nominal GDP in 2010 = ___________________________________________________.

Nominal GDP in 2011 = ___________________________________________________.

Using 2010 as the base year, calculate Cowistan’s real GDP in 2011.

Calculate the percentage change in nominal GDP and real GDP from 2010 to 2011.

Percent change in nominal GDP = ______________________________________________.

Percent change in real GDP = ______________________________________________.

16. Suppose that in 1998 you deposited $1000 in a savings account that gives 5% interest compounding annually. How much would your savings be worth in 2008?

17. Real GDP per person in the United States was $11,484 in 1950 and $34,875 in 2003. Suppose the United States had grown at a rate of 3.0% from 1950 to 2003 instead 2.1%. How much larger would real GDP per person have been in 2003?

18. Suppose U.S. real GDP per person grows at a rate of approximately 4% per year. About how long will it take for real GDP to double from $50,000 per person to $100,000 per person?

19. Suppose one knows the average labor productivity in an economy. What else would one need to measure real GDP per capita?

20. Use the “rule of 70” to calculate what real GDP per capita will be in the countries in 140 years:

A: Per capita income = $3,000; growth rate = 2%;

B: Per capita income = $1,000; growth rate = 3%;

C: Per capita income = $20,000; growth rate = 1%;

21. Use the formula for compound interest (Future Value = Present Value*(1+r)t) to calculate the following:

A: The value of a $10,000 investment with an interest rate of 6% in 30 years.

B: The value of a $10,000 investment with an interest rate of 6% in 40 years.

C: The value of a $20,000 investment with an interest rate of 3% in 40 years.

D: The value of a $3,000 investment with an interest rate of 2% in 140 years.

22. Suppose average productivity growth is zero. As the baby boom generation begins to retire, what will happen to real GDP per person in the United States?

23. What are the primary reasons for the increase in real GDP per person in the U.S over the past 100 years?

24. Suppose real GDP per person is $20,000 when the average productivity of labor is $50,000 and the share of the population in the workforce equals 0.40. Suppose average productivity of labor remains constant and the share of the population in the workforce increases to 0.50. What happens to real GDP per person? 

25. How is economic growth shown on a production possibilities curve? How is a recession show on a production possibilities curve?

26. What are the major determinants of productivity?

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27. Given the diagram above, what are the periods of:

Expansion:

Peak:

Recession:

Trough:

28. What is the definition of a recession?

29. Suppose the population of Employtown is 1000. Of those 1000, 600 people have jobs, 100 people do not have jobs but are looking for jobs, and 300 people are not in the labor force. What is the unemployment rate in Employtown?

30. Suppose that out of the working age population, the U.S. has 150 million employed, 8 million unemployed, and 80 million not in the labor force. What is the participation rate for the United States?

31. Suppose a country has a population of 80 million, of which 25% are not working age. The number of working age adults currently not looking for jobs is 11 million. The number of employed people equals 40 million. Use this information to calculate the following:

Unemployment rate

Labor force participation rate

32. Suppose 1 million unemployed workers become discouraged and drop out of the labor force (so the number of adults not looking for jobs is 12 million). Everything else is the same. Calculate the:

Unemployment rate

Labor force participation rate

33. How does the true unemployment rate differ from the official unemployment rate?

34. Bob worked as an IT specialist for a large investment bank, but he lost his job due to the slumping economy. What type of unemployed would he be considered?

35. What are the three types of unemployment and what is the natural unemployment rate?

36. According to Okun’s Law, if there is a recessionary output gap of 4%, and the natural rate of unemployment is 5%, what is cyclical unemployment and what is the actual unemployment rate?

37. Suppose that the actual unemployment rate is 5.5% and assume that the natural rate of unemployment is 5.0%. According to Okun’s Law, by what percentage did actual GDP differ from potential GDP?

38. What will happen to equilibrium wages and equilibrium employment levels if demand for labor decreases, other things constant?

39. Suppose the CPI in year one equaled 1.45. The CPI in year two equaled 1.51. The rate of inflation between years one and two was _____ percent.

40. Here are values of the CPI for each year from 1990 to 1994.

|Year |CPI |Inflation Rate (%) |

|1990 |1.307 |x |

|1991 |1.362 | |

|1992 |1.403 | |

|1993 |1.445 | |

|1994 |1.482 | |

a. For each year beginning with 1991, calculate the rate of inflation from the previous year.

b. If the nominal interest rate was 6.4% in 1992, what was the real interest rate?

c. Suppose you learn your grandfather earned $3,000 in 1933 when the CPI was 0.130. Your father earned $50,000 in 1993. Who earned more in real terms?

41. Suppose the CPI equaled 1.00 in 1995 and 1.65 in 2005 and a typical household's income equaled $35,000 in 1995 and $40,000 in 2005. What happened to real household income between 1995 and 2005?

42. Suppose workers expect inflation to be 3% next year and create a contract to increase real wages by 4%. Actual inflation turns out to be 5%. What happens to the real wages of workers?

43. If a bank wants to earn a 4% real interest rate and inflation is 6%, what nominal interest rate would the bank have to charge?

44. Why is deflation generally considered to be worse as far as its impact to the economy than inflation?

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