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MIDTERM

Name ________________________________________Student ID ______________

Instructions:

The exam consists of two parts: (1) 20 multiple choice questions; (2) two analytical questions. Please answer all questions in the space provided in this exam. Budget your time appropriately. Good Luck!

Multiple Choice [60 points total, 3 points each]

|1. |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. |

|2. |Assume that the production function is Cobb-Douglas (Y = AK(L1-( ) with parameter ( = 0.3. In the neoclassical model, if the |

| |labor force increases by 10 percent, then output: |

|A) |increases by about 10 percent. |

|B) |increases by about 7 percent. |

|C) |increases by about 3 percent. |

|D) |does not increase since the new workers are unemployed. |

|3. |An example of increasing returns to scale is when capital and labor inputs: |

|A) |both increase 10 percent and output increases 5 percent. |

|B) |both increase 10 percent and output increases 10 percent. |

|C) |both increase 5 percent and output increases 10 percent. |

|D) |do not change and output decreases 5 percent. |

|4. |When a firm sells a product out of inventory, GDP: |

|A) |increases. |

|B) |decreases. |

|C) |is not changed. |

|D) |increases or decreases, depending on the year the product was produced. |

|5. |According to the Fisher equation, the nominal interest rate is |

|A) |equal to the real interest rate plus inflation |

|B) |equal to the real interest rate minus inflation |

|C) |always greater than the real interest rate |

|D) |constant |

|6. |If nominal GDP grew by 5 percent and real GDP grew by 3 percent, then the GDP deflator grew by approximately ______ percent. |

|A) |2 |

|B) |3 |

|C) |5 |

|D) |8 |

|7. |National saving refers to: |

|A) |disposable income minus consumption. |

|B) |taxes minus government spending. |

|C) |income minus consumption minus government spending. |

|D) |income minus investment. |

|8. |If Y = AK0.5L0.5 and A, K, and L are all 100, the marginal production of capital is: |

|A) |50. |

|B) |100. |

|C) |200. |

|D) |1000. |

|9. |Consider an economy described by the following equations |

| |G = T = 1000 |

| |C = 250 + 0.75 (Y – T) |

| |I = 1000 – 50 r |

| |NX = 500 – 500 ε |

| |r = r * = 10 |

| |The equilibrium exchange rate is |

|A) |0.5. |

|B) |1. |

|C) |2. |

|D) |5. |

|10. |If net capital outflow is positive, then |

|A) |S - I is negative. |

|B) |private savings exceeds private investment. |

|C) |NX is positive. |

|D) |public saving exceeds public investment. |

|11. |In the small open economy model of Chapter 5, if a country begins in a position of balanced trade,  what happens when the |

| |government increases taxes? |

|A) |Net capital outflow becomes negative. |

|B) |The interest rate rises. |

|C) |Net exports decrease. |

|D) |The balance of trade goes into surplus. |

|12. |In the small open economy model of Chapter 5, starting from balanced trade, an increase in the world interest rate from a fiscal|

| |expansion abroad leads to which of the following? |

|A) |Negative net capital outflow and a trade surplus. |

|B) |Positive net capital outflow and a trade surplus. |

|C) |Positive net capital outflow and a trade deficit. |

|D) |Negative net capital outflow and a trade deficit. |

|13. |Which of the following causes a decrease in the real exchange rate? |

|A) |An exogenous increase in foreign demand for domestic goods |

|B) |An exogenous decrease in investment |

|C) |An increase in government purchases |

|D) |A decrease in taxes |

|14. |Choose the pair of words that best complete this sentence: If government purchases increase, national saving will ________ and |

| |the equilibrium real exchange rate will _______. |

|A) |fall; fall |

|B) |fall; rise |

|C) |rise; rise |

|D) |rise; fall |

|15. |Assume that the nominal exchange rate for the euro is .75 euros per dollar. Suppose that a Volkswagen Golf costs 10,000 euros in|

| |Germany, while it costs $12,000 in the United States. What is the real exchange rate? |

|A) |0.75 |

|B) |0.9 |

|C) |1.2  |

|D) |1.1 |

|16. |Which of the following does the Solow model predict? |

|A) |Real rental price of capital and real wage stays constant |

|B) |Real rental price of capital stays constant whereas real wage grows at the rate of technology progress |

|C) |Real rental price of capital grows at the rate of technology progress whereas real wage stays constant |

|D) |Real rental price of capital and real wage grows at the rate of technology progress |

|17. |An economy described by the Solow growth model in Chapter 8 has the following production function |

| |y = k0.5 |

| |where lower case letter represents unit per effective worker. If δ = 0.04, s = 0.28, n = 0.01, g = 0.02, what is the |

| |steady-state value of y? |

|A) |1 |

|B) |4 |

|C) |10 |

|D) |40 |

|18. |A permanent change in the growth rate of total output can arise from a change in the |

|A) |rate of technological progress. |

|B) |saving rate. |

|C) |ratio of capital per worker. |

|D) |number of workers. |

|19. |In the Solow model with technological progress, an increase in the rate of technological change will |

|A) |shift the investment curve upward. |

|B) |shift the investment curve downward. |

|C) |leave the investment curve unchanged. |

|D) |lead to a lower level of consumption at the steady state. |

|20. |In the Solow growth model with population growth (n) and technological progress (g), the steady-state growth rate of output per |

| |worker is |

|A) |0. |

|B) |n. |

|C) |g. |

|D) |n + g. |

| |Analytical Questions [40 points total, 20points each] |

| | |

| |Instructions: Please answer in the space provided after each question. |

| | |

| |You are a distinguished macroeconomist in a country called McEcon, President Yagihashi summoned you to analyze the domestic |

| |economy in the past 12 years. He hands you the following table. Please answer the following questions (a)-(e) |

| | |

| | |

| |year |

| |1-6 |

|1. |year |

| |7-12 |

| |actual change |

| |closed economy |

| |small open economy |

| | |

| | |

| |G-T |

| | |

| | |

| |6.2 |

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| |7.4 |

| | |

| |↑ |

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| |↑ |

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| |↑ |

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| |S |

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| |20.5 |

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| |19.5 |

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| |↓ |

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| |↓ |

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| |↓ |

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| |r |

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| |1.2 |

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| |1.4 |

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| |↑ |

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| |↑ |

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| |no change |

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| |I |

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| |19.3 |

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| |18.1 |

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| |↓ |

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| |↓ |

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| |no change |

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| |NX |

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| |1.3 |

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| |1.4 |

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| |↑ |

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| |no change |

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| |↓ |

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| |ε |

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| |131.5 |

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| |116.1 |

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| |↓ |

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| |no change |

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| |↑ |

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| |(the numbers are presented as a percent of GDP. All figures are averages of the decade shown) |

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| |a. Fill in the above blanks to show what each theory predicts (increase / decrease /no change) |

| | |

| |b. Are the behavior of variables consistent with what the closed economy model predicts? Are they also consistent with what the |

| |open economy model predicts? Explain in both words and diagrams |

| |Answer: |

| | |

| |Change in S, r, I are consistent with what the closed economy model predicts. |

| |Saving (S=Y-C-G) went down because of expansionary fiscal policy. |

| |Interest rate went up because in the market for loanable funds, the supply of loanable funds decreased. |

| |Investment also went down along with saving. |

| |However change in NX, ε are inconsistent with what the closed economy model predicts, since the model assumes these variables |

| |to stay constant. |

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| |Change in S, NX, ε are consistent with what the open economy model predicts. |

| |Net exports increased because net capital outflow (S-I) went up |

| |Real exchange rate depreciated because the supply of international funds went up |

| |However, change in r, I are inconsistent with what the open economy model predicts, since by assumption r = r* is constant and |

| |so is I = I(r*) |

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| |c. From the magnitude of change shown in the model, which of the two models do you think best applies to this country? Justify |

| |your answer. |

| |Answer: |

| | |

| |Based on the information given, this economy best applies to the closed economy model. Saving and investment almost went down by|

| |the same magnitude while net export only increased by a small margin. |

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| |d. Using the above table and attached graphs, analyze what has been happening in this country in the last 12 years. Explain |

| |using the model you chose in part d (you may also use diagram you have learned in class) |

| |Answer: |

| | |

| |This economy has been in recession in the first half of the sample period. Consumption has been relatively low and investment |

| |kept falling. Government purchase relative to GDP was pretty high. |

| | |

| |Government tried to stimulate the economy through expansionary fiscal policy (lower T-G). The expansionary fiscal policy was |

| |mostly done through tax cut rather than higher government purchase. This caused a drop in public saving leading to a fall in |

| |national saving (period 3-8) |

| | |

| |The abovementioned expansionary fiscal policy led to a crowd out – higher interest rate and lower investment – that the |

| |classical closed economy model predicts. Saving and investment dropped almost hand-in-hand while interest rate increased. This |

| |confirms the above statement that closed economy model best applies to this country. |

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| |(optional) |

| |After 8th year the investment starts to pick up and after 9th year consumption start to rise again, leading to an overall |

| |recovery of the economy. |

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[pic][pic][pic][pic]

|2. |The below table shows the accounting for Economic Growth in the United States. When calculating the source of growth, α is |

| |estimated to be 0.3. Please answer the following questions (a) – (e) |

| | |

| | |

| |Output growth |

| |∆Y / Y |

| |source of growth: capital |

| |α ∆K / K |

| |source of growth: labor |

| |(1-α) ∆L / L |

| |source of growth: risidual |

| |∆A / A |

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| |1965-2005 |

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| |3.2 |

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| |1.1 |

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| |1.4 |

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| |0.7 |

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| |1965-1990 |

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| |3.4 |

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| |1.1 |

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| |1.8 |

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| |0.5 |

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| |1990-2005 |

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| |2.9 |

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| |1.0 |

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| |0.9 |

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| |1.0 |

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| |(numbers are average percentage increase per year) |

| | |

| |a. Compare the two subsamples 1965-1990 and 1990-2005. Explain in words / numbers what has happened to output growth in the |

| |United States, referring to the source of growth in each period. |

| |Answer: |

| | |

| |Output growth has slowed down from 3.4% to 2.9%. This is mainly explained by the slowdown in labor growth . On the other hand, |

| |the Solow residual, which potentially represents the technology progress in United States, went up from 0.5% to 1%. Its |

| |importance in the overall output growth has also increased from 0.5 / 3.4 = 14.7% to 1 / 2.9 = 34.5%. The capital growth has |

| |remained almost unchanged, but its importance in the output growth has slightly increased from 32.3% to 34.5% |

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| |b. Solow growth model predicts that output-capital ratio remains constant over time. Does this apply for whole sample 1965-2005?|

| |Explain your logic. |

| |Answer: |

| | |

| |YES. Since α ∆K / K = 1.1, ∆K / K = 1.1/ α = 1.1/0.3 = 3.67. This is within half percentage point difference from growth rate of|

| |output (=3.6%). This shows that output and capital has grown in a similar pace and output-capital ratio has remained roughly |

| |constant. |

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| |c. Compute the growth rate of living standard (=Y/L) in 1965-1990 AND 1990-2005. Compare it to the growth rate of output during |

| |the same time period. Are they qualitatively different? Give comment / possible explanation on what you found |

| |Answer: |

| | |

| |first, note that labor growth in first period is n = 1.8 / 0.7 = 2.6% and for second period n = 0.9 / 0.7 = 1.3% |

| | |

| |since y=Y/L gy=gY-gL, hence gy = 3.4-2.6 = 0.8% for the first subsample and gy = 2.9-1.3 = 1.6% for second subsample. This |

| |result shows that although the output growth slowed down from the first subsample to the second, the improvement in living |

| |standard has actually speeded up, due to the large fall in labor growth and increase in Solow residual. The fall in labor growth|

| |can be intuitively explained by the end of baby boom. Women’s labor force participation has also hit the ceiling and contributed|

| |less to the overall growth. Increase in Solow residual might be capturing the phenomenon known as “I.T revolution”, where |

| |technological progress through information technology such as computer and cell phone has boosted the productivity of individual|

| |worker as well as overall production efficiency of the economy. |

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| |d. Suppose you are asked to give advice to the President in order to further improve the living standard of the country. OTHER |

| |THAN promoting R&D (and other policies that boost technology progress), what policy would you recommend? Explain your logic both|

| |in words and in diagram. Furthermore, discuss its pros and cons. |

| | |

| |Answer: |

| | |

| |Any policy that increases saving rate, decrease labor / labor growth rate is fine. However it has to be a policy that is |

| |“feasible” (that is, for example starting a war is not acceptable). Also for “cons” you need to mention that the policy might |

| |have a positive level effect on living standard but not positive growth effect. |

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