ECO 302
Spring 2014
Midterm #2
Name: ____________________
ID #: _____________________
Part I: Instructions: Write your answers in the spaces provided. Show your work whenever
possible. Use the back of the pages if necessary.
1. Suppose a country’s aggregate production function is Y = K(1/2)▪N(1/2). The country begins
with 81 units of capital and 100 units of labor, and produces 90 units of output (total). In some
later period, the country uses 100 units of capital and 121 units of labor to produce 110 units
of output. How would the growth accounting equation explain the increase in output from 90
units to 110 units? (Hint: aK and aN will both be equal to 1/2.)
2. Using the diagram from the neo-classical (Solow) growth model, show the situation of a
country that has reached its steady-state capital/worker ratio. Explain both on the graph and in
words what happens to a country that successfully implements a population control policy that
lowers the population growth rate n.
–1–
3. Suppose a country is in the steady-state with a savings rate that is “too high”. Show and
explain in words why the country’s citizens would benefit from lowering the savings rate s.
4. Suppose a country is ruled by a benevolent dictator who chooses how much of the
country’s income is saved, in order to steer the country towards the steady-state with the
highest possible steady-state consumption per worker. Show on the graph (clearly!) how the
dictator would select the right savings rate. Explain in words in the following way: “The dictator
would choose the savings rate so that the steady-state capital per worker ratio is ____”
–2–
5. Suppose next door to the benevolent dictatorship is a democratic country where citizens
decide for themselves how much to save. The citizens have adopted the rule that they always
save all of their income from capital, and spend all of their income from labor. With
competitive markets, their income from labor will be W/P which will equal the marginal
product of labor, and their income from capital will be r▪k – where r will equal the marginal
product of capital f’(k). Therefore total savings equals f’(k)▪k. In comparison to the
dictatorship, will the democratic country have a higher or lower steady-state capital per
worker? Explain how you know.
Instructions: Select the one best answer for each of the following questions. Record your final
choice CLEARLY next to the questions.
1.
A decrease in consumers’ expected future income shifts the desired national
savings curve to the _____, and the _____.
a.
b.
c.
d.
e.
left
right
right
left
right
IS curve to the right
LM curve to the left
LM curve to the right
FE to the left
IS curve to the left
2. Keynesians believe that the demand curve for money L(Y, r) can shift suddenly. If L(Y,r)
shifts to the right, then the _____. According the market-clearing model, this shift would cause
output to _____.
a.
b.
c.
d.
e.
LM shifts to the right
IS shifts to the left
IS shifts to the left
LM shifts to the left
LM shifts to the left
increase
decrease
remain unchanged.
increase
remain unchanged.
–3–
3.
Suppose in the neo-classical (Solow) growth model, Country A and Country B
share the same technology, same depreciation rate of capital, same population growth
rate, and same initial capital/worker ratio. Country A has a higher savings rate than
Country B. Which is also true?
a.
Country A will end up at a higher steady-state capital/worker ratio.
b.
Country A will have a lower growth rate of output/worker.
c.
Country A will have higher initial consumption per worker.
d.
Country B will have more depreciation per worker than Country A.
e.
Country B’s output per worker will always approach but never catch up to
Country A’s output per worker.
4.
The product market equilibrium in a large open economy (LOE) is in equilibrium
at a point where the LOE’s desired national savings is greater than its desired
investment. If the rest-of-the-world’s desired investment line shifts to the right (with no
change in the rest-of-the-world’s desired savings), then the effect in the LOE will be
_____ interest rates and ____.
a.
b.
c.
d.
e.
higher
lower
higher
lower
none of the above.
a smaller current account surplus
a smaller current account surplus
a smaller current account deficit
a smaller current account deficit
5.
Which of the following would be measured as “total factor productivity growth”
in the growth accounting framework?
(i)
reform of labor market regulation which induces older workers to continue
working instead of entering retirement.
(ii)
improving the collection of GDP data so that less of the country’s output goes
unrecorded
(iii)
investments in new capital equipment
(iv)
abolition of border controls with the country’s trading partners so that imports
and exports are not delayed coming in or out of the country.
a.
b.
c.
d.
e.
both (i) and (iii).
both (ii) and (iv).
both (i) and (ii).
both (ii) and (iii).
(i), (ii), and (iii).
–4–
6.
A shift to the left of the IS curve could be caused by:
(i)
Pessimism about the future leading a decrease in consumers’ expected future
income.
(ii) A technological breakthrough in automobile technology that causes auto
manufacturers to want to invest more in equipment to build engines using the new
technology.
(iii) Lower government expenditure.
a.
b.
c.
d.
e.
only (i) is true.
only (ii) is true.
only (iii) is true.
both (i) and (iii) are true.
both (ii) and (iii) are true.
7
Which of the following would cause a shift to the right of the LM curve?
(i)
(ii)
(iii)
(iv)
more liquidity of non-monetary assets.
Lower risk of non-monetary assets.
Increased money supply.
Higher price level
a.
b.
c.
d.
e.
(i), (ii), and (iii) are true.
(ii), (iii), and (iv) are true.
only (i) and (ii) are true.
only (ii) and (iv) are true.
only (iii) and (iv) are true.
8.
Keynesian business cycle theory cannot easily explain why:
a.
b.
c.
d.
e.
average labor productivity is procyclical.
money supply growth is procyclical.
inflation is procyclical.
unemployment is countercyclical.
consumption is procyclical.
–5–
9. If the interest rate is above the level at which Ms/P is equal to L(Y, r), then there is
______ and the economy is _________.
a.
b.
c.
d.
e.
excess supply of money; to the left of the LM curve.
excess demand for money, to the right of the LM curve.
excess supply of money, to the right of the IS curve.
excess demand for money; to the left of the IS curve.
none of the above.
10.
(i)
(ii)
(iii)
Which variables are leading?
nominal interest rates
business fixed investment
inflation
a.
b.
c.
d.
e.
only (i) and (ii) are true.
only (i) and (iii) are true.
(i), (ii), and (iii) are all true.
only (iii) is true.
none of the above.
11. In the market-clearing model, if the three lines (FE-IS-LM) do not intersect at the same
point, a general equilibrium can always be attained by:
(i) an adjustment of the price level, which shifts the FE line to the point where the IS and LM
lines meet.
(ii) an adjustment to the real wage, which shifts the LM curve to the point where the IS and
FE lines meet.
(iii) a fall in the real interest rate, which shifts the IS curve to the left, to the point where the
LM and FE lines meet.
a.
b.
c.
d.
e.
both (i) and (ii) are true.
only (i) is true.
only (ii) is true.
only (iii) is true.
none of the above.
12. Every point on the AS curve is a point where ____ could be in equilibrium. Every point on
the AD curve is a point where ____ could be in equilibrium.
a.
b.
c.
d.
e.
both the labor and product markets
the labor market
both the product and asset markets
the asset market
the product market
the asset market
both the product and asset markets
the labor market
both the labor and product
both the labor and asset
–6–
Output/worker
savings/worker
Capital /worker
13.
Suppose a country has a capital per worker ratio of k0 that is greater than the
level where the sf(k) line crosses the (n+d)k line. For this country, output per worker
will ___ over time because:
a.
grow
b.
shrink
c.
shrink
constant.
d.
grow
e.
shrink
population growth is greater than depreciation.
savings is greater than investment.
investment is less than that needed to keep capital per worker
consumption is greater than investment
depreciation of capital is greater than investment.
14.
In the graph above, for the country with a capital per worker ratio of k 0, the
amount of consumption per person can be seen as:
a.
b.
c.
d.
e.
the distance from point (1) to point (2).
the distance from point (2) to point (3).
the distance from point (1) to point (3)
the distance from point (2) to point (4).
none of the above
15.
The “portfolio allocation decision” determines the equilibrium conditions in the
____ market and the position of the _____ curve.
a.
b.
c.
d.
e.
product
asset
labor
product
asset
IS
IS
FE
LM
LM
–7–
16.
Classical (market-clearing) business cycle theory cannot easily explain why:
a.
b.
c.
d.
e.
average labor productivity is procyclical.
inflation is procyclical
consumption is procyclical.
business fixed investment is procyclical.
real wages are procyclical.
17.
“Reverse causation” is an argument used to try to explain why _____, even
though the _____ theory says it should not be.
a.
b.
c.
d.
e.
money growth is leading and procyclical
money growth is leading and procyclical
average labor productivity is procyclical
average labor productivity is counter-cyclical
government expenditure is procyclical
Real
interest
rate
Keynesian
market-clearing
market-clearing
Keynesian
Keynesian
S Nd
rw
Id
Savings, investment
18.
In the diagram above, a small, open economy has a desired national savings
curve that intersects its desired investment curve at the world’s real interest rate. If the
economy’s desired national savings curve then shifts to the right, then:
a.
b.
c.
d.
e.
the world’s real interest rate will rise.
the small country’s interest rate will rise above the world’s real interest rate.
the country will run a current account deficit.
the country’s product market cannot be in equilibrium.
none of the above are correct.
–8–
19.
The growth accounting analysis was applied to the experience of the “miracle”
growth countries of East Asia (Japan, Korea, Malaysia, etc.). The analysis showed that
the biggest difference between these countries and slower-growing countries like the
USA and Western Europe was that the high-growth countries had:
a.
higher values for aK and aN than already-developed countries.
b.
higher values for ΔA/A than already-developed countries.
c.
higher growth rates for ΔK/K and ΔN/N than already-developed countries.
d.
both more ΔA/A and more ΔN/N, but less ΔK/K than already-developed
countries.
e.
both more ΔA/A and more ΔK/K, but less ΔN/N than already-developed
countries.
Real
interest
rate
FE
LM
X
IS
Real output
20. Suppose the economy in the diagram above is operating at point X. In this case, there is
excess ____ of labor, excess _____ of products, and excess ____ of money.
a.
b.
c.
d.
e.
supply
supply
demand
demand
demand
supply
supply
demand
none of the above.
supply
supply
demand
demand
–9–
Part III Time Wasting Extra Credit (2 points)
1. Which of the following will your classmates choose as funniest? (Whichever option is
selected by the most students is the correct answer.)
a.
b.
c.
d.
e.
The batteries were given out free of charge.
A dentist and a manicurist got married. They fought tooth and nail.
The guy who fell onto an upholstery machine is now fully recovered.
A bicycle can't stand alone; it is two tired.
Did you hear about the man whose whole left side was cut off? He's all right now.
2. Below are photos of my dog, Andrew Abel (one of your textbook authors), IMF Chair
Christine Lagarde, Federal Reserve Board Chair Janet Yellen, and Erikur Fjollar (Iceland’s sexiest
pop music star). Which is which?
a.
b.
c.
d.
e.
(A) Lagarde; (B) Yellen; (C) Abel; (D) Fjollar; (E) Dog
(A) Lagarde; (B) Yellen; (C) Fjollar; (D) Abel; (E) Dog
(A) Yellen; (B) Lagarde; (C) Fjollar; (D) Abel; (E) Dog
(A) Fjollar; (B) Lagarde; (C) Abel; (D) Yellen; (E) Dog
(A) Abel; (B) Yellen; (C) Fjollar; (D) Lagarde; (E) Dog
– 10 –
– 11 –