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Principles of Macroeconomics (Econ 001) Signature: Drake University, Fall 2006 William M. Boal Printed name:
MIDTERM EXAMINATION #3 VERSION C
"Long-Run Economic Growth and Inflation"
November 6, 2006
INSTRUCTIONS: This exam is closed-book, closed-notes. Simple calculators are permitted, but graphing calculators or calculators with alphabetical keyboards are NOT permitted. Numerical answers, if rounded, must be correct to at least 3 significant digits. Point values for each question are noted in brackets. Maximum total points are 100. I. Multiple choice: Circle the one best answer to each question. [1 pts each, 16 pts total] (1) As of the date of this exam, we are in the _______ quarter of 2006. a. first. b. second. c. third. d. fourth. e. fifth. (2) According to the aggregate production function, potential GDP is determined by all of the following except a. the size of the capital stock. b. total spending. c. technology. d. the size of the labor force. e. None of the above determine potential GDP. (3) Real GDP grows faster in the long run, the higher the fraction of total spending on a. consumption. b. investment. c. government purchases. d. net exports. e. all of the above. (4) Suppose the capital stock at the beginning of 2006 was $13.2 trillion. Also suppose that during 2006, gross investment is $1.8 trillion and depreciation is $1.5 trillion. Then the capital stock at the beginning of 2007 will be a. $11.7 trillion. b. $12.3 trillion. c. $13.5 trillion. d. $14.7 trillion. e. $15.0 trillion. (5) Investment spending is a. unrelated to the real interest rate. b. zero when the interest rate is zero. c. positively related to the real interest rate. d. negatively related to the real interest rate. e. cannot be determined from information given. (6) If the interest rate rises in the United States, net exports fall because a. the dollar appreciates. b. the dollar depreciates. c. exporters have trouble borrowing money. d. foreign importers have trouble borrowing money. e. consumers increase their total spending. (7) If a person does not have a job, and last looked for work two months ago, that person would be classified by the Bureau of Labor Statistics as a. employed. b. out of the labor force. c. unemployed. d. both (b) and (c). e. cannot be determined from information given. (8) The so-called “natural rate of unemployment” does not include a. unemployment for less than four weeks. b. unemployment for more than four weeks. c. cyclical unemployment. d. structural unemployment. e. frictional unemployment.
Principles of Macroeconomics (Econ 001) Drake University, Fall 2006 Midterm Examination #3 Version C
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(9) Since 1700, long-run growth rates of real GDP per capita in the fastest-growing countries have a. increased from one century to the next. b. started out positive but recently have turned negative. c. remained about zero. d. remained positive and constant from one century to the next. e. remained positive but decreased from one century to the next. (10) So-called “embodied” technical change can only occur when a. the economy reaches a certain minimum size. b. investment spending exceeds consumption spending. c. workers ("bodies") are trained to use it. d. new capital is installed. e. a government body officially endorses the new technology. (11) "Human capital" means a. ergonomically designed equipment. b. education and training. c. retirement savings plans. d. aid to people in need. e. people-friendly businesses. (12) A new technique for building computers could potentially be used by many computer makers at once. Therefore, this new technique is a a. nonexcludable good. b. private good. c. transfer. d. nonrival good. e. natural resource. (13) The three essential functions of money include all of the following except a. form of physical capital. b. unit of account. c. medium of exchange. d. store of value. e. None of the above are essential functions of money. (14) When banks keep reserves on deposit with the Federal Reserve, those funds earn a. zero interest. b. a negative interest rate. c. an interest rate greater than the market rate. d. an interest rate equal to the market rate. e. an interest rate slightly below the market rate. (15) According to the quantity equation, if the money supply grows faster than the growth rate of real GDP, a. the price level will stabilize. b. the growth rate of real GDP must increase. c. there will be inflation. d. there will be deflation. e. investment spending will increase. (16) Hyperinflation is caused by excessive a. government spending. b. investment spending. c. growth of the money supply. d. taxes. e. government borrowing.
(1) [Interest rate: 4 pts] Suppose the interest rate is 7%. a. The opportunity cost of $1 of consumption next year is how many dollars of consumption today?
b. The opportunity cost of $1 of consumption today is how many dollars of consumption next year?
(2) [Interest rate and GDP shares: 10 pts] Suppose the following three equations relate the shares of consumption (C), investment (I), and net exports (X) in total GDP (Y) to the real interest rate (r) in the long run. In these equations, the GDP shares and the interest rate are expressed as percents.
(C/Y) = 74% 0.5 r (I/Y) = 25% 2 r (X/Y) = 4% 0.5 r
Suppose further that the share of government purchases (G/Y) is fixed at 21%. Compute the following. [Hint: Check your answer to be sure that the four GDP spending shares sum to 100%.] a. Interest rate (r)
d. Net exports' share of GDP (X/Y):
b. Consumption's share of GDP (C/Y):
% e. Savings as a share of
GDP (S/Y):
c. Investment's share of
GDP (I/Y): %
(3) [Interest rate and GDP shares: 10 pts] Suppose the government provides tax incentives for business investment spending. Use the spending allocation model to answer the following questions. [Hint: Use the graphs below for scratch work.] a. Does the long-run real interest rate increase, decrease , or remain constant? b. Does the share of consumption spending (C/Y) increase, decrease , or remain constant? c. Does the share of investment spending (I/Y) increase, decrease , or remain constant? d. Does the share of net exports (X/Y) increase, decrease , or remain constant? e. Does the long-run growth rate of real GDP increase, decrease , or remain constant? R 0
R R X/Y R NG/Y
1–(G/Y)
C/Y I/Y
NG/Y
(4) [Labor force: 6 pts] The Bureau of Labor Statistics reported that in October 2006, 6.7 million people were unemployed, 145.3 million people were employed, and 77.3 million working-age people were not in the labor force. a. Compute the unemployment rate (to the nearest tenth of a percentage point).
b. Compute the labor force participation rate (to the nearest tenth of a percentage point).
c. Compute the employment-to-population ratio (to the nearest tenth of a percentage point).
(5) [Malthusian model: 12 pts] The diagram below shows a Malthusian model of economic growth.
Labor force (millions)
Total output (millions)
Subsistence line
Production function
a. According to this Malthusian model, how much output is required to sustain each worker? In other words, what is the subsistence level of output per worker?
b. If the labor force were 8 million, would the population tend to increase, decrease, or remain constant? c. If the labor force were 3 million, would the population tend to increase, decrease, or remain constant? d. What is the equilibrium level of annual wages (output per worker) according to this model?
e. What is the equilibrium size of the labor force according to this model? million
f. Suppose the production function shifts up as new land is brought under cultivation. What will be the new equilibrium level of annual wages, according to this model?
(6) [Technical change: 4 pts] Over the period 1970 to 1990, the annual growth rate of output per worker in Canada was 1.62% and the annual growth rate of capital per worker was 3.12%. Assume that the share of capital
income plus depreciation in national income was about (1/3), as it is in the United States.
a. Compute the contribution of capital to productivity growth, to the nearest hundredth of a percentage point.
b. Contribute the contribution of technology to productivity growth, also called the Solow residual, to the nearest hundredth of a percentage point.
(11) [Phelps-Friedman critique of Phillips curve: 18 pts] The graph below shows the labor market. $
Millions of workers Real wage Labor supply Labor demand a. If this labor market were permitted to reach true equilibrium, how many workers would be employed? million b. If this labor market were permitted to reach true equilibrium, what would be the real wage? $ Assume for the rest of this problem that this labor market is characterized by job rationing. That is, assume that unions, a minimum wage law, or employers (seeking to reduce employee turnover) try to keep the real wage in this labor market at $12. c. How many workers are employed? (^) million d. How many workers are unemployed? (^) million Now suppose a surprise burst of inflation lowers the real wage to $11 in the short run. e. How many workers would be employed in the short run? (^) million f. How many workers are unemployed in the short run? (^) million According to the Phelps-Friedman critique of the Phillips curve… g. What is the real wage in the long run? (^) $ h. How many workers are employed in the long run? (^) million i. How many workers are unemployed in the long run? (^) million
III. Critical thinking: Write a one-paragraph essay answering one question below (your choice). [4 pts] (1) Consider the following statement. “People and their well-being are what really matter. The government should encourage consumption spending, not investment spending.” Do you agree or disagree? Why or why not? (2) Consider the following statement. “If we returned to using gold for money, instead of paper currency and bank deposits, we would never have inflation.” Do you agree or disagree? Why or why not? Circle the question you are answering and write your answer below. Full credit requires good grammar, accurate spelling, and correct reasoning. [end of exam]
