Midterm Exam #1

General Instructions

This exam is closed book and closed notes. The time limit is 80 minutes. Please read each question carefully before answering. If you are confused about a question please ask me to clarify it before answering. Be as specific as possible when answering questions. Make sure to label all graphs! Total points = 100. Relax, don't stress and good luck!

I. Definitions (25 points total, 5 points each).

Please give the definition and the current value (approximate) of 5 of the following 7 variables :

  1. short-term interest rate
  2. inflation rate
  3. unemployment rate
  4. growth rate of real GNP
  5. trade balance
  6. budget deficit
  7. real interest rate

II. Saving and Investment (25 points total, 5 points each).

The following questions concern the level of desired national saving, SD, and desired investment in an economy with no foreign sector.

  1. Draw the desired saving and investment curves (be sure to label all axes).
  2. Why does the desired saving curve slope upward and to the right and why does the desired investment curve slope downward and to the right? That is, what is the economic rationale for their shapes?
  3. What economic variables are held fixed in drawing the desired saving and investment curves? Indicate whether these variables have positive or negative effects on desired saving or desired investment.
  4. The goods market equilibrium condition with no foreign sector (i.e. the aggregate demand for goods is equal to the supply of goods produced) is often expressed as 
    	
                    SD  =  ID.

    Derive this equilibrium relationship.

  5. Assuming that there is no foreign sector affecting the economy (NX = 0), explain the difference between the national income accounting identity 
                        S = I

    and the equilibrium relationship given in (d) above.

III. Labor Supply and Labor Demand (25 points total, 5 points each).

  1. Briefly explain the substitution and income effects, associated with an increase in W/P, on labor supply.
  2. What is the relationship between the labor demand curve and the production function?
  3. Why does the labor demand curve slope downward? (Remark: the wrong answer is "the labor demand curve slopes downward because as the real wage decreases firms demand more labor".)
  4. What would the labor supply curve look like if the income effect dominated the substitution effect for very high values of the real wage?
  5. Assume that the labor market is initially in equilibrium with labor demand equal to labor supply. According to the model presented in class, what would happen to the equilibrium real wage and level of employment if the Clinton administration raised everyone's marginal income tax rates?

Midterm Exam #1: Winter 1994

General Instructions:

This exam is closed book and closed notes. The time limit is 1 hour and 50 minutes. Please read each question carefully before answering. If you are confused about a question or you think it is unclear please ask me to clarify it before answering. Be as specific as possible when answering questions. Make sure to label all graphs! Total points = 125. Relax, don't stress and good luck!

I. Definitions (20 points total, 4 points each).

Please define 5 of the following 7 terms. Keep your answers simple. Verbose answers just waste time.

  1. endogenous variable
  2. steady state
  3. constant returns to scale
  4. national saving
  5. productivity
  6. natural rate of unemployment
  7. equilibrium
  8. exogenous variable

II. Saving and Investment (20 points total).

The following questions concern the level of desired national saving, S, desired investment, ID and the real interest, r, in an economy with no foreign sector.

In the diagram below, the real interest rate is initially at r = r0.

  1. Explain why the economy is not in equilibrium at r = r0 (a few sentences is enough).
  2. At what interest rate is the economy in equilibrium (show on graph and call it r*)? why?
  3. Briefly explain the process by which the economy adjusts from the interest rate r0 to the equilibrium rate r*. That is, tell a story about how the competitive forces in the capital market work to adjust the interest rate to the equilibrium level.

Suppose the economy is initially in equilibrium. The Clinton administration then decides to institute a public works program to create jobs. That is, government spending, G, is increased. Assuming that GDP, Y, stays fixed, use the saving-investment diagram to show what happens to the equilibrium level of saving, investment and the real interest rate. Briefly compare the initial and new equilibria. In particular, what effect does the higher government spending have on the amount of investment in the economy.

III. Labor Supply, Labor Demand and the Production Function

The diagram above describes our long-run equilibrium model of the labor market and production. Using the above diagram, show what happens to the equilibrium values of the real wage, (W/P)*, employment, L*, and output, Y*, if the following variables increase:

  1. Capital stock (K)
  2. Productivity (A)
  3. Wealth (WL)
  4. Labor force size (LF)

IV. Growth Theory (25 points total)

Consider the Cobb Douglas production Y = AK^a*L^(1 - a), where Y = GDP, A = total factor productivity, K = capital stock, L = labor amount and a = 0.3. Suppose the growth rate of Y is 3% per year, the growth rate of K is 1% per year and the growth rate of L is 2% per year.

  1. What is the growth equation that describes the sources of growth of Y?
  2. What is the contribution of the growth in K to the growth in Y?
  3. What is the contribution of the growth in L to the growth in Y?
  4. What is the contribution of the growth in A to the growth in Y?

VI. Macroeconomic Data and History Essay Question

In the first few lectures, we talked about the behavior of several macroeconomic variables during the postwar period (after WW II to the present). In particular, we analyzed the growth rates of real GDP, labor productivity and real wages. Briefly compare and contrast the growth rates of these three variables over the period 1947 - 1973 and the period 1973 - 1993. Based on this comparison, do you think the economy is doing well now? Explain.