Econ 1B, Exam 1

Professor Michael J. Boskin

April 28, 2010

INSTRUCTIONS You have 50 minutes to answer the questions. Total points = 100. Use three bluebooks, labeled A, B, and C. Write your name and TAs name on the face of each bluebook. Be sure to answer each question in the correct bluebook. Your answers should be brief but complete. Make sure graphs are carefully labeled. If you believe a question is ambiguous or does not provide enough information to be answered, please write your additional assumptions explicitly with your answer.

Answer Questions 1 through 3 in Bluebook A

Question 1: True/False (1 point each; 5 points total) Indicate whether each statement is true or false. a) Greece is seeking help from the United States in financing its budget deficit. b) Brazil and Australia are raising interest rates. c) The per capita GDP of the richest countries is 100 times higher than in the poorest countries. d) The current unemployment rate in the U.S. is 13%. e) A disinflation means a fall in prices.

Question 2: True/False/Explain (5 points each; 20 points total) Indicate whether each statement is true or false, and explain your reasoning in a sentence or two (1 point for each correct answer; up to 4 points for each explanation). a) Increasing the required reserve ratio will cause an increase in the money supply. b) If real GDP is currently growing at 6% per year, the labor force is growing at 2% per year, and capital per labor hour is growing at 3% per year, then the implied annual rate of technical progress (i.e. the rate of improvement of technology) is 3%. c) If Savings is larger than Investment, then an economy will be experiencing a government budget deficit. d) If the money supply is growing at 3% per year, nominal GDP is growing at 4% per year, and the annual inflation rate is 2%, then we would predict that the velocity of money is growing at 1% per year.

Question 3: Employment and Unemployment (10 points total) The village of Fond Bassin Bleu has a population of 1,184. Out of those, 1000 are 16 years or older and capable of working. Out of those 1000, 800 are employed in a factory that produces cotton; 100 stay at home taking care of their children; and 50 of them do not have a job and are looking for one in the factory. In the past, the other 50 have looked for work. Now, they have grown disappointed and spend their days at the beach. Out of the 800 employed in the cotton factory, 100 of them are employed part-time. a) b) c) d) e) How many people are in the villages labor force? How many people are unemployed? What is the unemployment rate? What is the employment to population ratio? What is the labor force participation rate?

Answer Questions 4 and 5 in Bluebook B Question 4: The Spending Allocation Model (24 points total) Consider the following modification of the Spending Allocation Model in which the consumption share of GDP depends not only on the real interest rate, but also on the tax rate: G/Y = 0.2 C/Y = 0.8 - R - Tax rate X/Y = 0.1 - 3R I/Y = 0.3 - 2R a) Which component is most sensitive to changes in the real interest rate in this version of the model? b) Compute the equilibrium interest rate if the current tax rate is 0.1 (i.e. 10%). c) Compute the equilibrium level of C/Y, I/Y, and X/Y given the same tax rate as in part a). d) What would happen to C/Y, I/Y, and X/Y if the government increased the tax rate without increasing spending? Illustrate your answer with a set of Spending Allocation Model graphs.

Question 5: Money (12 points total) Consider the following information for a particular economy: Required Reserve Ratio = 0.2 Currency = $500 billion Deposits = $2 trillion a) Compute the monetary base, the money supply, and the size of the money multiplier. Show your work. b) What will happen to the money supply if the Central Bank buys $20 billion of government bonds? Show your work. c) How would your answer to part b) be different if banks held $10 billion in excess reserves (above the reserve requirement) at the Central Bank?

Answer Questions 6 and 7 in Bluebook C Question 6: Growth (21 points total) Consider a small country in which output is described by the following Malthusian production function: Y=1000L1/2. Assume that there are no machines or other forms of capital in this economy; the population increases whenever output per capita is above 500 units, and decreases otherwise. Assume also that the entire population is in the labor force. a) What will be the population and the level of per-capita output in long run equilibrium? Show your work. b) Suppose this economy is initially in long-run equilibrium, but that half the population decides to emigrate to other countries. What will be the effect on output per capita (in this country) in the short-run and in the long run? Explain in words and with a Malthusian diagram. c) At what rate do we predict that per-capita income will grow in the long run, after this economy has returned to equilibrium? How would the answer be different if this were a Solow economy, rather than this simple Malthusian economy? Question 7: GDP (8 points) Consider the following data for an economy: Investment (I) = $6 billion Net Exports (X) = -$2 billion Government Purchases (G) = $3 billion Taxes (T) = $2 billion Consumption (C) = $1 billion + 0.5 (Y-T)

[measured in $billions]

a) Compute national saving for this economy. b) Compute the government surplus (+) or deficit (-).