State Sonoma University
Department of Economics ECN 304
Florence Bouvet
Fall 2010
Practice Midterm 2- Answer Key
Multiple Choice Questions: Choose the best answer. 1. Which of the following would be counted as unemployed according to official statistics? a. Tim, who worked, but worked only 35 hours last week b. Mary, who is waiting for her new job to start c. Bev, who neither has a job nor is looking for one d. None of the above would be counted as unemployed.
2. Ifvelocity is constant and, in addition, real GOP grows at a constant rate: a. The price level is proportional to the money supply b. Real GDP is proportional to money supply c. The price level is fixed d. Nominal GDP is fixed
3. The natural rate of unemployment is a. The average rate of unemployment around which the economy fluctuates b. About 10 percent of the labor force c. A rate that never changes d. The transition of individuals between employment and unemployment.
4. During the past 50 years the natural rate of unemployment in the United States _----''-- during the 1970s and 1980s, compared to the 1950s and 1960s, and then __ .,.-during the 1990s, compared to the previous two decades. a. increased; increased b. increased; decreased c. decreased; decreased d. decreased; increased
5. Inflation tax means that: a. As the price level rises, taxpayers are pushed into higher tax brackets. b. As the price level rises, the real value of money held by the public decreases. c. As taxes increase, the rate of inflation also increases. d. In a hyperinflation, the chief source of tax revenue is often printing money. 6. All of a. b. c. d. the following are causes of structural unemployment except: Minimum-wage laws The monopoly power of unions Unemployment insurance Efficiency wage
7. How can the Solow model explain the trend of growth in output per person observed in u.S. data over the last century or longer? a. increase in capital stock as the economy converges to steady state b. population growth c. technological progress d. all of the above 8. Frictional unemployment differs from structural unemployment in that it: a. has a shorter duration b. can be caused by 'efficiency wages' c. implies the supply of labor is larger than the number of jobs d. all of the above 9. Assume a country experiences a reduction in productivity that shifts the labor demand curve downward and to the left. If the real wage were rigid, this would lead to: a. No change in the real wage and a rise in unemployment b. No change in the real wage and no change in unemployment c. No change in real wage and a fall in unemployment d. A decrease in the real wage and in unemployment 10. According to the quantity equation, ifM increases by 3 percent and V increases by 2 percent, then a. real income increases by approximately 5 percent. b. the price level increases by approximately 5 percent. c. the nominal interest rate increases by approximately 5 percent. d. nominal income increases by approximately 5 percent.
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11. Consider the following data on inflation and nominal interest rates Year Inflation Rate 5% 2 10% By how much has a. b. c. Nominal Interest Rate 10% 5% the real interest It has increased It has decreased It has increased rate changed between year 1 and year 27 5 percentage points. 5 percentage points. 10 percentage points.
d. It has decreased 10 percentage points.
12. Which of the following could help explain high unemployment a. wage rigidity b. large unemployment insurance benefits c. sectoral shifts due to technological change
in Europe?
d. all of the above
13. If the steady-state rate of unemployment equals 0.125 and the fraction of unemployed workers who find jobs each month (the rate of job findings) is 0.56, then the fraction of employed workers who lose their jobs each month (the rate of job separations) must be:
a. 0.08.
b. 0.125. c. 0.22. d. 0.435.
14. If the per-worker production function is given by y = k 1/2, the saving ratio is 0.2, and the depreciation rate is 0.1 (no population growth), then the steady-state ratio of output per worker (y) is: a. 1.
b. 2. c. 3. d. 4.
15. The real return on holding money is:
a. the real interest rate.
b. minus the real interest rate. c. the inflation rate. d. minus the inflation rate.
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16. According to the Fisher effect, the nominal interest rate moves one-for-one with changes in the: a. inflation rate. b. expected inflation rate. c. ex ante real interest rate. d. ex post real interest rate. 17. In the Solow growth model, the assumption of constant returns to scale means that: a. all economies have the same amount of capital per worker. b. the steady-state level of output is constant regardless of the number of workers. c. the saving rate equals the constant rate of depreciation. d. the number of workers in an economy does not affect the relationship between output per worker and capital per worker. 18. Assume two economies are identical in every way except that one has a higher depreciation rate. According to the Solow growth model, in the steady state the country with the higher depreciation rate will have a level of total output and rate of growth of output per worker as/than the country with the lower depreciation rate. a. higher; the same b. higher; a higher c. lower; the same d. lower; a lower 19. Currency equals: a. Ml. b. the sum of funds in checking accounts. c. the sum of checking accounts paper and money. d. the sum of coins and paper money. 20. If the national saving rate increases, the: a. economy will grow at a faster rate forever. b. capital-labor ratio will increase forever. c. economy will grow at a faster rate until a new, higher, steady-state capital-labor ratio is reached. d. capital-labor ratio will eventually decline. 21. According to the Quantity theory of money, if real output is lower, real money balances are required, and for a given money supply, this means__ price level. a. Higher; lower b. Lower; higher c. Higher; higher d. Lower; lower
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22. According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will the demand for real money balances, and will the interest rate.
a. Increase; increase
b. Increase; decrease c. Decrease; decrease d. Decrease; increase
23. In the long run, a rise in money supply will lead to a. lower interest rates
b. higher prices
c. d. higher output lower real wage
24. lfthe short-run aggregate supply curve is horizontal, an increase in labor unions' aggressiveness that pushes wages up will result in prices and ___ output in the short-run. '
a. Higher; lower
b. Lower; higher c. Higher; higher d. Lower; lower
25. An economic change that does not shifts the aggregate demand curve is a change in: a. Money supply b. The investment function
c. The price level
d. Taxes
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Short Answers
1) Labor Market Consider an economy with the following Cobb-Douglas production function: Y=F(L ,K)= KI/2LJ/2, with L=400 , K=1600 a) What is the value of the real wage guaranteeing full employment? (give the formula and numerical value) The real wage that 2uarantees full employment is equal to MPL. MPL= (1/2) K1I2L-I/I= (1I2)(KlL)II2=(1I2)*(1600/400)"2=1
So real wage = 1 unit of output
b) Suppose the low fertility rate of the population causes a fall in the labor force to 200. What happens to the real wage, output and employment? Illustrate your answer with the appropriate graph and provide new numerical values for these variables.
A fall in the fertility rate induces represented graphically by a left real wage increases. If we let the employment, so that employment falls.
J
a fall in the labor force. So L decreases. This is shift of the vertical labor supply. As a result, the real wage adjust, the economy will still be at full =L. Because fewer workers are available, output
wlP
LSJ
Lso
l.~' =(w/P)J
1= (wlP)o
Lo L
r>
w/P= MPL = (1/2)*(1600/200)112=1.41 So real wage = 1.41 units of output Employment = L=200
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Output
=
Y=(1600)l/2(200)112=40xI4.14=565.85
c) Would your answer to part c differ if there was a minimum wage law in place imposing a wage of 2? Explain. A minimum wage law only affects the labor market and the level of employment/unemployment when it behaves as a price floor (preventing the wage to fall below a certain level). In our example, the minimum wage is set at 2, that is, at a level higher than the equilibrium real wage (=1.41). Consequently it will affect the market outcome. Firms won't be hiring all ofthe 200 workers, and as a result, there will be unemployment. If not all the labor force is hired, output will decrease (we would plug a number lower than 200 in the production function).
2) Solow Growth Model Suppose the U.S. can be characterized by the production function: Y = F(K,L) = 2Ko5 L05 Suppose the depreciation rate is 8%, the saving rate is 10%, the population growth rate is 2%, and there is no technological progress. Using the Solow growth model, compute the following: a) The steady state values ofGDP per person and consumption per person. Steady state condition: s f(k*) = (d+n) k* 0.10 x 2k*112 O.lOk* = 2k*1I2= k* k* 112 = 2 so k* = 4 y* = 2k*1I2 = 2 x 2 so GDP = 4 in steady state. c* = (l-s)y* = 0.9 x 4 so consumption = 3.6 in steady state.
b) The golden rule levels of GOP per person and consumption per person. Golden rule condition: MPK = d+n so (k*gOldrI12 0.10 = ( k*gold) 12 10 and k*gold= 100. 1= GDP in golden rule = f(k*gOld) 2( k*gOld)1122 x (100) 112= 20. = = Consumption in golden rule = f(k*gold) - (d+n) k*gold= 20 - (0.10) 100 = 10. c) How would each of your answers in (a) change if the U.S. raised its saving rate by some amount: rise, fall, no change, ambiguous? Explain why in 2-3 sentences. No calculation necessary. You might draw a graph to illustrate your argument. A higher saving rate means that more investment is available, so a larger capital stock is available to replace depreciated machines (see graph). Therefore, a larger capital stock can be maintained as a steady. Since output is a function of capital, steady state output will be higher also.
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Investment and depreciation
>-----k
ft:* 2
This is clear from the steady state condition in part (a): s f(k*) = (d+n) k* s x 2k*112 0.10k* = k*112 20s = so k* = 400s2 and y* = 2k*ll2= 40s. A rise in s raises both of these. But a rise in output does not guarantee that consumption will rise. Remember that it is possible to save too much. For example, ifthe saving rate were 100%, GDP would be very high but consumption would be O. c*= (l-s)y*. An increase in s has two opposite effects on c*. First an increase in s clearly reduces c. however, an increase in s leads to an increase in y*, which causes an increase in c*. We cannot know for sure which one will be stronger.
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