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Unformatted text preview: Professor McClelland Monday, October 23, 2006
Midterm Exam Note: Total time — 50 minutes
Answer both Part A and Part B
Part A and Part B are of equal value USE TWO EXAIVI BOOKS, ONE FOR PART A AND THE OTHER FOR PART B.
ON EACH EXAM BOOK PRINT YOUR NAME AND YOUR TA’S NAME. Part A (25 minutes) Below are 4 pairs of concepts or ideas. Explain brieﬂy (that is, in no more than one or two
sentences) EACH member of a pair, and then explain the relationship between the two. (1) gross domestic product (GDP) AND the treatment of housework done by residents of the
house in measuring GDP (from Handout #7). (2) causes of a shift in the demand curve for orange juice AND causes of a movement along
a given demand curve for orange juice. (3) production possibilities frontier (PPF) AND unemployment caused by rigidity in wages
(a key Keynesian assumption). (4) the four factors of production AND the law of diminishing returns. OVER Part B (25 minutes) The isolated island economy of Tigerland has no exports and no imports. SHOW ALL YOUR WORK (1) (2) (3) The consumption function is
where Y = national income,
TX = taxes, and
a = 100 ($100 billion)
(a) Explain in words what this ﬁmction asserts. (b) What is the marginal propensity to consume? Investors always want to invest $400 billion, or
._ I = f = 400.
The government spends $50 billion, and taxes are $50 billion, or
G $ 50
TX = 50.
(a) What is the equilibrium level of income? (b) Demonstrate that at this equilibrium income level, investment equals total saving. The island’s inhabitants learn to their dismay that their spiritual leader is retiring and
going to the mainland to play golf. As a result, the entire nation becomes pessimistic,
and (i) planned investment is cut in half, or now I=I=200, and (ii) while the marginal propensity to consume remains unchanged, the “a” value in
the consumption function C = a + b(Y— T10
is cut inhalf. (a) What effect do these two changes have on the Keynesian multiplier for
government spending? Explain your answer. (b) What is the combined initial impact of these two changes upon actual
investment? (0) What is the new equilibrium level of national income? ((1) At that new equilibrium income level, how much will be invested in
inventory accumulation? ' ...
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- Spring '05