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Unformatted text preview: Page 1 Test 1 Solutions Intermediate Macro Part I: SHORT ANSWER QUESTIONS 1. Briefly state what the following terms mean: (3) (a) Gross Domestic Product (GDP) GDP is the total income earned domestically in a given year. It is also the value of final goods and services produced domestically in a given year. GDP for a given year, say 2005, is calculated as the sum of values of final goods and services as GDP = ∑ i P 2005 i * Q 2005 i , where i is some final good or service, P is price and Q is the quantity. (b) GDP deflator GDP deflator provides a measure for the average price level in a given year relative to a base year. It is constructed as the ratio of nominal GDP to real GDP, that is GDP deflator = Nominal GDP Real GDP * 100. (c) Marginal Product of Capital (MPK) Marginal product of capital is the change in output when capital changes by 1 unit holding the amount of labour constant. That is MPK = F ( K + 1 ,L )- F ( K,L ) , where F ( K,L ) is the aggregate production function. 2. What is the difference between endogenous variables and exogenous variables? (2) Exogenous variables are taken as given for an economic model. Given the value of exogenous variables, an economic model is used to solve for endogenous variables. That is, endogenous variables are those variables that a model tries to explain. Example: Demand and Supply model for some good X: Income of consumers and price of inputs are exogenous variables while price and quantity of good X are endogenous variables. 3. Solow Model without growth in population and technology n = 0, g = 0: Suppose that two countries are exactly alike in every respect except that country A has a higher savings rate than country B. Which country will have the higher level of output per worker in the steady state? Explain your answer using a diagram. (4) Since savings rate is higher for country A, it will have a higher capital per effective worker in the steady state than country B (SHOW THIS USING THE STEADY STATE DIAGRAM)....
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