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Unformatted text preview: Answer key, midterm one Version 1.0 (February 3, 2009). 1 Short answer questions 1.1 True, false, uncertain If the govt were to make the sale of nutmeg illegal, GDP would fall but welfare would rise. Uncertain: GDP as measured by the expenditure approach would fall because nutmeg becomes a black market good, the sales of which are no longer reported. As for welfare, the effect is unclear. Welfare depends on more things than income per capita; in particular, it depends on consumption. You could say nutmeg consumption is a social disease, in which case any barrier to its use might raise welfare. You could argue the opposite, saying nutmeg is fun and games for all concerned, in which case the governments meddling can only sap joy from our lives. Probably the second is the better choice because most people use nutmeg for cooking, not getting high. Credit is given for any answer (true, false or otherwise) that says GDP as measured will fall and takes some reasonable stance on the scourge of nutmeg. 1.2 True, false, uncertain If the Laspeyres index is less than one, we can conclude that living standards have fallen. True: If L < 1 then last years economy could have purchased this years bundle yet chose to buy something else. Because it could have consumed this years product but did not, it must prefer last years product to this years. (This strategy of argument is called revealed preference.) Credit is given to any answer justifying the revealed preference verbally, mathematically or graphically. Also, a few answers gave uncertain because, they argued, the economy might have switched from consumption goods to investment goods, which do not (directly) increase welfare. This is a possibility. A mathematical answer might include: L = i q 2 i p 1 i i q 1 i p 1 i < 1 i q 2 i p 1 i < i q 1 i p 1 i New bundle Old bundle The new bundle was affordable but not chosen Hence dispreferred And a graphical answer might use: 1 1.3 True, false, uncertain Suppose x . This has no long-run effects on the level of Y L . False: This question is as easy as remembering the definition of g Y L in steady state. It is: g Y L = x If x rises to x , so does the long-run growth rate of output per capitaan important contributor to the level of Y L . Credit was given to any answer that came to this conclusion through other means. A common one was an answer that noted k new ss < k old ss on the Solow cross: Recall that y ss = Y AL = f ( k ss ) Y L = Af ( k ss ) so if k ss changes, it forces a permanent change in the Y L ratio. This does not mean that the Y L ratio declines. Although k will now fall to k new , do not forget that A is now growing at a faster rate....
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