Spring2019MT1_Solutions.pdf - Name UTID Economics 320 Fall...

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1 Name: UTID #: Economics 320, Fall 2019 Midterm 1 Please put all papers away. No calculators, no cell phones, no computers: nothing electronic is allowed. The exam is scheduled for 75 minutes. There are 75 points total on the exam. Part 1: Definitions (2 points each) 1) Reservation wage: The lowest wage workers are willing to work for. This is influenced by unemployment benefits, the provision of universal healthcare, the value of leisure, etc. 2) GDP Deflator: A measure of overall prices in the economy. This is constructed by taking the ratio of nominal GDP to real GDP. 3) Money multiplier: The idea that an increase in the money supply via open market operations ends up increasing the total money supply by more than the initial increase as the money works its way through the financial system. The size of the multiplier is given by 1/R, where R is the reserve requirement of banks. 4) Extensive margin of labor supply: When wages change, this induces some people to enter or exit the labor force/ employment. 5) User cost of capital: When firms are choosing the optimal level of capital, they set marginal benefit (which is marginal product of capital) equal to marginal cost. The cost of capital is equal to the interest rate r (the opportunity cost) and the depreciation rate δ (from capital breaking down).
Part 2: IS-LM Model (25 points total) a) Draw the IS-LM diagram and illustrate the effects of a decrease in consumer sentiment on the interest rate and output. Be sure to label each axis and curve, as well as equilibrium values. (5 points)
b) Does a decrease in consumer sentiment increase or decrease consumption, investment, and savings? (5 points)
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