First Midterm-

1. Identify and briefly explain the importance of each of the following terms.

1. Complete Crowding Out

2. Shoe-Leather Cost of Inflation

3. Natural Rate of Unemployment

4. Purchasing-Power Parity

2. Discuss each of the following statements.  Explain your answer in a paragraph in the space provided.  Do not exceed the space allowed.

1. In the Classical model when capital, labor and technology are fixed, what fiscal policy choice of government spending (G) and taxation (T) maximizes GDP?

2. The Consumer Price Index (CPI) and the GDP Deflator capture the same information and can be used in identical ways.

3. For a given Cobb-Douglas production function, explain what is the marginal productivity of labor as well as what happens to the real wage when the state of technology doubles.

4. We expect tourist visits to the United States to increase when the dollar appreciates.  Agree or disagree and explain your answer.

3.  In the Classical Model with a closed economy, government spending increases.

a. If this is the only change that occurs in this economy explain what its effect on the loanable funds market will be.  Be explicit in your answer.

b. In this economy this increase in government spending leads to a decrease in the real interest rate in the loanable funds market.  Provide two possible scenarios explaining how this could happen.

4.  Using the graph below and your knowledge of the quantity theory of money discuss the validity of the theory over the period 1960 through the present. You should address the following questions in your answer.

a. According to the theory what are the expected relationships between the variables presented in the graph?

b. The behavior of these variables before 1987 is very different from the behavior of these variables after 1987.  What assumption in the quantity theory could be relaxed to explain this behavior?

5. There is a village in which there are 10 farmers. The only thing which farmers plant is corn. Thus, when we speak of village output or the farmer's output, we mean the total bushels of corn produced per period. Farmers use two things to produce corn: labor and corn. Farmers inelastically supply one unit of labor every period. The only physical capital in the economy is corn from the previous harvest that is planted to generate more corn. At the beginning of the period, each farmer possesses 16 bushels of corn. Corn production follows a Cobb-Douglas production technology that exhibits constant returns to scale. Capital's share of income is .5 and the state of technology is 16. Farmers, once the corn is harvested, must give 4 bushels of corn to the village government (the Chief). After paying their taxes, farmers can then either choose to consume corn or save their corn by giving it to the Chief. Consumption is determined by a Keynesian consumption function with a marginal propensity to consume net output (total output - taxes) equal to .8. The Chief pays an interest rate of 1/3 so that at the beginning of the next period, farmers have the amount of corn they saved plus the interest paid by the Chief. The Chief is able to pay such a high interest rate because he occupies the best farmland and "invests" the corn his villagers have saved by planting it on his own land. The village government runs a balanced budget.

a. Calculate the village GDP.

b. Determine the total consumption in the village

c. Determine the level of government spending in the village

d. Determine the level of investment in the village.

e. Show that the National Income Identity holds in this village.

f. Determine the wage that each farmer receives.

g. Determine the rental price of capital (the price of one bushel of corn for planting) in the village.

h. Show that the income in the village equals the expenditure.

i. How much corn does a farmer possess at the beginning of the following period?