I. Binary Choice

1. According to the Quantity Theory of Money , an increase in the money supply will affect the value of
a. Real GDP in the economy.
b. Nominal GDP in the economy.

2. Suppose an economy's production function is given by Y = 10K1/4 L3/4. Then the ratio of labor income to capital income equals
a. 3.
b. 1/3.

3. According to the Loanable Funds framework an increase in government spending holding everything else constant results in
a. A leftward shift in the supply of loanable funds and a movement along the demand for loanable funds curve resulting in a decrease in investment spending.
b. Crowding out of investment spending so that real GDP increases but by less than the increase in government spending.

4. Consumers purchase $5 million worth of imports during 2006. These purchases will
a. Be added to GDP as part of consumption and subtracted from GDP as imports.
b. Be added to GDP as imports.

5. Assume the base year is Year 1. Holding everything else constant, when the aggregate price level increases in Year 2
a. Real GDP in Year 2 increases.
b. Real GDP in Year 2 stays the same.

6. In an economy, wealth, the number of unemployed, the level of capital, and the level of GDP are all examples of variables measured as stocks.
a. True
b. False

7. GNP minus depreciation equals
a. Net national product.
b. National income.

8. The unemployment rate decreases from 5% to 3% during the relevant time period. According to Okun's Law real GDP for this time period will
a. Decrease by 1%.
b. Increase by 7%.

9. Suppose the real GDP of your favorite Midwestern state was $100 in 1995 and $120 in 2005. To calculate the average growth rate of real GDP over the period, one would take the total percent change over the period (20%) and divide by the number of years (10). Thus, the average growth rate of real GDP between 1995 and 2005 was 2.0%. Given this, the Compound Annual Growth Rate (CAGR) must be
a. Greater than 2.0%
b. Less than 2.0%.

10. In the classical model with fixed income, a decrease in the real interest rate could be the result of a/an
a. Increase in government spending (holding everything else constant).
b. Decrease in desired investment at every real interest rate (holding everything else constant).

II. Short Response

For each of the following statements write a brief answer. Make sure your answers are well organized, neatly written, and explicit.

1. A firm finds that its marginal product of labor is equal to $9 for the next unit of labor it is considering hiring while the real wage in the labor market is $10. Briefly analyze what the firm should do given this information.

2. Describe the effect of the Great Depression in the early 1930s on real GDP per person, the inflation rate, and the unemployment rate in the United States during this period.

3. Suppose inventories in an economy decreased by $50 during the year 2006. In addition, during the same year, consumption expenditure was $1000, total investment expenditure (including inventory changes) was $500, government expenditure was $100, and net exports were $100. What is GDP for this economy in 2006? In your answer provide a verbal explanation of how you are calculating GDP.

4. Suppose a government moves to reduce a budget deficit. Using the classical model developed in class (chapter 3) provide a graph of the loanable funds market to identify the impact of reducing a government's budget deficit by increasing (lump-sum) taxes on household income. State in words what happens to: i. the real interest rate; ii. national saving; iii. investment; iv. consumption; and v. output.

III. Problems

Answer the following problems in the space provided. Make sure you show all your work and that you write the general form of any formula you use before you enter explicit numbers into the formula. Your work must be neat, legible, and organized in order to get full credit.

1. Suppose you are given the following information about an economy.

Y = F(K,L) = AK1/2L1/2
Where Y is aggregate real output, K is capital, L is labor, and A is a measure of the available technology. K, L, and technology are assumed to be constant throughout this problem. You are also given the following values for this economy. M is the money supply and V is the velocity of money.
K = 100 units
L = 10,000 units
A = 2
M = 10,000
V = 2 and is constant

a. What is the aggregate output equal to in this economy?

b. What is the price level, P, in this economy?

c. Suppose the central bank in this economy increases the money supply by $5000. Assuming velocity, V, is constant, make a quantitative verbal prediction about the effect of this change in the money supply on the aggregate output level (Y), the aggregate price level (P), and the inflation rate during this next time period. (In particular, make sure to indicate by how much Y and P move, and what the inflation rate is.)

d. Now, calculate the effect of the change in the money supply described in part (c) on Y, P and the inflation rate. Make sure you clearly identify any formulas you use to make these calculations.

2. Use the following data to answer this question.

a. Calculate the value of nominal GDP for 2000 and for 2001. Provide a formula for the calculation prior to calculating a value with specific numbers.

Formula for calculating: Nominal GDP2000 = _____________________________

Nominal GDP2000 = _____________________________

Nominal GDP2001 = _____________________________

b. Use the data above to calculate the real GDP for 2000 and 2001. Provide a formula for the calculation prior to making the calculations with specific values. Assume 2000 is the base year.

Formula for calculating: Real GDP2000 = _____________________________

Real GDP2000 = _____________________________

Real GDP2001 = _____________________________

c. Using the above data and your calculations, find the GDP deflator, or the Implicit Price Deflator for 2001. Provide a formula before you explicitly calculate this value.

Formula for GDP deflator 2001 = Implicit Price Deflator2001 =

GDP deflator 2001 (round to 2 places past the decimal) = ________________

d. Suppose you are told that real GDP2002 is unchanged from real GDP2001, but that the GDP deflator for 2002 has a value of 1.1. What is the value of nominal GDP in 2002?

e. Using 2000 as the base year and assuming the market basket consists of 100 units of housing and 1000 units of food, calculate the CPI for 2001. Provide a formula before you explicitly calculate this value.

Formula for CPI2001 = ____________________________________________

CPI2001 (round to 2 places past the decimal) = _________________________

f. Using the CPI you calculated in part (e), what was the rate of inflation between 2000 and 2001? Give an interpretation of your answer.

Formula for rate of inflation = ____________________________________

Rate of Inflation = ____________________________
Interpretation of answer:

IV. Essay

General Directions for Essay: You are to write an essay on the following topic. This should be a unified, thoughtful essay. The essay will be graded on content, expression, clarity, organization, and overall quality (including legibility).

1. During the past ten to fifteen years, the Internet has changed the way many businesses operate, leading often to an increase in firm productivity. Using the production-side assumption of constant returns to scale and an aggregate Cobb Douglass production function, in addition to the assumption of perfect competition in both the output and input markets, construct an argument which relates the effect of the Internet on GDP, real wages, firm profits, and the income share of capital. Be explicit about how the assumptions stated in the question tie into your argument.