Second Midterm-

Section I: Binary Choice Questions:

1) Last year, the nation of Bruinville had $500 of private savings.  Government spending was $400, and total tax revenue was $900.  Households spent $2100 on consumption goods and businesses spent $1000 on investment.  Transfer programs cost the government $200.  Under the assumptions of the classical model, what was the value of capital inflows in Bruinville last year?

a. -200

b. 200

Use the chart below for the following two questions.

2) Which country has higher labor productivity?

a. Germany

b. England

3) Which country has a higher standard of living?

a. England

b. Germany

4) If private savings equals investment in an open economy, then which of the following must also be true?

a. Capital inflows = G - (T - TR)

b. Imports = Exports

5) We know the following information about a closed economy: total wages earned by the employed (including government workers and officials) in the country's labor market this year equal $500 million; total profit earned by firms in the country this year equals $1,000 million; rent and interest (including usage of land as well as money) for this year equals $200 million; government spending this year is $100 million; and investment spending this year is $1,500 million. Based on the above information and the principles underlying the circular flow diagram, can we compute GDP for this country this year?

a. No

b. Yes

6) Suppose the Consumer Price Index (CPI) rose over one year from 120 to 150, while during the same period of time the nominal wage rose from $6 to $9. Then the real wage

a. rose by 20%

b. rose by 25%

7) Fluctuations from the long run potential real GDP level are most easily explained by the

a. Classical Model

b. Keynesian Model

8) Leakages are defined as

a. income earned, but not spent, in domestic markets

b. spending from sources other than households

9) Holding everything else constant, labor productivity increases as you add more workers.

a. True

b. False

Use the information below to answer the following two questions using the Keynesian Model:

C = consumption spending = 20 + 0.8 (Y - T)

I = investment spending = 20

G = government spending = 8

T = net taxes = 0.75 Y

10) What is the value of disposable income for this closed economy?

a. 0.25 (Y-T)

b. 0.25 Y

11) What is the equilibrium level of income for this closed economy?

a. 48

b. 60

12) Ancient Kingdom is a closed economy with gold as currency.  Recent explorations have caused an increase in the quantity of gold in Ancient Kingdom.  According to the quantity theory of money, what will happen to nominal output if the preferred ratio of money holdings to income (k) is held constant?

a. Nominal output will decrease.

b. Nominal output will increase.

13) The labor market in Celtictown is given by

Labor Supply: LS = 4W - 3

Labor Demand: LD = 18 - 3W

where W is the real wage and LS and LD are in millions of workers.

Celtictown's aggregate production function is Output = Y = √(K*L), and the initial level of capital (K) is $4 million. What is the labor productivity of the average Celtictown worker at full employment?

a. 1/3

b. 2/3

14) Using the classical model, the classical model's emphasis on equilibrium in all markets implies that recessions and booms can only be explained by shifts in the labor supply and labor demand curves if technology and capital are constant.

a. True

b. False

Answer the following two questions based on the following information:

Labor Demand: W = 20 - 0.5L_D

Labor Supply: L_S = 3W

where W is the real wage rate and LS and LD are the quantity of labor supplied and demanded in the economy.

15) What is the equilibrium real wage and equilibrium quantity of labor?

a. W = $8, L = 24

b. W = $24, L = 8

16) What is labor productivity equal to if the aggregate production function is Y = 100 + 48/L

a. 4.25

b. 13.25

Section II: Multiple Choice Questions:

Use the information below to answer the following two questions:

When the government has a balanced budget and there are zero capital inflows, the market for loanable funds on Whaler Island is defined by

Supply:                 LF_S = S_p = 600 + 500i

Demand: LF_D = I = 4100 - 200i

where i is the interest rate expressed in percentages (i.e., i = 14 is a 14% interest rate), LFS and LFD are the quantity of loanable funds supplied and demanded in the economy, SP is private savings, and I is investment.

17) The Whaler Island government begins running a deficit and an equilibrium interest rate of 7% results in the loanable funds market.  How large is the deficit?

a. $0

b. $200

c. $700

d. $1400

18) How much private investment spending is crowded out by the government deficit?

a. $0

b. $200

c. $400

d. $1000

 19) Which of the following will NOT increase labor productivity in a country?

a. A general improvement of education

b. An increase in the capital stock of a country

c. An increase in available technology

d. A higher level of employment

20) In the classical model of a closed economy, if G increases by $1000 without any change in taxes or transfer programs, then which of the following best describes the response of other economic aggregate variables?

a. The equilibrium interest rate will fall, while consumption and investment fall by a combined amount of $1000

b. The equilibrium interest rate will rise, while consumption and investment fall by a combined amount of $1000

c. The equilibrium interest rate will rise, while investment will fall by $1000

d. The equilibrium interest rate will fall, while investment will fall by $1000

21) What happens to aggregate output if there is a simultaneous increase in technology and a decrease in the level of employment for an economy?

a. Aggregate output decreases

b. Aggregate output increases

c. Aggregate output remains the same

d. The change in aggregate output is indeterminate

22) Larry and Sergey would like to borrow $1 billion for developing their Gphone. The UW Credit Union offers them a simple one-year loan for this amount requiring Larry and Sergey to pay back the credit union $1.2 billion in a year. At the same time, AT&T offers to lend them $1 billion for a year so long as they promise to pay AT&T back in a year with a payment that provides AT&T with a real interest rate of 10% on this loan.  Which of the following statements is right?

a. If Larry and Sergey expect the inflation in a year to be 5%, they should borrow from UW Credit Union.

b. If Larry and Sergey expect the inflation in a year to be 8%, they should borrow from UW Credit Union.

c. If Larry and Sergey expect the inflation in a year to be 9%, they should borrow from AT&T.

d. If Larry and Sergey expect the inflation in a year to be 12%, they should borrow from AT&T.

23) Larry and Sergey end up borrowing $1 million for a year from another source, Citi Group, at a nominal interest rate of 21% in 2007. Both sides of the deal expect the inflation rate from 2007 to 2008 to be 10% when reaching the deal. Which one of the following statements is correct?

a. If actual inflation rate is 12%, then Citi Group gains from this unexpected change of inflation.

b. If actual inflation rate is 8%, then Larry and Sergey gain from this unexpected change of inflation.

c. Citi Group would like the actual inflation rate to be below 10%.

d. None of the above statements are correct.

Use the information below to answer the following two questions using the Keynesian Model:

C =  consumption spending = 200 + 0.5 (Y - T)

G = government spending = 100

X = exports = 10

M =  imports = 5

I = investment spending = 140

T = net taxes = 90

24) What is the savings function with respect to aggregate income?

a. S = - 245 + 0.5 Y

b. S = - 245 + 0.5 (Y - T)

c. S = - 200 + 0.5 (Y - T)

d. S = - 155 + 0.5 Y

25) What is the equilibrium level of income for this economy?

a. 300

b. 800

c. 1600

d. None of the above

26) The aggregate production function is shaped like this due to

a. Increasing marginal returns to capital

b. Increasing marginal returns to labor

c. Diminishing marginal returns to labor

d. None of the above

27) What happens to labor productivity if simultaneously there is a decrease in capital and an increase in the level of employment for an economy?

a. Labor productivity increases

b. Labor productivity decreases

c. Labor productivity remains the same

d. The change in labor productivity is indeterminate

Use the information below to answer the following two questions using a classical model:

Cubland is a closed economy.  The economy in Cubland has

T = taxes = 1000

TR = government transfer payments = 200

G = government spending = 600

I = investment spending = 5000 - 600i

Sp = private saving = 200i

Where i is the interest rate expressed in percentages (i.e., i = 14 is a 14% interest rate) and all numerical values are in dollars (e.g., government spending is equal to $600).

28) What is the equilibrium interest rate?

a. 5%

b. 6%

c. 6.25%

d. 7%

29) What is the total quantity of leakages in Cubland?

a. $2000

b. $2050

c. $2200

d. $2250

30) In 2006, the US had a real GDP of $10,000 billion. People consumed $7,400 billion and saved $1,800 billion. Firms spent $2,600 billion on new investment. Government purchases were $1,000 billion and the government collected taxes equal to $2,400 billion. Assume the US economy was in equilibrium in 2006 when answering this question. Which of the following is an INCORRECT statement?

a. US government transfers exceeded private savings.

b. US leakages were equal to US injections in 2006.

c. US capital inflows were equal to $1,000 billion in 2006.

d. US national saving was $1,600 billion in 2006.

31) Which of the following statements is FALSE?

a. Decreasing labor demand, holding everything else constant, causes real wages to decrease.

b. There is still unemployment at the equilibrium level of employment.

c. An increase in real wages, holding everything else constant, will cause the labor supply to shift right.

d. An increase in capital and technology, holding everything else constant, causes aggregate output to increase.