ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi

SummerSession2 2007 August 20, 2007

MIDTERM

Name ________________________________________Student ID ______________

Instructions:

The exam consists of two parts: (1) 20 multiple choice questions; (2) two analytical questions. Please
answer all questions in the space provided in this exam. Budget your time appropriately. Good Luck!

Multiple Choice [60 points total, 3 points each]

1. Which of the following does the Solow model predict?

A) Real rental price of capital and real wage stays constant
B) Real rental price of capital stays constant whereas real wage grows at the rate of technology
progress
C) Real rental price of capital grows at the rate of technology progress whereas real wage stays constant
D) Real rental price of capital and real wage grows at the rate of technology progress

2. An economy described by the Solow growth model in Chapter 8 has the following production function
y = k0.5
where lower case letter represents unit per effective worker. If δ = 0.04, s = 0.28, n = 0.01, g = 0.02, what
is the steady-state value of y?
A) 1
B) 4
C) 10
D) 40

3. A permanent change in the growth rate of total output can arise from a change in the
A) rate of technological progress.
B) saving rate.
C) ratio of capital per worker.
D) number of workers.

4. In the Solow model with technological progress, an increase in the rate of technological change will
A) shift the investment curve upward.
B) shift the investment curve downward.
C) leave the investment curve unchanged.
D) lead to a lower level of consumption at the steady state.

5. In the Solow growth model with population growth (n) and technological progress (g), the steady-state
growth rate of output per worker is
A) 0.
B) n.
C) g.
D) n + g.

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

6. Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C = 500 + 0.6Y. No
government exists. In this case, equilibrium investment is:
A) 1,500.
B) 2,000.
C) 2,500.
D) 3,000.

7. Assume that the production function is Cobb-Douglas (Y = AKL1- ) with parameter  = 0.3. In the
neoclassical model, if the labor force increases by 10 percent, then output:
A) increases by about 10 percent.
B) increases by about 7 percent.
C) increases by about 3 percent.
D) does not increase since the new workers are unemployed.

8. An example of increasing returns to scale is when capital and labor inputs:

A) both increase 10 percent and output increases 5 percent.
B) both increase 10 percent and output increases 10 percent.
C) both increase 5 percent and output increases 10 percent.
D) do not change and output decreases 5 percent.

9. When a firm sells a product out of inventory, GDP:

A) increases.
B) decreases.
C) is not changed.
D) increases or decreases, depending on the year the product was produced.

10. According to the Fisher equation, the nominal interest rate is

A) equal to the real interest rate plus inflation
B) equal to the real interest rate minus inflation
C) always greater than the real interest rate
D) constant

11. If nominal GDP grew by 5 percent and real GDP grew by 3 percent, then the GDP deflator grew by
approximately ______ percent.
A) 2
B) 3
C) 5
D) 8

12. National saving refers to:

A) disposable income minus consumption.
B) taxes minus government spending.
C) income minus consumption minus government spending.
D) income minus investment.

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

13. If Y = AK0.5L0.5 and A, K, and L are all 100, the marginal production of capital is:
A) 50.
B) 100.
C) 200.
D) 1000.

14. Consider an economy described by the following equations

G = T = 1000
C = 250 + 0.75 (Y – T)
I = 1000 – 50 r
NX = 500 – 500 ε
r = r * = 10
The equilibrium exchange rate is
A) 0.5.
B) 1.
C) 2.
D) 5.

15. If net capital outflow is positive, then

A) S - I is negative.
B) private savings exceeds private investment.
C) NX is positive.
D) public saving exceeds public investment.

16. In the small open economy model of Chapter 5, if a country begins in a position of balanced trade, what
happens when the government increases taxes?
A) Net capital outflow becomes negative.
B) The interest rate rises.
C) Net exports decrease.
D) The balance of trade goes into surplus.

17. In the small open economy model of Chapter 5, starting from balanced trade, an increase in the world
interest rate from a fiscal expansion abroad leads to which of the following?
A) Negative net capital outflow and a trade surplus.
B) Positive net capital outflow and a trade surplus.
C) Positive net capital outflow and a trade deficit.
D) Negative net capital outflow and a trade deficit.

18. Which of the following causes a decrease in the real exchange rate?
A) An exogenous increase in foreign demand for domestic goods
B) An exogenous decrease in investment
C) An increase in government purchases
D) A decrease in taxes

19. Choose the pair of words that best complete this sentence: If government purchases increase, national
saving will ________ and the equilibrium real exchange rate will _______.
A) fall; fall
B) fall; rise

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

C) rise; rise
D) rise; fall

20. Assume that the nominal exchange rate for the euro is .75 euros per dollar. Suppose that a Volkswagen
Golf costs 10,000 euros in Germany, while it costs $12,000 in the United States. What is the real
exchange rate?
A) 0.75
B) 0.9
C) 1.2
D) 1.1

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

Analytical Questions [40 points total, 20points each]

Instructions: Please answer in the space provided after each question.

You are a distinguished macroeconomist in a country called McEcon, President Yagihashi summoned you
to analyze the domestic economy in the past 12 years. He hands you the following table. Please answer
the following questions (a)-(e)

year year actual closed small open

1-6 7-12 change economy economy
1.
G-T 6.2 7.4 ↑ ↑ ↑

S 20.5 19.5 ↓ ↓ ↓

r 1.2 1.4 ↑ ↑ no change

I 19.3 18.1 ↓ ↓ no change

NX 1.3 1.4 ↑ no change ↓

ε 131.5 116.1 ↓ no change ↑

(the numbers are presented as a percent of GDP. All figures are averages of the decade shown)

a. Fill in the above blanks to show what each theory predicts (increase / decrease /no change)

b. Are the behavior of variables consistent with what the closed economy model predicts? Are they also
consistent with what the open economy model predicts? Explain in both words and diagrams
Answer:

Change in S, r, I are consistent with what the closed economy model predicts.
 Saving (S=Y-C-G) went down because of expansionary fiscal policy.
 Interest rate went up because in the market for loanable funds, the supply of loanable
funds decreased.
 Investment also went down along with saving.
However change in NX, ε are inconsistent with what the closed economy model predicts, since the
model assumes these variables to stay constant.

Change in S, NX, ε are consistent with what the open economy model predicts.
 Net exports increased because net capital outflow (S-I) went up
 Real exchange rate depreciated because the supply of international funds went up
However, change in r, I are inconsistent with what the open economy model predicts, since by
assumption r = r* is constant and so is I = I(r*)

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

c. From the magnitude of change shown in the model, which of the two models do you think best applies
to this country? Justify your answer.
Answer:

Based on the information given, this economy best applies to the closed economy model. Saving and
investment almost went down by the same magnitude while net export only increased by a small
margin.

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

d. Using the above table and attached graphs, analyze what has been happening in this country in the last
12 years. Explain using the model you chose in part d (you may also use diagram you have learned in
class)
Answer:

This economy has been in recession in the first half of the sample period. Consumption has been
relatively low and investment kept falling. Government purchase relative to GDP was pretty high.

Government tried to stimulate the economy through expansionary fiscal policy (lower T-G). The
expansionary fiscal policy was mostly done through tax cut rather than higher government
purchase. This caused a drop in public saving leading to a fall in national saving (period 3-8)

The abovementioned expansionary fiscal policy led to a crowd out – higher interest rate and lower
investment – that the classical closed economy model predicts. Saving and investment dropped
almost hand-in-hand while interest rate increased. This confirms the above statement that closed
economy model best applies to this country.

(optional)
After 8th year the investment starts to pick up and after 9th year consumption start to rise again,
leading to an overall recovery of the economy.

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

2. The below table shows the accounting for Economic Growth in the United States. When calculating the
source of growth, α is estimated to be 0.3. Please answer the following questions (a) – (e)

Output growth source of source of source of

∆Y / Y growth: capital growth: labor growth: risidual
α ∆K / K (1-α) ∆L / L ∆A / A

1965- 3.2 1.1 1.4 0.7

2005

1965- 3.4 1.1 1.8 0.5

1990

1990- 2.9 1.0 0.9 1.0

2005

(numbers are average percentage increase per year)

a. Compare the two subsamples 1965-1990 and 1990-2005. Explain in words / numbers what has
happened to output growth in the United States, referring to the source of growth in each period.
Answer:

Output growth has slowed down from 3.4% to 2.9%. This is mainly explained by the slowdown in
labor growth . On the other hand, the Solow residual, which potentially represents the technology
progress in United States, went up from 0.5% to 1%. Its importance in the overall output growth
has also increased from 0.5 / 3.4 = 14.7% to 1 / 2.9 = 34.5%. The capital growth has remained
almost unchanged, but its importance in the output growth has slightly increased from 32.3% to
34.5%

b. Solow growth model predicts that output-capital ratio remains constant over time. Does this apply for
whole sample 1965-2005? Explain your logic.

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

Answer:

YES. Since α ∆K / K = 1.1, ∆K / K = 1.1/ α = 1.1/0.3 = 3.67. This is within half percentage point
difference from growth rate of output (=3.6%). This shows that output and capital has grown in a
similar pace and output-capital ratio has remained roughly constant.

c. Compute the growth rate of living standard (=Y/L) in 1965-1990 AND 1990-2005. Compare it to the
growth rate of output during the same time period. Are they qualitatively different? Give comment /
possible explanation on what you found
Answer:

first, note that labor growth in first period is n = 1.8 / 0.7 = 2.6% and for second period n = 0.9 / 0.7
= 1.3%

since y=Y/L gy=gY-gL, hence gy = 3.4-2.6 = 0.8% for the first subsample and gy = 2.9-1.3 = 1.6%
for second subsample. This result shows that although the output growth slowed down from the
first subsample to the second, the improvement in living standard has actually speeded up, due to
the large fall in labor growth and increase in Solow residual. The fall in labor growth can be
intuitively explained by the end of baby boom. Women’s labor force participation has also hit the
ceiling and contributed less to the overall growth. Increase in Solow residual might be capturing the
phenomenon known as “I.T revolution”, where technological progress through information
technology such as computer and cell phone has boosted the productivity of individual worker as
well as overall production efficiency of the economy.

d. Suppose you are asked to give advice to the President in order to further improve the living standard of
the country. OTHER THAN promoting R&D (and other policies that boost technology progress), what

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ECN 101 – Intermediate Macroeconomics Professor Takeshi Yagihashi
SummerSession2 2007 August 20, 2007

policy would you recommend? Explain your logic both in words and in diagram. Furthermore, discuss its
pros and cons.

Answer:

Any policy that increases saving rate, decrease labor / labor growth rate is fine. However it has to be
a policy that is “feasible” (that is, for example starting a war is not acceptable). Also for “cons” you
need to mention that the policy might have a positive level effect on living standard but not positive
growth effect.

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