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Second Midterm

Economics 201: Introduction to Macroeconomics

Fall Quarter 2022
Mark Witte
Northwestern University

Do not turn this exam over or begin working until you are told to do so.

We will post scores and grades on Canvas as soon as we can.

The test is out of 100 points (19 short questions worth 4 points each, 4 graphs worth 4 each, and an essay
worth 8 points) and is worth 25% of your class grade. There is no guessing penalty so answer all the
questions. Please be thorough but concise. Verbose answers will not help you. You can use a calculator.
Handing the exam in on time (by 4:50) will gain you a bonus of 4 points. Handing the exam in after
4:52 will cost you five points with the penalty rising after that.

Coverage: Lectures up through Thursday, November 3rd. Krugman & Wells chapters 7, 9-13, Buchholz
on Malthus, Ricardo, Marx, and Keynes. Shrinkflation,Measuring Inflation, Inflation History, Gordon,
Klenow, Rosling, Rosner, OWID: Global Inequality, OWID: Extreme Poverty, Yield Curve, Budget Basics
The problems on this page refer to this table and these abbreviations. Consumption = C, Taxes = T,
Investment Demand = ID, Disposable Income = Y-T, Govt. Purchases of Goods and Services = G
Aggregate Expenditure = AE, the MPC is constant, Foreign trade is zero. Autonomous consumption = $50.
AS = Y T Y-T C ID G AE ΔInventories

$7,000 $300 $6,415 $250 $350

$7,100 $300 $6,510 $250 $350

$7,200 $300 $250 $350

$7,300 $300 $250 $350

$7,400 $300 $250 $350

$7,500 $300 $250 $350

$7,600 $300 $250 $350

1. (4 points) Fill in the table.

2. (4 points) How big a change in G would it take to increase the equilibrium by $200?
(Sign, as in + or -, matters here.)

3. (4 points) How much of a tax change would it take to accomplish the same change? (Sign matters here.)

4. (4 points) How much is savings when Y = $7,500?

5. (4 points) Elections have consequences, and people don’t like inflation! Suppose we now cut government spending by
$100 and also cut taxes by $100. The Fed changes interest rates to change investment demand by $50 to tamp down
inflation (signs matter here). What’s the change in the equilibrium level of output? (You’ll have to do math here; the
answer won’t necessarily hit any of the table choices exactly. Please show enough of your work that we can understand
how you got your answer.)

Put your short answers here:

2. 3. 4. 5.
6. (4 points) What is equilibrium output in this economy? When RGDP is $1,000, consumption is $435. Autonomous
consumption is $15. Investment demand is $585. Taxes are $400. Imports are $80. A rise in after-tax income of $400
raises consumption spending by $280. Government Spending on Goods & Services is $450. Exports are $30.
Please show enough of your work that we can understand how you got your answer. (Please put your answer below.)

7. (4 points) In the previous problem, what is happening to leakages when production = $2,000? Please show enough of
your work that we can understand how you got your answer. (Please put your answer below.)

8. (4 points) In the previous problem, if the Fed raised interest rates and this caused investment demand to change by 100,
how would this change the amount of savings? (Please put your answer below.)

9. (4 points) Everyone has an MPC of 0.85.

Pat and Shirley Ryan pay Fitz $4,000 to build a new stadium. Fitz saves some of this income and spends the rest to buy
plans for beating UCLA and USC from President Schill. Schill saves some of this income and spends the rest to buy some
sporty purple suits from Morty. Morty prudently saves some of this income for his retirement and spends the rest to buy a
ticket out of town! How much is Morty paying to jet out of here?
Person Δ(Y-T) ΔSaving ΔConsumption

Put your short answers here:

6. 7. 8. 9.
10. (4 points) “It’s me. Hi! I’m the CPI problem. It’s me.” Compute the CPI for 2020, using 2022 as the base year.
Please show enough of your work that we can understand how you got your answer. (Answer goes at the bottom.)
P2020 Q2020 P2021 Q2021 P2022 Q2022

Tea $4 4 $5 3 $6 2

Sunglasses $12 1 $14 2 $11 3

Mirrors $10 2 $15 1 $10 2

Barf-remover $8 3 $10 2 $7 4

11. (4 points) In the previous problem, what is the simple inflation rate from 2021 to 2022, using 2020 as the base year?
Show your work and put your answer in the box below.

12. (4 points) If interest rates were expected to be 10% per year, what is the most you would be willing to pay today to get
$400 four years from today? Show your work and put your answer in the box below.

13. (4 points) The winning Powerball ticket that someone just bought gives the winner the choice two options. Option A
is a single lump sum payment of $1,000 million right now. Option B is many years of $70 million per year (for simplicity,
let’s assume these go on forever). If the long run interest rate is 7.5%, what is Option A - Option B? (That is, which would
be better to take?) Show your work.

14. (4 points) The 30-year interest rate on mortgages right now is 7.84%. The New York Federal Reserve’s “Underlying
Inflation Gauge” shows an expected long run inflation rate of 4.4%. What would be the increase in purchasing power from
lending at a 7.84% nominal interest rate? Show your work and put your answer in the box below.

Put your short answers here:

10. 11. 12. 13. 14.
15. (4 points) If we ignore “shrinkflation,” then….
A. …we will overstate inflation because prices will be too high.
B. …consumers will clearly be worse off, but it’s not really about measuring inflation.
C. ...consumers will choose to buy less of stuff at lower or the same prices.
D. ...we will understate inflation because per ounce or other measured unit, the cost has risen.
E. ...we will understate inflation because we will have missed out on productivity growth.

16. (4 points) Ceteris paribus, the Short Run Aggregate Supply Curve (SRAS) will move to the left if….
A. ...energy prices fall.
B. ...unemployment is extremely low.
C. ...government spending is cut.
D. ...investment demand rises.
E. ...productivity increases.

17. (4 points) In terms of doing policy to fight a deep recession,

A. ...it’s hard to use tax cuts because people have so little income to tax anyway.
B. ...it can be hard to use monetary policy because that depends on cutting interest rates, which may already be low.
C. ...it’s hard to use government spending because in a recession tax revenues are so low.
D. ...the first step it to eliminate inflation.
E. ...the self-correcting mechanism is probably the fastest solution.

18. (4 points) With income inequality and global incomes,...

A. ...we know that some rich countries have a fair amount of income equality, so it’s important at every stage of
growth to prevent inequality from arrising along the way.
B. ...in Our World in Data, we see in terms of living conditions, “who you are matters more than where you live,” that
is, if you’re smart and hard working, you’ll be fine.
C. ...most of the extremely poor people in the world live in Africa.
D. ...while extreme poverty still exits, the vast majority of people in the world live on more than $30/day.
E. ...the poorest countries are growing the fastest (in terms of per capita real GDP).

19. (4 points) According to Karl Marx….

A. ...an economy with high unemployment would result in high profitability per worker employed.
B. ...leakages and injections could not be relied upon to bring equilibrium.
C. ...monetary policy could not be relied upon to save us from recessions.
D. ...economies of scale must be destroyed so that every worker was equal, and was his or her own firm.
E. ..workers would never be free as long as there remained capital anywhere.

Put your short answers here:

15. 16. 17. 18. 19.
Graphs
Graph 1: (4 points) On a well labeled graph of Real Output versus Aggregate Expenditure (45o diagram), clearly show
why the multiplier on government spending is expected to be bigger than one. Explain in words why this is expected to be
true.

Graph 2: (4 points)

The survey found 63 percent of respondents said they agree—with 42 percent

saying they "strongly agree"—when asked if the federal government should issue
new stimulus checks to tackle inflation.
Show what this policy would do on a Aggregate Expenditure graph and on an AD-SRAS-LRAS graph.
In words explain whether this would be an effective way of dealing with this problem.
Graph 3: (4 points) We are in an inflationary gap. Show this on a well drawn AD-SRAS-LRAS graph, and label our
current position A. Show what will be expected to happen if we take no policy actions, and label this B.
What sort of fiscal tax policy could we do to prevent the economy moving to point B? Show what this would look like on
the graph and label this point C.

Graph 4: (4 points) Think of the the model of an economy as a production function and its associated graph (RGDP per
capita on the vertical and capital per capita on the horizontal). For most of the last 40 years, China’s real GDP per capita
has grown faster than that in the US, but of late, China’s growth rate has slowed substantially. On the graph, show why
China’s growth rate has slowed relative to its former rate? Briefly explain what factor could offset that and return China to
its former growth rate.
 On-time bonus? (We will mark this one for you.) Yes: +4. No: + 0. Late: -5.

ESSAY (8 points) Explain why Gordon thinks that “education” and “international trade” will contribute to slowing growth
in the years to come, relative to what we observed in the second half of the 20th Century. Would efforts to remove race or
sex based barriers to employment be expected to have any impact on GDP? Explain.