Econ 102 Practice Final

Chris Surro
March 16, 2023

Name:

Student ID:

Exam Notes
1. This is a combination of questions that I gave in my Spring and Summer Econ 102
classes in 2019

2. The actual exam will not be this long (15 multiple choice questions vs 20 and 3 long
questions vs 4), but I figured more practice was better.

3. Since the length is different, I recommend timing yourself per question rather than
for the whole exam. Aim for roughly 3 minutes per multiple choice question and 30
minutes per long question.

4. I recommend taking this after you feel like you have completed the rest of your studying.
Treat it as if it were a real exam.

5. I recommend going through it four times. Once closed book and timed using the
guidelines above. Next, untimed but still closed book, filling in any gaps for things
you missed on the first pass. Third, review anything you were unsure of by going back
to the notes/past similar questions. Finally, comparing your answers to the provided
answer key.

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Multiple Choice (2 points each)
1. Consumers buy 100 iPhones (produced in the US) for $500 each and 50 Samsung
Galaxies (produced in Korea) for $500 each. If these are the only transactions, GDP
in the United States is

(a) $0
(b) $25,000
(c) $50,000
(d) $75,000

2. A United States car manufacturer sells a car in the US in 2019 for $20,000. The tires
for the car were produced by another firm in the US in 2018 and sold out of their
inventory for $2000 total. The frame of the car was purchased from Japan for $4000.
The remaining labor and supplies necessary to build the car all came from the US in
2019 and cost $10,000. As a result of the car being built, US GDP in 2019 increased
by

(a) $10,000
(b) $14,000
(c) $16,000
(d) $20,000

3. The government budget deficit is a and the government debt is a

(a) stock...stock
(b) flow...stock
(c) stock...flow
(d) flow...flow

4. A consumer has utility over consumption and leisure given by U (c, l) = 2c − (24 − l)2
where l is measured as a hours of time spent in leisure and the rest spent on labor. If
consumer spends half their time on leisure l = 12 and the real wage is 18, to increase
utility, the consumer should

(a) Work more

(b) Work less
(c) They are already at the optimal point
(d) Not enough information

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5. Assume a classical labor market with an upward sloping labor supply and downward
sloping labor demand. There are two industries and workers can freely move between
them at no cost. The economy starts in equilibrium, but then a minimum wage is
imposed on one sector (above the current wage). What would we expect to happen in
the other sector?
(a) Quantity of labor increases and wage falls
(b) Quantity of labor falls and wage falls
(c) Quantity of labor increases and wage increases
(d) Quantity of labor falls and wage increases
6. You found that in a simple Keynesian Cross model of the economy, a change in gov-
ernment spending of $1000 causes GDP to increase by $5000. How much would a tax
cut of $1000 increase GDP?
(a) $1000
(b) $4000
(c) $5000
(d) $6000
7. Two economies are exactly the same in every aspect except for the investment function.
Economy A has investment function given by I A = 10, 000 − 10r. Economy B has
investment function I B = 10, 000−100r. Based on the IS-LM model, in which economy
will government spending have a larger increase on output
(a) Economy A
(b) Economy B
(c) Same effect
(d) We cannot tell from the information given
8. In a liquidity trap, which of the following is true?
(a) Fiscal policy is more effective, but monetary policy is less effective than usual
(b) Monetary Policy is more effective, but fiscal policy is less effective than usual
(c) Neither fiscal nor monetary policy is as effective as usual
(d) Both fiscal and monetary policy are more effective than usual
9. The same hamburger costs $10 in the US and 1000 Yen in Japan. A US citizen sells a
hamburger for dollars in the United States, exchanges the dollars for yen, and buys 2
hamburgers in Japan. What is the nominal exchange rate (in Yen/Dollar)?
(a) 1/2
(b) 2
(c) 1/200
(d) 200

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10. In the Mundell-Fleming model with perfect capital mobility, a tariff can reduce a
country’s trade deficit only if

(a) Exchange rates are floating

(b) Exchange rates are fixed
(c) The tariff is targeted on goods where the country is very productive
(d) The tariff is targeted on goods where the country is not very productive

11. If the economy is below the natural rate of unemployment and inflation remains con-
stant, Milton Friedman would say that eventually the Phillips curve would shift
causing the unemployment rate to at the same rate of inflation

(a) Left...fall
(b) Left...increase
(c) Right...fall
(d) Right...increase

12. Which of the following examples best demonstrates the Lucas Critique of Keynesian
economics

(a) Government intervention in the economy distorts price signals, which causes firms
to invest in projects that are eventually revealed to be unprofitable
(b) Since the private economy is better at allocating resources than government, gov-
ernment intervention in the economy should be kept to a minimum
(c) The economy has a natural rate of unemployment, therefore policy can only be
effective in the short run
(d) Individuals in the economy have rational expectations, and their behavior will
change when policy changes.

13. A firm with supply function S = 10pe sets its expectations using an adaptive rule given
by pet = 0.5pet−1 + 0.5pt−1 . Demand for its product is given by D = 300 − 5p. In period
0, pe0 = p0 = 10. What is the price in period 3?

(a) 10
(b) 17.5
(c) 25
(d) 40

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14. What is the rational expectations equilibrium price in the example from the previous
question?

(a) 10
(b) 20
(c) 25
(d) 40

15. All of the following production functions are constant returns to scale EXCEPT

(a) Y = K α L1−α
(b) Y = 3K + 6L
 1/2
(c) Y = L2 + K 2
(d) Y = KL

16. In steady state, an economy has a capital stock of 25 units of capital per worker. If the
production function for the economy is Y = 2K 1/2 L1/2 and the depreciation rate is 0.2
(and no population growth), then the economy can increase steady state consumption
if

(a) The saving rate increases

(b) The saving rate decreases
(c) It is already at the maximum consumption
(d) We need to know the current saving rate to answer this question

17. An economy with production function Y = AK 1/2 L1/2 has a population growth rate
of 1% and technology growth rate (growth rate of A) of 2%. What is the growth rate
of aggregate capital (K) in steady state

(a) 0%
(b) 1%
(c) 3%
(d) 5%

18. Which of the following is NOT true of Real Business Cycle (RBC) Models and New
Keynesian (NK) Models

(a) Both RBC and NK models usually assume rational expectations

(b) Both RBC and NK models are considered microfounded economic models
(c) Both RBC and NK models have utility maximizing consumers and profit maxi-
mizing firms
(d) Both RBC and NK models always have perfectly flexible market clearing prices

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19. Other things equal, a higher interest rate in the 2-Period saving model is

(a) Good for savers and borrowers

(b) Good for savers and bad for borrowers
(c) Bad for savers and good for borrowers
(d) Bad for savers and borrowers

20. Consumer A has utility function U A (c1 , c2 ) = ln(cA A

1 ) + βA ln(c2 ). Consumer B has
utility function U (c1 , c2 ) = ln(c1 ) + βB ln(c2 ). Both consumers have the same income
in both periods y1A = y2A = y1B = y2B = ȳ. If βA > βB , in equilibrium who will borrow in
period 1 and who will save? (Hint: You do not need to fully solve for the equilibrium
to answer this question - use your intuition)

(a) Consumer A will borrow from consumer B

(b) Consumer B will borrow from consumer A
(c) Neither consumer will want to borrow or lend
(d) It depends how much larger βA is

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Analytical Questions (25 Points Each)
1. You are given:
C = 300 + 0.9(Y − T )
I = 5000 − 100r
G = 3000
T = 2000
Md
= 2Y − 2000r
P
M s = 50, 000
P =1

(a) (4 Points) Derive the IS and LM curves and solve for equilibrium output and the
interest rate
(b) (4 Points) The money supply doubles (so now M s = 100, 000). Find the new
equilibrium output and interest rate and show the change on a graph.
(c) (4 Points) After the increase in the money supply assume that firms expect prices
to increase and double all prices so now P=2. What happens? Connect your
answer to the Lucas Critique.
(d) (3 Points) If people have adaptive expectations, explain how an increase in the
money supply would affect output (and unemployment) and inflation in the short
and long run. You do not need to refer to the specific numbers in the problem,
but you should make reference to the Phillip’s Curve in your answer.
Return to the original values. For the rest of the question assume that
the economy is an open economy with the following equations governing
its current and capital accounts

CA = N X = 5000 − 500ε

KA = z(r − r∗ )
(e) (4 Points) If the world interest rate is r∗ = 20 and there is perfect capital mobil-
ity, derive the IS, LM, and BP curves of the Mundell-Fleming model. Solve for
equilibrium output, the real exchange rate, and the level of net exports. Show the
initial equilibrium on a graph with the real interest rate on the y axis and output
on the x axis.
(f) (6 points) The world interest rate falls to r∗ = 10. Solve for the new output,
exchange rate, and net exports under both fixed and floating exchange rates.
Show each on a graph. Be sure to be clear about which curves shift in each case
(more space on next page if you need it)

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2. (There are g parts in this question) An economy has production function Y = AK 3/5 L2/5 .
Population grows at 3%, Technology (A) grows at 2%, the depreciation rate is δ = 0.02,
and the saving rate is s = 0.4.
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(a) (2 Point) Define à = A 2 . What is the growth rate of � Show that we can write
K Y
the production function as ỹ = f (k̃) where k̃ = ÃL and ỹ = ÃL
(b) (3 Points) Capital per effective worker in period t is k̃t = 1. Write down the law
of motion of capital per effective worker (don’t need to derive) and find k̃t+1 and
k̃t+2
(c) (4 Points) Find the steady state capital per effective worker (k̃), output per ef-
fective worker (ỹ), and consumption per effective worker (c̃). What is the growth
rate of each of these variables in the steady state?
(d) (3 Points) Find the saving rate that maximizes consumption per effective worker
in the steady state (for full credit you must show the derivation)
(e) (5 Points) The growth rate of technology increases to 4%. On three separate
graphs, show how capital per effective worker, capital per worker, and aggregate
capital change over time. You do not need to solve for the new steady state but
the direction should be correct. You do need to be clear about the slope of the
line at each point on each graph.
For the remaining questions, assume the same production function with
population growth and technology growth both set to 0 and A=1. How-
ever, now assume that the government imposes a tax on saving. More
specifically, saving in the economy is now given by S = s(1 − τ )Y where
τ is the fraction of saving the government takes in taxes (assume that
the government throws these resources into the ocean so they do not
add to the capital stock). Assume the saving rate is still s = 0.4 and
the depreciation rate is still δ = 0.02
(f) (5 Points) Find an expression for the steady state capital per worker as a function
of the tax rate τ . What is the steady state capital when τ = 0.2? Is this higher
or lower than when τ = 0?
(g) (3 Points) How does the tax affect the level of steady state capital that maximizes
steady state consumption? Will the optimal rate be higher or lower as the tax
goes up (Note: it’s tricky to calculate the level directly - intuition is enough here)

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3. (This question has g parts) Two consumers, A and B, allocate consumption between
period 1 and period 2. They each have the same utility function given by

U (c1 , c2 ) = ln(c1 ) + ln(c2 )

However, in each period they have different incomes. Consumer A receives an income
y1A = 200 in period 1 and y2A = 200 in period 2. Consumer B receives an income
y1B = 100 in period 1 and y2B = 300 in period 2.

(a) (3 Points) Assume consumers are not allowed to borrow or save so just consume
their income in each period. Who has higher utility? Explain why by talking
about the marginal utilities of each good for each consumer.
(b) (3 Points) Now allow consumers to borrow and save. Without solving for it
directly, will the equilibrium interest rate be above or below 0? Justify your
answer.
(c) (6 Points) Find the equilibrium interest rate and consumption in each period for
each consumer. How much does each consumer borrow or save?
(d) (3 Points) Who has more consumption overall across the two periods? Explain
the intuition behind this result.
(e) (4 Points) Calculate the interest rate if utility becomes U (c1 , c2 ) = ln(c1 )+β ln(c2 )
and β = 0.9 for each consumer. Is it higher or lower than your result from part
c? Explain the intuition
For the remaining questions, assume both consumers have the same
income in each period y1A = y1B = y2A = y2B = 100, but have different
discount factors, β A = 1, β B = 0.5
(f) (3 Points) Without calculating, who will be a borrower and who will be a saver
in equilibrium. Explain your answer.
(g) (6 Points) Calculate the equilibrium interest rate

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4. (There are f parts in this question) An economy consists of 120 consumers who each
have a utility function of U (c, l) = c1/2 − (24 − l) where l is the number of hours the
consumer commits to leisure (let the total hours in a day be 24). There are 2 firms in
the economy and each has production function given by Y = 6000 ln(L) where L is the
number of hours the firm employs. Assume the firms can sell anything it produces at
price p = 1.

(a) (5 Points) Write down the consumer’s utility maximization problem (including
constraints) and derive an individual’s labor supply as a function of the real wage
and the aggregate labor supply as a function of the real wage.
(b) (5 Points) Write down the firm’s profit function and derive the firm’s labor demand
as a function of the real wage.
(c) (5 Points) Find the equilibrium real wage, hours worked, real consumption for
each worker, and real output and real profit of each firm (remember there are 120
consumers and 2 firms).
Now assume that consumers also care about their commute time. In
particular, let their utility be

(c1/2 − (24 − l))

U (c, l) =
d
Where d is a constant that represents the amount of time it takes the
consumer to drive to work.
(d) (2 Points) Assume d = 30. How does the consumer’s optimal labor choice change?
Now assume there are two firms that only differ in commuting time.
They have the same productions given above, but the first firm (Firm
1) is a 30 minute drive (d1 = 30), and the second (Firm 2) is a 60 minute
drive (d2 = 60) from every consumer. Consumers can choose which firm
they prefer to work at.
(e) (2 Points) If the two firms each pay the wage you found in part c, would a
consumer prefer to work at firm 1 or firm 2 (hint: what would their utility be in
each case?)?
(f) (6 Points) Find an equilibrium where both firms hire a positive number of workers.
A complete answer should have a wage and quantity of labor for each firm (Hint
1: it might be helpful to define a variable x to represent the number of workers
working firm 1 (so 120-x is the number at 2). Hint 2: what does the question
above tell you about the relationship between wages? What does it mean must
happen to the wage at the farther firm? Also, this is the hardest question on the
exam - I suggest saving it for last unless you are pretty sure you know how to
solve it. It’s only worth 6/150)

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