Economics 302 Name _______________________________

Spring 2007
First Midterm Student ID Number ____________________
February 22, 2007 Section Number _______________________

This midterm consists of four parts: a binary choice section comprised of 10 questions worth 2 points each;
a short response section with 4 short response questions worth 5 points each; a problem section with two
problems worth a total of 40 points; and an essay section worth a total of 20 points.

You will want to write legibly since illegible answers will be graded as wrong answers.

You will want to present your work in an orderly fashion since a lack of organization will be interpreted as
a lack of mental clarity and competent expression.

You will want to make sure your answers are clear and easy to find on the test.

In the binary choice section of the exam, pick the BEST answer.

All work should be done on the exam booklet and all answers should provide work and any formulas that
are used. A lack of work for any answer will be penalized by a lower grade on that section.

Calculators are fine to use.

If there is an error on the exam or you do not understand something, make a note on your exam
booklet and the issue will be addressed AFTER the examination is complete. No questions regarding
the exam can be addressed while the exam is being admininistered.

SCORE:

Binary Choice 20 points __________________

Short Response 20 points

1. __________________
2. __________________
3. __________________
4. __________________

Problems 40 points

1. 20 points __________________

2. 20 points __________________

Essay 20 points __________________

TOTAL 100 points __________________

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I. Binary Choice (worth 2 points each or 20 points total)

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%.

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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 (worth 5 points each or 20 points total)

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

1. (5 points) 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.

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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.

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III. Problems (worth a total of 40 points)
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. ( 5 points) What is the aggregate output equal to in this economy?

b. (5 points) What is the price level, P, in this economy?

c. (5 points) 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. (5 points) 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.

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 2. (20 points total) Use the following data to answer this question.

Year Price of Housing Quantity of Housing Price of Food Quantity of Food

2000 $2000 100 $60 1000
2001 $1600 110 $50 1300

a. (4 points) 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. (4 points) 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 = _____________________________

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c. (4 points) 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. (2 points) 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. (4 points) 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. (2 points) 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:

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 IV. Essay (worth a total of 20 points)

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.

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