ECON 001 - Principles of Macroeconomics Drake University, Fall 2013 William M. Boal

EXAMINATION 3

### Version A

I. Multiple choice [2 pts each: 14 pts total]

(1)c. (2)c. (3)b. (4)a. (5)d. (6)b. (7)c.

II. Problems

(1) [Aggregate production function: 6 pts]

1. true.
2. false.
3. false.
4. true.
5. true.
6. false.

(2) [Measuring the labor force: 5 pts]

1. Out of the labor force.
2. Out of the labor force.
3. Employed.
4. Unemployed.
5. Unemployed.

(3) [Measuring the labor force: 8 pts]

1. 7.7 million = labor force - employed.
2. 5.2 percent = unemployed / labor force.
3. 62.6 percent = employed / working-age population.
4. 66.1 percent = labor force / working-age population.

(4) [Growth of capital stock: 2 pts] \$30.2 trillion.

(5) [Interest rate: 4 pts]

1. \$1061 = 1000 × (1.02)3.
2. \$1331 = 1000 × (1.10)3.

(6) [Interest rate and GDP shares: 6 pts]

1. 4 percent.
2. 68 percent.
3. 13 percent.
4. -3 percent (a trade deficit).
5. 10 percent.

(7) [Interest rate and GDP shares: 16 pts]

1. left.
2. unchanged.
3. unchanged.
4. left.
5. unchanged.
6. decrease.
7. decrease.
8. Justification: As shown in the graph, investment's share of GDP (I/Y) increases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending increases, the capital stock grows faster and the long-run growth rate of real GDP will increase.

(8) [Malthusian limits to growth: 8 pts]

1. \$6000.
2. more than enough.
3. increase.
4. not enough.
5. decrease.
6. 3 million.
7. \$6000.
8. \$6000.

(9) [Technical change: 4 pts]

1. 3.0 percent.
2. 3.9 percent.

(10) [GDP and real GDP: 4 pts]

1. unit of account.
2. store of value.
3. medium of exchange.
4. medium of exchange.

(11) [Measuring the money supply: 10 pts]

1. \$1.4 trillion, because M1 = currency + checking deposits.
2. \$7.1 trillion, because M2 = M1 + savings deposits
3. 10.1 , because velocity = GDP / M1.
4. \$0.84 trillion, because MB = currency + bank reserves.
5. 1.7 , because money multiplier = M1/MB.

(12) [Money multiplier: 4 pts]

1. 3.0 , because money multiplier = (1+k)/(k+RR).
2. \$150 billion.

(13) [Quantity equation: 2 pts]

1. 4.2 percent.

III. Critical thinking [3 pts]

(1) Yes, the government can influence the labor force participation rate, which equals the ratio of the labor force to the working-age population. For example, to raise the labor force participation rate, it must encourage people who are out of the labor force to look for work, and discourage workers from leaving the labor force. There are many ways it can do this.

1. The government can reduce taxes on wages, so that work pays more. That would encourage more people to work or at least look for work. (An actual example is the Earned Income Tax Credit, which gives a tax refund to low-income workers with children.)
2. The government can alter Social Security benefits to encourage people to delay retirement. (In fact, Congress made this change awhile ago. To enjoy full benefits, workers must now wait till age 66 instead of age 65.)
3. The government can operate job banks that seek to match unemployed workers with employers. This might entice people who are out of the labor force to look for work. (In fact, the State of Iowa operates a job bank at www.iowajobs.org.)
4. The government can offer free or subsidized training in valuable work skills. (Community colleges do this.)
5. The government can offer free or subsidized day care, to encourage young mothers to enter the labor force.

(2) Yes, the government can influence the fraction of GDP devoted to consumption (C/Y). According to the spending shares model, if the government changes the share of government purchases in GDP (G/Y), then the interest rate will change and the share of consumption in GDP (C/Y) will change in the opposite direction. For example, if the government increases (G/Y), the interest rate will rise and (C/Y) will decrease.

But the government can also influence (C/Y) without changing (G/Y) by taking actions that shift the (C/Y) curve in the spending shares model. For example, to shift the (C/Y) curve to the right and increase (C/Y), it must encourage consumers to save more and spend less. There are many ways it can do this.
1. The government can switch from an income tax to a consumption tax or a national sales tax. (This has been proposed in Washington.)
2. The government can offer retirement accounts, which shelter savings from taxation until they are withdrawn at retirement. (In fact, U.S. tax law allows several kinds of retirement accounts, though contributions to them are limited by law.)
3. The government could reduce future retirement benefits under Social Security for current workers. That would encourage current workers to consume less now and save more for retirement outside the Social Security system. (See Version A problem (7) above.)
4. The government could lower taxes on interest income. That would encourage people to consume less and save more, because they would enjoy a higher return on their savings.

### Version B

I. Multiple choice [2 pts each: 14 pts total]

(1)b. (2)a. (3)d. (4)b. (5)e. (6)d. (7)b.

II. Problems

(1) [Aggregate production function: 6 pts]

1. true.
2. false.
3. true.
4. false.
5. false.
6. true.

(2) [Measuring the labor force: 5 pts]

1. Unemployed.
2. Unemployed.
3. Out of the labor force.
4. Out of the labor force.
5. Employed.

(3) [Measuring the labor force: 8 pts]

1. 6.8 million = labor force - employed.
2. 4.5 percent = unemployed / labor force.
3. 62.9 percent = employed / working-age population.
4. 65.9 percent = labor force / working-age population.

(4) [Growth of capital stock: 2 pts] \$31.5 trillion.

(5) [Interest rate: 4 pts]

1. \$1093 = 1000 × (1.03)3.
2. \$1368 = 1000 × (1.11)3.

(6) [GDP, saving, GDP per capita: 6 pts]

1. 5 percent.
2. 67 percent.
3. 10 percent.
4. -5 percent (a trade deficit).
5. 5 percent.

(7) [Interest rate and GDP shares: 16 pts]

1. unchanged.
2. right.
3. unchanged.
4. right.
5. unchanged.
6. increase.
7. increase.
8. Justification: As shown in the graph, investment's share of GDP (I/Y) increases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending increases, the capital stock grows faster and the long-run growth rate of real GDP will increase.

(8) [Malthusian limits to growth: 8 pts]

1. \$8000.
2. not enough.
3. decrease.
4. more than enough.
5. increase.
6. 5 million.
7. \$8000.
8. \$8000.

(9) [Technical change: 4 pts]

1. 0.6 percent.
2. 0.2 percent.

(10) [GDP and real GDP: 4 pts]

1. medium of exchange.
2. unit of account.
3. store of value.
4. medium of exchange.

(11) [Measuring the money supply: 10 pts]

1. \$1.6 trillion, because M1 = currency + checking deposits.
2. \$8.4 trillion, because M2 = M1 + savings deposits
3. 1.7 , because velocity = GDP / M2.
4. \$1.7 trillion, because MB = currency + bank reserves.
5. 4.9 , because money multiplier = M2/MB.

(12) [Money multiplier: 4 pts]

1. 4.0 , because money multiplier = (1+k)/(k+RR).
2. \$200 billion.

(13) [Quantity equation: 2 pts]

1. 0.7 percent.

III. Critical thinking [3 pts]

Same as Version A.

### Version C

I. Multiple choice [2 pts each: 14 pts total]

(1)a. (2)b. (3)e. (4)c. (5)e. (6)a. (7)a.

II. Problems

(1) [Aggregate production function: 6 pts]

1. false.
2. true.
3. true.
4. false.
5. true.
6. false.

(2) [Measuring the labor force: 5 pts]

1. Out of the labor force.
2. Employed.
3. Unemployed.
4. Unemployed.
5. Out of the labor force.

(3) [Measuring the labor force: 8 pts]

1. 13.9 million = labor force - employed.
2. 9.0 percent = unemployed / labor force.
3. 59.8 percent = employed / working-age population.
4. 65.7 percent = labor force / working-age population.

(4) [Growth of capital stock: 2 pts] \$31.6 trillion.

(5) [Interest rate: 4 pts]

1. \$1125 = \$1000 × (1.04)3.
2. \$1405 = \$1000 × (1.12)3.

(6) [GDP, saving, GDP per capita: 6 pts]

1. 3 percent.
2. 69 percent.
3. 16 percent.
4. -1 percent (a trade deficit).
5. 15 percent.

(7) [Interest rate and GDP shares: 16 pts]

1. unchanged.
2. unchanged.
3. unchanged.
4. unchanged.
5. left.
6. increase.
7. decrease.
8. Justification: As shown in the graph, investment's share of GDP (I/Y) decreases. Investment is spending on new economic capital, such as buildings, machines, vehicles, computers, and software. In the long-run, the level of real GDP depends on the size of the labor force, the level of the capital stock, and technology. Since investment spending decreases, the capital stock grows slower and the long-run growth rate of real GDP will decrease.

(8) [Malthusian limits to growth: 8 pts]

1. \$5000.
2. more than enough.
3. increase.
4. not enough.
5. decrease.
6. 8 million.
7. \$5000.
8. \$5000.

(9) [Technical change: 4 pts]

1. 1.1 percent.
2. 0.6 percent.

(10) [GDP and real GDP: 4 pts]

1. medium of exchange.
2. medium of exchange.
3. unit of account.
4. store of value.

(11) [Measuring the money supply: 10 pts]

1. \$1.8 trillion, because M1 = currency + checking deposits.
2. \$8.8 trillion, because M2 = M1 + savings deposits
3. 8.4 , because velocity = GDP / M1.
4. \$2.0 trillion, because MB = currency + bank reserves.
5. 0.9 , because money multiplier = M1/MB.

(12) [Money multiplier: 4 pts]

1. 4.8 , because money multiplier = (1+k)/(k+RR).
2. \$240 billion.

(13) [Quantity equation: 2 pts]

1. 4.5 percent.

III. Critical thinking [3 pts]

Same as Version A.