ECON 001 - Principles of Macroeconomics Drake University, Fall 2014 William M. Boal

FINAL EXAMINATION

### Version A

I. Multiple choice [1 pt each: 20 pts total]

(1)d. (2)a. (3)a. (4)c. (5)b. (6)d. (7)a. (8)c. (9)c. (10)a.
(11)a. (12)c. (13)c. (14)c. (15)c. (16)c. (17)a. (18)b. (19)a. (20)b.

II. Problems

(1) [Economic capital: 6 pts] Economic capital includes factories, buildings, machinery, equipment, vehicles, computers, and software: goods that help produce more goods. Note that economic capital is NOT the same as financial capital.

1. yes.
2. no.
3. yes.
4. no.
5. yes.
6. yes.

(2) [Production functions: 6 pts]

1. Average product of workers = packages/workers = 3 packages per worker.
2. Marginal product of workers = Δ packages/Δ workers = 1.5 package per worker.
3. Marginal product of trucks = Δ packages/Δ trucks = 3 packages per truck.

1. 1/3 tablets.
2. 1/2 tablets.
3. 3 bicycles.
4. 2 bicycle.
5. Country A (because it has the lower opportunity cost of producing bicycles).
6. Country B (because it has the lower opportunity cost of producing tablets).
7. ... if Country B produces and exports two million tablets to Country A, which produces and exports 5 million bicycles in return.
8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(4) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

1. Demand shifts right, supply unchanged, equilibrium price increases, equilibrium quantity increases.
2. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
3. Demand shifts left, supply shifts left, equilibrium price cannot be determined, equilibrium quantity decreases.

(5) [Components of GDP: 16 pts]

1. Consumption = \$800 billion, investment = \$200 billion, government purchases = \$300 billion, total GDP = \$1300 billion.
2. Value added by Raw Concrete Industry = \$450 billion, by Building Industry = \$150 billion, by Road Construction Industry = \$200 billion, by Birdbath Industry = \$500 billion.

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

1. \$15.0 billion.
2. \$1.6 trillion.
3. \$48,387.

(7) [Value added: 2 pts] \$250,000.

(8) [Nominal GDP, real GDP, and inflation: 7 pts]

1. base year = 2010 (because nominal GDP = real GDP in that year).
2. GDP price index = nominal GDP / real GDP × 100 = 94.4, 98.7, 100.0.
3. Rate of inflation = (new price index - old price index) / (old price index) = 4.6 percent, 1.3 percent.

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

1. 12.3 million = labor force - employed.
2. 7.9 percent = unemployed / labor force.
3. 58.4 percent = employed / working-age population, where working-age population = labor force + not in labor force.
4. 63.4 percent = labor force / working-age population.

(10) [Growth of capital stock: 2 pts] \$33.6 trillion = capital stock at end of prior year + gross investment - depreciation.

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

1. unchanged.
2. unchanged.
3. unchanged.
4. unchanged.
5. shifts right.
6. decrease.
7. increase.
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 stock of capital, and technology. Since investment spending decreases, the capital stock grows slower and the long-run growth rate of real GDP will decrease.

(12) [Technical change: 4 pts]

1. 1.1 percent.
2. 0.7 percent.

(13) [Measuring the money supply: 8 pts]

1. \$1.7 trillion, because M1 = currency + checking deposits.
2. \$8.4 trillion, because M2 = M1 + savings deposits.
3. 8.8, because velocity = GDP / money supply.
4. \$2.0 trillion, because MB = currency + bank reserves.

(14) [Quantity equation: 2 pts] 2.4 percent.

(15) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$17.5 trillion.
2. down.
3. \$0.5 trillion.
4. decrease.
5. \$1.5 trillion. (Find this by drawing the new expenditure line carefully.)
6. 3. (Using the answers to parts c and e, ΔY/ΔG = 1.5/0.5)

(16) [Monetary policy rule: 8 pts]

1. 2.0 percent.
2. 5.0 percent, because real interest rate = nominal interest rate - inflation rate.
3. up, because "tightened" monetary policy means the interest rate is raised without any change in inflation.
4. decrease, because a higher interest rates would decrease C, I, and X.
5. unchanged, because inflation has momentum in the short run.

1. \$16.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$17.0 trillion (an increase).
4. 3 percent, because inflation rate has momentum in short run.
5. less than the natural rate because GDP is now greater than potential GDP.
6. \$16.5 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 5 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because once again GDP = potential GDP.

(18) [Fiscal policy, tax rates: 4 pts]

1. 19 percent = total tax owed / income.
2. \$19,140 = \$19,000 + 28 percent × \$500.

(19) [Monetary policy: 6 pts]

1. increase, because the Fed pays for bonds by giving banks more reserves.
2. decrease, because demand for money slopes down, so an increase in the money supply causes interest rates to decrease.
3. 0.15 percentage points. Find this by solving 0.03/\$100 billion = x/\$500 billion.
4. sell.
5. \$1500 billion. Find this by solving 0.03/\$100 billion = 0.45/x.
6. decrease, because banks pay the Fed for bonds by giving up reserves.

(20) [GDP growth around the world: 10 pts]

1. NO.
2. NO.
3. YES.
4. YES.
5. YES.

(21) [International accounts: 10 pts]

1. -0.4 = net exports = (exports of goods + exports of services) - (imports of goods + imports of services).
2. -0.4 = trade balance + (income receipts - income payments) + (transfer receipts - transfer payments).

III. Critical thinking [3 pts]

(1) Japan's central bank could raise the value of its currency by raising interest rates in Japan. However, raising interest rates would reduce consumption spending, investment spending, and net exports. If Japan is already on the brink of recession, raising interest rates would lower GDP and cause a recession. Therefore one should not recommend that the central bank of Japan raise interest rates at this time.

(2) One should agree with this argument. Let S denote national saving. By definition, S = GDP - C - G, so S = I + X, and S - I = X. This last equation shows that if investment (I) remains constant and saving (S) increases, then net exports (X) will rise, becoming less negative and reducing the trade deficit.

### Version B

I. Multiple choice [1 pt each: 20 pts total]

(1)b. (2)b. (3)b. (4)d. (5)c. (6)b. (7)d. (8)d. (9)b. (10)c.
(11)b. (12)b. (13)e. (14)c. (15)d. (16)e. (17)b. (18)a. (19)b. (20)d.

II. Problems

(1) [Economic capital: 6 pts] Economic capital includes factories, buildings, machinery, equipment, vehicles, computers, and software: goods that help produce more goods. Note that economic capital is NOT the same as financial capital.

1. yes.
2. yes.
3. no.
4. no.
5. yes.
6. no.

(2) [Production functions: 6 pts]

1. Average product of workers = packages/workers = 3 packages per worker.
2. Marginal product of workers = Δ packages/Δ workers = 2 package per worker.
3. Marginal product of trucks = Δ packages/Δ trucks = 4 packages per truck.

1. 2 tablets.
2. 1 tablets.
3. 1/2 bicycles.
4. 1 bicycle.
5. Country B (because it has the lower opportunity cost of producing bicycles).
6. Country A (because it has the lower opportunity cost of producing tablets).
7. ... if Country A produces and exports three million tablets to Country B, which produces and exports 2 million bicycles in return.
8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(4) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

1. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
2. Demand shifts right, supply unchanged, equilibrium price increases, equilibrium quantity increases.
3. Demand shifts right, supply shifts left, equilibrium price increases, equilibrium quantity cannot be determined.

(5) [Components of GDP: 16 pts]

1. Consumption = \$900 billion, investment = \$400 billion, government purchases = \$500 billion, total GDP = \$1800 billion.
2. Value added by Raw Concrete Industry = \$450 billion, by Building Industry = \$350 billion, by Road Construction Industry = \$400 billion, by Birdbath Industry = \$600 billion.

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

1. \$14.7 billion.
2. \$1.7 trillion.
3. \$48,197.

(7) [Value added: 2 pts] \$300,000.

(8) [Nominal GDP, real GDP, and inflation: 7 pts]

1. base year = 2002 (because nominal GDP = real GDP in that year).
2. GDP price index = nominal GDP / real GDP × 100 = 97.8, 100.0, 106.9.
3. Rate of inflation = (new price index - old price index) / (old price index) = 2.2 percent, 6.9 percent.

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

1. 13.9 million = labor force - employed.
2. 9.1 percent = unemployed / labor force.
3. 58.2 percent = employed / working-age population, where working-age population = labor force + not in labor force.
4. 64.0 percent = labor force / working-age population.

(10) [Growth of capital stock: 2 pts] \$34.2 trillion = capital stock at end of prior year + gross investment - depreciation.

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

1. left.
2. unchanged.
3. unchanged.
4. shifts left.
5. unchanged.
6. decrease.
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 stock of capital, and technology. Since investment spending increases, the capital stock grows faster and the long-run growth rate of real GDP will increase.

(12) [Technical change: 4 pts]

1. 2.2 percent.
2. 2.3 percent.

(13) [Measuring the money supply: 8 pts]

1. \$2.0 trillion, because M1 = currency + checking deposits.
2. \$9.2 trillion, because M2 = M1 + savings deposits.
3. 1.7, because velocity = GDP / money supply.
4. \$2.5 trillion, because MB = currency + bank reserves.

(14) [Quantity equation: 2 pts] 2.6 percent.

(15) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$15.5 trillion.
2. up.
3. \$0.5 trillion.
4. decrease.
5. \$1.0 trillion. (Find this by drawing the new expenditure line carefully.)
6. 2. (Using the answers to parts c and e, ΔY/ΔG = 1.0/0.5)

(16) [Monetary policy rule: 8 pts]

1. 2.5 percent.
2. 6.5 percent, because real interest rate = nominal interest rate - inflation rate.
3. down, because "relaxed" monetary policy means the interest rate is lowered without any change in inflation.
4. increase, because a lower interest rates would increase C, I, and X.
5. unchanged, because inflation has momentum in the short run.

1. \$16.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$18.0 trillion (an increase).
4. 2 percent, because inflation rate has momentum in short run.
5. less than the natural rate because GDP is now greater than potential GDP.
6. \$16.5 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 8 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because once again GDP = potential GDP.

(18) [Fiscal policy, tax rates: 4 pts]

1. 10 percent = total tax owed / income.
2. \$3075 = \$3000 + 15 percent × \$500.

(19) [Monetary policy: 6 pts]

1. decrease, because banks pay the Fed for bonds by giving up reserves.
2. increase, because demand for money slopes down, so a decrease in the money supply causes interest rates to decrease.
3. 0.09 percentage points. Find this by solving 0.03/\$100 billion = x/\$300 billion.
4. sell.
5. \$800 billion. Find this by solving 0.03/\$100 billion = 0.24/x.
6. decrease, because banks pay the Fed for bonds by giving up reserves.

(20) [GDP growth around the world: 10 pts]

1. YES.
2. YES.
3. YES.
4. YES.
5. NO.

(21) [International accounts: 10 pts]

1. -0.5 = net exports = (exports of goods + exports of services) - (imports of goods + imports of services).
2. -0.3 = trade balance + (income receipts - income payments) + (transfer receipts - transfer payments).

III. Critical thinking [3 pts]

Same as Version A.

### Version C

I. Multiple choice [1 pt each: 20 pts total]

(1)c. (2)b. (3)b. (4)a. (5)a. (6)c. (7)e. (8)b. (9)b. (10)d.
(11)e. (12)c. (13)b. (14)c. (15)c. (16)b. (17)b. (18)b. (19)c. (20)a.

II. Problems

(1) [Economic capital: 6 pts] Economic capital includes factories, buildings, machinery, equipment, vehicles, computers, and software: goods that help produce more goods. Note that economic capital is NOT the same as financial capital.

1. no.
2. yes.
3. yes.
4. yes.
5. no.
6. yes.

(2) [Production functions: 6 pts]

1. Average product of workers = packages/workers = 2 packages per worker.
2. Marginal product of workers = Δ packages/Δ workers = 1 package per worker.
3. Marginal product of trucks = Δ packages/Δ trucks = 3 packages per truck.

1. 2 tablets.
2. 3 tablets.
3. 1/2 bicycles.
4. 1/3 bicycle.
5. Country A (because it has the lower opportunity cost of producing bicycles).
6. Country B (because it has the lower opportunity cost of producing tablets).
7. ... if Country B produces and exports three million tablets to Country A, which produces and exports 5 million bicycles in return.
8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(4) [Shifts in demand and supply curves: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

1. Demand shifts left, supply unchanged, equilibrium price decreases, equilibrium quantity decreases.
2. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
3. Demand shifts right, supply shifts right, equilibrium price cannot be determined, equilibrium quantity increases.

(5) [Components of GDP: 16 pts]

1. Consumption = \$500 billion, investment = \$200 billion, government purchases = \$100 billion, total GDP = \$800 billion.
2. Value added by Raw Concrete Industry = \$300 billion, by Building Industry = \$150 billion, by Road Construction Industry = \$50 billion, by Birdbath Industry = \$300 billion.

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

1. \$14.4 billion.
2. \$1.5 trillion.
3. \$46,906.

(7) [Value added: 2 pts] \$350,000.

(8) [Nominal GDP, real GDP, and inflation: 7 pts]

1. base year = 1998 (because nominal GDP = real GDP in that year).
2. GDP price index = nominal GDP / real GDP × 100 = 100.0, 154.3, 230.2.
3. Rate of inflation = (new price index - old price index) / (old price index) = 54.3 percent, 49.2 percent.

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

1. 12.6 million = labor force - employed.
2. 8.2 percent = unemployed / labor force.
3. 58.3 percent = employed / working-age population, where working-age population = labor force + not in labor force.
4. 63.5 percent = labor force / working-age population.

(10) [Growth of capital stock: 2 pts] \$34.8 trillion = capital stock at end of prior year + gross investment - depreciation.

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

1. unchanged.
2. left.
3. unchanged.
4. left.
5. unchanged.
6. decrease.
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 stock of capital, and technology. Since investment spending decreases, the capital stock grows slower and the long-run growth rate of real GDP will decrease.

(12) [Technical change: 4 pts]

1. 1.6 percent.
2. 0.8 percent.

(13) [Measuring the money supply: 8 pts]

1. \$2.4 trillion, because M1 = currency + checking deposits.
2. \$10.1 trillion, because M2 = M1 + savings deposits.
3. 6.8, because velocity = GDP / money supply.
4. \$2.6 trillion, because MB = currency + bank reserves.

(14) [Quantity equation: 2 pts] 3.9 percent.

(15) [Keynesian cross, Keynesian multipliers: 12 pts]

1. \$16.0 trillion.
2. up.
3. \$1.5 trillion.
4. increase.
5. \$2.0 trillion. (Find this by drawing the new expenditure line carefully.)
6. 4/3 = 1.333. (Using the answers to parts c and e, ΔY/ΔG = 2.0/1.5)

(16) [Monetary policy rule: 8 pts]

1. 3.0 percent.
2. 8.0 percent, because real interest rate = nominal interest rate - inflation rate.
3. up, because "tightened" monetary policy means the interest rate is raised without any change in inflation.
4. decrease, because a higher interest rates would decrease C, I, and X.
5. unchanged, because inflation has momentum in the short run.

1. \$16.5 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment because GDP = potential GDP.
3. \$15.5 trillion (a decrease).
4. 6 percent, because inflation rate has momentum in short run.
5. greater than the natural rate because GDP is now less than potential GDP.
6. \$16.5 trillion, because eventually the inflation rate will fall until GDP once more equals potential GDP.
7. 2 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment because once again GDP = potential GDP.

(18) [Fiscal policy, tax rates: 4 pts]

1. 15 percent = total tax owed / income.
2. \$9125 = \$9000 + 25 percent × \$500.

(19) [Monetary policy: 6 pts]

1. decrease, because banks pay the Fed for bonds by giving up reserves.
2. increase, because demand for money slopes down, so an decrease in the money supply causes interest rates to increase.
3. 0.15 percentage points. Find this by solving 0.03/\$100 billion = x/\$500 billion.
4. sell.
5. \$400 billion. Find this by solving 0.03/\$100 billion = 0.12/x.
6. decrease, because banks pay the Fed for bonds by giving up reserves.

(20) [GDP growth around the world: 10 pts]

1. NO.
2. NO.
3. NO.
4. YES.
5. NO.

(21) [International accounts: 10 pts]

1. -0.5 = net exports = (exports of goods + exports of services) - (imports of goods + imports of services).
2. -0.4 = trade balance + (income receipts - income payments) + (transfer receipts - transfer payments).

III. Critical thinking [3 pts]

Same as Version A.