Midterm Exam

Directions: Each Problem has the indicated weight. Work all problems on the exam itself. If necessary, use the back of the exam sheets, indicating that you have done so.

 

Name:

 

 

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Please reserve this table for my use

1.     (8 Points).  In any international trade agreement, the nation with the comparative advantage will get the best terms.  Explain whether you agree or disagree with the statement.

 

2.       (8 points). An individual who has a lifetime utility function of the form

U = log(c1)+ log (c2) + log(c3) +log(c4)

will, in period 1 of his life consume

 

He expects to earn $240,000  in period 2, and $450,000 in period 3 and then retire.  (All of the above is true).  The discount rate is 50% per period.  Baring surprises, he will consume $25,000 in the first period of life. 

Explain whether you agree or disagree with this statement.  Hint:  disagree, and give me the right number.

3.     (8 points).  Y=AK(1-b)Nb.  Thus no matter what we do to stimulate demand, we cannot change GDP.  Explain why you agree or disagree with these statements.

 

4.  (8 points).  A permanent change in taxes will always move us along the long run labor supply curve.  Explain whether you agree or disagree with the statement.

5.       (8Points).  The demand for loans curve cannot always be downward sloping: after all, a temporary increase in income will cause demand to increase.  Explain whether you agree or disagree with the statement.

6.       (8 Points).  A low natural unemployment rate is evidence of a well-run economy.  Explain whether you agree or disagree with the statement.

7        (30 points). Midwestern Backwater is a closed economy.  While the country is somewhat backward, it is a quite pleasant place to live.  The scenery is lovely, and crime is negligible.  Everyone cares deeply about children believing that “they are our future”.  It runs a balanced budget, but pays for its government services by a mixture of sales taxes and wage taxes.  There is no national debt.  Capital income is exempt from tax. Its economics minister firmly believes that “consumption generates growth”, and he wants Midwestern Backwater to grow.  Accordingly he enacts the following program.

  • No change in government spending
  • The sales tax is cut from 7% to 4%.
  • To make up for the lost revenue, the economics minister begins to borrow.  His economics staff projects that, given these policies, the debt will soon equal 1/3 of GDP; after it reaches that level normal economic growth will keep the debt- GDP ratio constant.
  • Everyone believes, and so should you, that these policies are permanent.

Your task is to figure out what will happen, in year one.  Specifically, you want to tell me what will happen to

·        GDP

·        Interest Rates

·        Investment

·        Consumption Demand

·        The Total Demand for Loans

·        The Trade Deficit

 

A couple of hints: there is an old proverb that a well-labeled and well-explained graph is worth a thousand words.  I fully expect a graph or two on this answer.  Note that you cannot tell me (I do not think) that interest rates  will go up (or down) by 1%.  Tell me as much as you can.

8.                       (30 Points) For each of the following events, what will be the impact on the US trade deficit? Explain your answer. It is not enough to guess the right answers: you must explain why these are the correct answers. I want to see a well-labeled and well-explained graph of the demand for loans.  Note: in all of these questions, you may assume that the only nominal assets and liabilities in the US, Europe and the UK are $, €, and £.

1.      Europeans are suddenly hit with a desire to visit the United States and see our scenic wonders.

2.      California vineyards go on a month-long strike, effectively running this years production of wine.

 

 

 

 

 

 

 

 

 

 

3.      The government repeals the tax on wage income, replacing it by a tax on consumption expenditures that raises the same amount of money.

4.      The government announces plans to spend $10,000,000 this year to build a monument to Irving Fisher, to be paid for with a temporary one year tax on wage incomes.   (Reluctantly, I will let you consider this a foolish project).

 

 

 

 

 

 

 

 

 

 

5.      Much of the underdeveloped world shakes off its lethargy, leading to a significant rise in the world-wide demand for loans.