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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1.           (10 Points).  Consumption generates growth.  Explain whether you agree or disagree with the statement.

 

 

 

 

 

 

 

 

 

 

 

2.           (10 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

 

(All of the above is true).  He expects to earn $180,000 in period 2, $450,000 in period 3 and then retire.  (All of the above is true).  The discount rate is 100% per period.  He is subject to a 50% tax on interest income and a 1/3 tax on wage income.  

 

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.           (10 Points).  If a nation removes a tariff on a good whose domestic demand is met by a combination of domestic production and imports, it is hard to tell whether the gains to consumers will exceed the losses to the producers.  Explain whether you agree or disagree with the statement. (Hint: a well-labeled and well-explained graph seems in order.)

4.           (10 Points).  If we love our children, we ought to pay off the national debt. .  Explain whether you agree or disagree with the statement.

 

5.           (10 Points).  In a nation where there is no trade, a temporary increase in government spending on a wasteful project will invariably increase interest rates more if it is financed by borrowing than if it is financed by a tax based on last year’s income tax liability.  Explain whether you agree or disagree with the statement.

 

6.           (10 Points).  The short run labor supply curve shows how people respond to a temporary increase in taxes on wages..  Explain whether you agree or disagree with the statement.

7.           (40 Points)  Warning: this problem asks you to fill out a table and explain your answers.  Do not fall prey to the temptation to merely fill out the table.  You do so at your peril.  Unlike its neighbors, Eastern Backwater is an open economy.  That is, it both imports and exports.  This year it is projecting a significant negative balance on current account.   Newspaper editorials have been uniform in condemning the government for permitting the deficit to become so large.  Unlike the United States, the large deficit on current account is not accompanied by a budget deficit.  Backwater’s constitution requires a balanced budget.

 

In an effort to eliminate the balance on current account, the government is proposing a massive cut in government transfer payments.  Each citizen would lose about $100 a year of government subsidies for items like education, health care, taxi rides, etc.  The budget savings would be used to cut tc,

 

Your task is to analyze this proposal.  Specifically:

(1)    What will be the impact on GDP, Investment, Interest Rates and the Balance on Current Account in the coming year?

 

I suggest you fill in the following tables:

 

What will be the effect on

(circle one)

GDP

increase/decrease/unsure

Investment

increase/decrease/unsure

Interest Rates

increase/decrease/unsure

Balance on Current Account

become more negative/
become less negative

Explain your answer:  this is important.  Take plenty of time to draw and explain the appropriate graphs.