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:

 

 

1

2

3

4

5

6

7

S

1.           (10 Points).  If we increase unemployment benefits, we will get a higher natural rate of unemployment.  Explain whether you agree or disagree with the statement.

2.           (10 Points).  A bright young MBA student 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 $200,000 in period 2, $600,000 in period 3 and then retire.  (All of the above is true).  The discount rate is 100% per period.  He is subject to a 20% tax on interest income and a 50% 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).  Rapid economic growth must be accompanied by a steeper Lorenz curve.  Explain whether you agree or disagree with the statement.

4.           (10 Points).  The short run labor supply curve intersects the long run labor supply curve where labor supply and demand are equal.   Explain whether you agree or disagree with the statement.

 

5.           (10 Points).  Higher taxes never lead to more saving.  Explain whether you agree or disagree with the statement.

 

6.           (10 Points).  Two nations trade CD’s and t-shirts with each other.  The nation with the largest comparative advantage will gain the most by free trade.  Explain whether you agree or disagree with this statement.

7.           (40 Points)  While the citizens of Middle Backwater s are generally aware of what is going on in the world, its economy is essentially cut off from the rest of the world.   Its international sector is negligible.   Despite this isolation, the dreaded bird flu has spread to Middle Backwater, and – a great tragedy! – it has migrated to the human population.  The Ministry of Health predicts that about half of the population will come down with the flu this year.   Experts at the Ministry have determined – and they are never wrong in their forecasts – that the strain affecting the human population is relatively mild.  No one will die from the flu, and the only treatment required is about six weeks of bed rest; there are no other medical requirements.  After this year, the population will have acquired immunity to the flu so there will be no long term impacts.

 

The Ministry of Economics has been asked to predict the impact of this outbreak, and they have subcontracted this job to you.  Specifically, they want to know the impact of this flu on GDP and interest rates.

 

Ethyl Birkenstock (known as EB to her friends), a prominent politician, is concerned about the economic impact of the flu on the population.  EB, whose slogan is “we should all share the pain”, knows that half the population will be ill – miserably ill – for six weeks and half will escape without any ill effects.  In order to spread the pain, EB proposes to pay $1500 as a one time payment to every person who contacts the flu.  (There is a simple test to see if you have this new flu, no there will be no problem denying benefits to anyone faking it).   EB has also asked you to look at three means of financing the payments.

 

·        A simple head tax of $750 per person.

·        Borrowing the money

·        Paying for the program with a special one time tax on wages this year.  (Someone else is computing the rate so you need not worry about the number).

·        Paying for the program with a special sales tax surcharge this year.  (Someone else is computing the rate so you need not worry about the number).

 

Specifically, she wants you to determine the impact of these four plans on GDP, interest rates, and the trade deficit.  Will each of these be higher or lower than it would be had the flu come and the government done nothing?

 

EB is a busy woman, so she wants you to fill in the following two tables:

 

 

Plan

Interest Rates

(Circle one)

GDP

(Circle one)

Trade Deficit

(Circle one)

Head Tax

Higher/Lower

Higher/Lower

Higher/Lower in Absolute Value

Borrowing

Higher/Lower

Higher/Lower

Higher/Lower in Absolute Value

Wage Tax

Higher/Lower

Higher/Lower

Higher/Lower in Absolute Value

Sales Tax

Higher/Lower

Higher/Lower

Higher/Lower in Absolute Value

 

As to the second table, she wants you to rank the ideas in turn of their impact on these variables.  She knows that economists sometimes like to say that two plans have the same impact so she will accept ties.

 

Plan

Interest Rates

GDP

Trade Deficit

Doing Nothing

 

 

 

Head Tax

 

 

 

Borrowing

 

 

 

Wage Tax

 

 

 

Sales Tax

 

 

 

 

 

Note: to fill this table in, place a “1” in the column country you think will have the highest interest rate, a “2” in the country you think will have the second highest interest rate, and so on.  Ditto for GDP and trade deficit.  If you think two plans tie for place “2” place a “2” in twice.

 

Now, I have somewhat more time, so you probably want to use the rest of this space to explain your answers: