MGEA06 Midterm Answer Key Winter 2018
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MGEA06 Midterm Solution – Winter 2018 Iris Au 1
Question 1 – Question 2: A closed economy consumes four goods only. The following table shows the prices and quantity exchanged in 2016 and 2017, and the year of 2016 is the base year.
Goods Price
Question 1
Quantity exchanged Price
Quantity exchanged
9 $6 10 5 $2.5 6 5 $4 4 8 $2 7
Find the value of real gross domestic product in 2017. Show your work and keep your answer to 2 decimal places if needed.
Real GDP2017 = $5.5 10 + $3 6 + $4 4 + $3 7 = $55 + $18 + $16 + 21 = $110
Real gross domestic product:
Find the GDP deflator in 2017. Show your work and keep your answer to 2 decimal places if needed.
Nominal GDP2017 = $6 10 + $2.5 6 + $4 4 + $2 7 = $60 + $15 + $16 + 14 = $105
GDP deflator2017 = $105 × 100 = 95.45 $110
Question 2
GDP deflator:
Question 3
Determine whether each of the following transactions will be counted as investment under the Expenditure Approach. Yes/No.
__NO_____ __NO_____ __YES____
Peter’s Pizza Parlour buys a used oven from Betty’s Bakery.
The Rigid Steel Company purchases 2,000 shares of a construction company. Alex’s Auto Paint and Supplies places 200 cans of unsold auto paints to storage.
MGEA06 Midterm Solution – Winter 2018 Iris Au 2
Question 4
Consider an economy that has three firms only: Cotton Co., which grows the cotton needed for the production of fabric; Fabric Co., which produces various fabrics used in clothing production; and Clothing Ltd., which produces clothing for households to purchase.
The following table summarizes all the transactions carried by these firms. Fill in the blanks.
Cotton Co.
$1,250 Intermediate goods $0
Fabric Co.
Clothing Ltd.
$6,700 $3,100
$1,400 $450
Value of sales
Interest payments
Rent Profit
Question 5
Determine whether each of the following statements about inflation is true or false.
__TRUE___ __TRUE___
Questions 6
A low and predictable inflation is welcomed by both consumers and firms because it helps them make better economic decisions.
If the inflation rate is 6%, a product that cost $75 last year will now cost $79.50. Unexpected inflation hurts savers but benefits borrowers.
Both lectures and the textbook discussed how government policies could affect the level of natural rate of unemployment (NRU). Name any two government policies that might lead to higher NRU.
1) ___Provision of a generous employment insurance_______________________________________ 2) ___Increase in minimum wage ______________________________________________________ 3) ___Reducing spending on job training programs or employment subsidies ___________________ 4) ___Closing government-funded employment agencies ____________________________________
MGEA06 Midterm Solution – Winter 2018 Iris Au 3
Question 7 – Question 8: The following table provides the labour market statistics of an economy.
Adult population Labour force Frictionally unemployed
262,000 240,000 24,250
Question 7
Structurally unemployed 11,250
Cyclically unemployed 8,000
Find the employment rate and the labour force participation rate of this economy. Be sure to show your work and keep your answer to 2 decimal places if needed.
Employment rate = 196,500 × 100% = 75% 262,000
LFPR = 240,000 × 100% = 91.60% 262,000
Question 8
What is the natural rate of unemployment of this economy? Is this economy at full employment? Be sure to show your work and keep your answer to 2 decimal places if needed.
NRU = 24,250+11,250 × 100% 240,000
For each of the following transactions, determine the type of inflation costs (shoe-leather cost, menu cost, or unit of account cost) that the economy is experiencing.
Employment rate (in % terms):
Labour force participation rate (in % terms):
Natural rate of unemployment (in % terms):
Is this economy at full employment? (Yes/No):
Question 9
Cost of inflation
UNIT OF ACCOUNT COST
SHOE-LEATHER COST SHOE-LEATHER COST
Transaction
High inflation forces Joan to list prices in more stable currencies.
Hyperinflation forces Pedro to change the price stickers on the books in his bookstore very frequently to keep up with the aggregate price level. Hyperinflation forces Emily to visit her bank very frequently to keep her cash holdings to a minimum.
The number of ATM machines available in the city increase.
MGEA06 Midterm Solution – Winter 2018 Iris Au 4
Question 10
The following diagram depicts the per-worker production function (PF) of an economy. y
Suppose studies show that there is an increase in the average years of schooling in the work force. Show the effect of this event on the diagram on the left. Be sure to show the new level of per-worker output on the diagram.
Holding all else constant, the marginal product of capital (MPk) __INCREASES___ (increases / decreases / does not change) after the release of the studies.
Question 11
Initially, an economy has a per capita income of $8,000, and average income is growing at a rate of 5% per year. According to the Rule of 70, how many years will it take for per capita income to increase to $64,000?
From $8,000 to $64,000, income increases by 8 times. # of years needed = 70 × 3 = 42 years
Number of years needed (in integer):
Question 12
Determine the effect of the following events on (real) GDP: answer FASTER if the event causes GDP to grow faster and answer SLOWER if the event causes GDP to grow slower.
_SLOWER_ _SLOWER_ _FASTER__
Outbreak of civil war.
Consumption represents a larger fraction of GDP. Rule of law applied equally and generally respected.
MGEA06 Midterm Solution – Winter 2018 Iris Au 5
Question 13
Suppose the growth rates of total factor productivity and capital per worker are 2% and 4% respectively, and the capital share of income is 0.3 (i.e., 30%). Use the growth accounting equation to find the growth rate of human capital per worker that will give a per capita output growth of 6.7%. Keep your answer to 2 decimal places & be sure to show your work.
0.067 = 0.02 + 0.3 × 0.04 + 0.7 × ∆h
∆h = 0.05 (5%) h
Growth rate of human capital per worker (in percentage terms):
Question 14
Determine whether each of the following statements is true or false.
Question 15
You purchased a financial asset for $2,000, and sold it $2,450 a year later. If the inflation rate over the same period was 4.5%, then the real return of this investment was 27%.
You hold a 3-year bond that has a face value of $1,000 with a coupon rate of 4%. If the current/market interest rate is 2%, you are willing to sell your bond for $1,075.
Determine whether each of the following statements is true or false.
__FALSE__ __TRUE___ __FALSE__
Holding all else constant, a closed economy will find the level of investment falls when the government lowers government spending.
Holding all else constant, a closed economy will find the level of investment falls when the government provides a more generous transfer.
Holding all else constant, if national savings falls short of (domestic) investment, an open economy can make up the difference by having net capital outflows.
MGEA06 Midterm Solution – Winter 2018 Iris Au 6
Question 16 – Question 17: The market for loanable funds for a closed economy can be described by the following equations:
Demand for loanable funds: DF = 190 – 75i
Supply of loanable funds: SF = 100 + 225i
where i = interest rate (interest rate is expressed in decimal form; i.e., if i = 0.1, then i is 10%)
Question 16
Find the equilibrium levels of interest rate and national savings. Be sure to show your work and keep your answer to 2 decimal places if necessary.
Question 17
Equilibrium: 100 + 225i = 190 – 75i 300i = 90
i* = 0.3 (30%)
National savings = 100 + 225(0.3) National savings = 167.5
Interest rate (in % terms):
National savings:
Suppose the loanable market is in its equilibrium as shown in Question 16. Suppose the government imposes rent control; as a result, the incentive for real estate developers to build new rental apartments falls.
Show the effect of the change on the diagram on the left. Be sure to show to identify the new equilibrium.
When the loanable funds market reaches its new equilibrium, the level of national savings _DECREASE_ (increases/decreases / no change).
MGEA06 Midterm Solution – Winter 2018
Question 18 – Question 20: In this question, interest rate and prices are held fixed, and the economy can be described by the income-expenditure model.
Consumption: Planned investment: Taxes:
Transfers: Government spending:
Question 18
C = 1200 + 0.75YD; IPlanned = 410 – 200i, T = 250
where YD = disposable income
where i = 0.05 (i.e., 5% & it is held fixed)
Find the levels of output and public savings in this economy. Be sure to show your work and keep your answer to 2 decimal places if necessary.
C = 1200 + 0.75(Y – 250 + 90) = 1080 + 0.75Y
AEPlanned = (1080 + 0.75Y) + (410 – 200 0.05) + 200 AEPlanned = 1680 + 0.75Y
Equilibrium: 1680 + 0.75Y = Y Y* = 6720
SPublic =250–90–200=–40
Public savings:
Question 19
The economy is initially in its equilibrium as shown in Question 18. Suppose the government wants to lower its budget deficit by half via a change in government spending. You need to determine whether government spending increases or decreases.
Show the effect of this change in government spending on the diagram to the left. Be sure to identify the new equilibrium.
Immediately after the change in government spending, firms find their inventories ___RISES____ (rises / falls) unexpectedly.
Immediately after the change in government spending, the level of unplanned investment is equal to ___+ 20____.
AEPlanned = Y AE0Planned
AE1Planned
MGEA06 Midterm Solution – Winter 2018
Question 20
(Continued from Question 19) Find the change in equilibrium level of output. Y* = – 20 1 =– 80
EPlanned: AE1Planned = 1660 + 0.75Y
Equilibrium: 1660 + 0.75Y = Y Y* = 6640
Y* = 6640 – 6720 = – 80
Change in equilibrium level of output:
– 80 or by 80
Suppose the economy consists of 3 people: Aaron, Benny, and Carl. The following table shows how
Question 21
their consumption varies as their current disposable income changes.
Current disposable income (YD)
$10,000 $11,000
$7,460 $8,200
Level of Consumption Benny
$8,000 $8,580
Which person has the highest (induvial) marginal propensity to consume? Find the aggregate marginal propensity to consume. Keep your answer to 2 decimal places.
Aaron’s MPC = 0.74 Benny’s MPC = 0.68
Carl’s MPC = 0.58
Aggregate MPC = 2,000 = 0.67 (or 2⁄3) 3,000
Person with the highest MPC:
marginal propensity to consume:
0.67 or 2⁄3
MGEA06 Midterm Solution – Winter 2018 Iris Au 9
Question 22
Determine whether each of the following statements about the income-expenditure model is true or false.
__TRUE___ __TRUE___
The paradox of thrift shows that increased savings by individuals increase their chances of becoming unemployed.
The multiplier increases when households consume a larger fraction of their income. An increase in (lump-sum) tax paid by households will have no effect on the multiplier.
Question 23 – Question 24: Consider a closed economy that can be described by the AD-AS model. In addition, prices can adjust to a change in aggregate demand or aggregate supply.
Question 23
Planned aggregate expenditure: AEPlanned = 800 – 5P + 0.8Y
Short-run aggregate supply (SRAS): P = (0.1Y – 50) W , where W = wage
If the long-run equilibrium level of output (YFE) is 1500, find the (long-run) equilibrium levels of price
and wage. Be sure to show your work and keep your answer to 2 decimal places if necessary.
AD: Y = 800 – 5P + 0.8Y
P = 160 – 0.04Y or Y = 4000 – 25P
Solve for P from AD:
P = 160 – 0.04(1500)
Sole for W from SRAS:
100 = (0.1 1500 – 50)(W)
W = 100 50 100
MGEA06 Midterm Solution – Winter 2018 Iris Au 10
Question 24
Suppose the economy is in initial long-run equilibrium as shown in Question 23. Suppose there is a fall in business confidence such that autonomous expenditure changes by 10%.
(Note: You need to decide whether autonomous expenditure increases or decreases).
Show the effect of this change in business confidence on the AD-AS diagram. Be sure to identify the new equilibrium.
When the economy reaches its short-run equilibrium, the price ___DECREASES__ (increases or decreases) and the economy
has a ___RECESSIONARY_____ (inflationary or recessionary) gap.
Question 25
For each of the following events, determine which curve(s), aggregate demand (AD), short-run aggregate supply (SRAS), and/or long-run aggregate supply (LRAS), will shift and to which direction.
Shift in AD, SRAS, Direction
and/or LRAS (left or right) Event
This is the end of the exam.
An increase in the size of the labour force.
Drop in housing prices.
MGEA06 Midterm Solution – Winter 2018 Iris Au 11
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