PRINCIPLES OF ECONOMICS II MIDTERM EXAM

Transcription

1 PRINCIPLES OF ECONOMICS II MIDTERM EXAM April 19, 2005 Professor Kyung-Hwan Kim INSTRUCTIONS: 1. THINK BEFORE YOU WRITE. 2. DO NOT WORRY TOO MUCH ABOUT YOUR ENGLISH. THIS IS AN ECONOMICS EXAM. FEEL FREE TO USE ARROWS, UP/DOWN, GRAPHS, & EQUATIONS. Part I: State whether each statement is true (T) or false (F), and briefly explain your answer. (2-3 lines will do.) (3 points for T/F, 3 points for explanation. 2 points for question 6. Total=32 points) 1. If you buy a $40,000 BMW that was produced entirely in Germany, it will not affect GDP of Korea. T: Consumption increases by $40,000 but net exports fall by $40, A growing population may enhance or inhibit growth in productivity. T: Capital is spread over a larger number of workers, and hence productivity falls. On the other hand, a larger population implies greater opportunities for technological breakthrough. 3. Increasing the diversification of a portfolio from 1 stock to 10 stocks reduces the portfolio s risk by the same amount as increasing the diversification from 10 to 20 stocks. T: See the diagram relating the number of stocks in the portfolio and the level of risk. 4. If the unemployment rate falls, we can be certain that more workers have jobs. F: An increase in discouraged workers could lead to lower unemployment.

2 5. Suppose that your great-great-grandfather bought $50 in stock 100 years ago and it is now worth $1,600. The interest rate must have been 7% according to the rule of 70. F: The situation is consistent with 3.5% interest rate. 6. If CPI rises by 1 % due to a dramatic increase in CD players, GDP deflator will increase by less than 1 %. T: The weight of CD in CPI is larger than that in GDP deflator. Sorry about the typo. Everybody was given two points. Part II. Answer each question. Use graphs or equation if necessary. (28points) 1. Australia has recently implemented a national sales tax. Assume that the revenue from the national sales tax is used to reduce income tax rates. Answer the following questions using the diagram of the loanable market equilibrium. (15 points) (1) How would the change affect the equilibrium real interest rate and the volume of saving and investment? Explain your answer. An income tax is levied on full income whereas sales tax is levied only on income spent on consumption. Therefore, replacing income tax with sales tax will encourage saving, and hence the supply of loanable funds curve will shift to right. The equilibrium interest rate will fall and saving/investment will increase. (6 points) (2) What would happen to growth as a result of the change? Explain why. As capital accumulates, the economy will grow faster, but the growth rate will not increase permanently. (4 points) (3) How would the magnitude of the change in equilibrium interest rate be affected by the responsiveness of investment to interest rate. Explain your answer. (5 points)

3 Draw a graph comparing two demand curves and the supply schedule which shifts to right. The more interest-elastic investment is, the greater the amount of increase in saving and investment. 2. The market basket used to calculate the CPI in Fantasy Island is 4 loaves of bread, 6 gallons of milk, 2 shirts and 2 pants. The prices of one unit of these goods in 2003 were $1.00, $1.50, $6.00, and $ In 2004, the prices were $1.50, $2.00, $7.00, and $ What was the rate of inflation between 2003 and 2004 assuming 2003 as base year? Show your work. (6 points) The cost of purchasing the consumption bundle in 2003 is $45 (=4x$1+6x$1.5+2x$6+2x$10) and that in 2004 is $56 (=4x$1.5+6x$2+2x$7+2x$12). Therefore, inflation rate is 24.4% (=100x (56-45)/45). 3. The share of GDP devoted to investment was similar for U.S. and Korea over the last 40 years. However, Korea had a 6 % growth rate of average annual income, while US had only a 2 % growth rate over the last 40 years. Explain this puzzle. (7 points) It can be explained by the diminishing returns to capital and the catchup effect. Part III. Answer the following multiple-choice questions. You do not need to explain your answers. (4 points each, total =40 points) 1. Large or persistent inflation is almost always caused by a. an increase in demand for domestic production. *b. growth in the quantity of money. c. foreign competition. d. higher worker productivity.

4 2. The total sales of all firms in the economy for a year a. equals GDP for the year. *b. is larger than GDP for the year. c. is smaller than GDP for the year. d. equals GNP for the year. 3. When the quality of a good deteriorates the purchasing power of the dollar a. increases, so the CPI overstates the change in the cost of living if the quality change is not accounted for. b. increases, so the CPI understates the change in the cost of living if the quality change is not accounted for. c. decreases, so the CPI overstates the change in the cost of living if the quality change is not accounted for. *d. decreases, so the CPI understates the change in the cost of living if the quality change is not accounted for. 4. If an economy with constant returns to scale were to double its physical capital stock, its available natural resources, and its human capital, but leave the size of the labor force the same,

5 a. its ouput would stay the same and so would its productivity. *b. its output and productivity would increase, but less than double. c. its ouput and productivity would increase by more than double. d. None of the above are correct. 5. Other things the same, if a country increased its saving rate, in 40 years they would likely have a. higher productivity, and a higher growth rate of real GDP. *b. higher productivity, but not a higher growth rate of real GDP. c. the same productivity and growth of real GDP they began with. d. None of the above are correct. 6. Suppose that in a closed economy GDP is equal to 10,000, taxes are equal to 2,500 Consumption equals 6,500 and Government expenditures equal 2,000. What are private saving, public saving, and national saving? a. 1500, 1000, 500 *b. 1000, 500, 1500 c. 500, 1500, 1000 d. None of the above are correct. 7. The present value of a payment to be made in the future is lower at *a. higher interest rates and as the time until the payment is made increases. b. higher interest rates and as the time until the payment is made decreases. c. lower interest rates and as the time until the payment is made increases. d. lower interest rates and as the time until the payment is made decreases. 8. Which of the following is not consistent with the efficient market hypothesis? a. Stock prices should follow a random walk. *b. Managed funds should consistently outperform indexed funds. c. The only thing that affects the price of a stock are unpredictable events. d. There is little point in spending many hours studying the business pages looking for undervalued stocks 9. If an unemployed person quits looking for work, ceteris paribus, the unemployment rate a. decreases, and the participation rate increases

6 *b. decreases, and the participation rate decreases c. stays the same, and the participation rate decreases d. and the labor force participation rate stay the same. 10. Which of the following causes of unemployment is not associated with a wage rate above the equilibrium level? a. unions b. efficiency wages *c. job search d. minimum-wage laws