Final Exam Econ 51 Fall Resources are not specialized in other words, each plot is equally good at growing either rice or oats.

Transcription

1 Final Exam Econ 51 Fall 2005 Answer 7 of the following 9 problems: 1. A farmer has two plots of land, and he grows rice and oats on them. Here is what can be produced on each plot: Plot A: 68 bushels of rice or 24 bushels of oats Plot B: 12 bushels of rice or 6 bushels of oats Resources are not specialized in other words, each plot is equally good at growing either rice or oats. (a) What is the maximum total amount of rice this farmer can grow? What is the maximum total amount of oats? (b) What is the opportunity cost of oats in terms of rice on Plot A? On plot B? (c) Suppose that the farmer starts out completely specialized in rice on both plots of land. Now, he decides to gradually start reallocating production from rice to oats. On which plot would the farmer choose to start growing oats first, and why? On which plot would he start growing oats last, and why? (d) Use all of the information in parts (a)-(c) to draw the PPF for this farmer. Put rice on the vertical axis and oats on the horizontal axis. Denote the coordinates of all intercepts and kinks. You do not need to draw to scale.

2 2. Which of the following items are included in GDP? For those items not included, explain why they are not included in GDP. a. Jane sells her newly issued shares of stock in Macro.com, Inc. b. Ross buys a new pair of jeans from Professor Widner. c. Joey has his truck tires rotated at a local garage. d. Rachel buys an antique chest on ebay. e. David builds his own computer. f. Phoebe grows her own herbs on her apartment balcony. g. Michael travels to Paris and buys wine, cheese, and a new Trek bicycle. 3. Assume an economy with no government or foreign trade and the following equations: C = DI I = 2500 a) What is equilibrium output and savings? b) Now assume the country decides it needs to save more. So assume individuals reduce their MPC from.9 to.8 (though autonomous consumption remains 550). What is the new level of equilibrium savings? Explain please. c) What does this result imply for public policy?

3 4. Jeremy Rifkin, in a book entitled The End of Work, foresaw dramatic improvements in productivity in our economy during the 21 st century with the advent of robots and ever-faster computers. He argued that it would lead to widespread unemployment by reducing the demand for workers and stagnant real incomes. What would most economists predict would happen to unemployment and real incomes from this? 5. Monetarists, such as Milton Friedman, have argued that the Fed should keep the growth rate of the money supply constant. They argue this would keep AD and Y growing at a pretty constant rate. Let s think of this Monetarist proposal as one which would keep the money supply constant in the very short-run. And let s figure out how stable output would be under that rule. Assume that money demand unexpectedly rises significantly. a) What happens to nominal interest rates? Real interest rates? Please graph. b) What would happen to the position of our AD curve? Why? c) What would happen to output? Please graph. d) Many economists believe that money demand is quite variable in our economy. If so, would a constant money growth rule lead to stable or variable output?

4 6. In the spring of 2001 President Bush signed into law a tax cut that was expected to reduce tax revenue by roughly $1.5 trillion over the next 10 years. The main part of the tax cut was lowering personal income tax rates: Old tax rate New tax rate 15% 10% or 15% (10% if your income is very low) 28% 25% 31% 25% 36% 33% 39.6% 33% These lower rates are being slowly phased in over 5 years ( ). Americans received tax rebates in the mail in the summer of 2001: $600 for married households and $300 for single individuals. In subsequent years the tax cut just takes the form of people having less taxes deducted from their paychecks. Assume the tax cut is permanent. From a macroeconomic perspective was this tax cut a good idea? What are the potential benefits and costs of such a policy? Come to an overall conclusion about whether you support the tax cut or not.

5 7. Article Response: WASHINGTON - The Federal Reserve lifted interest rates to the highest level in 4 1/2 years Tuesday but also indicated its 18-month rate-raising campaign was winding down. At least one more increase in borrowing costs seemed in store to keep inflation under control. Chairman Alan Greenspan and his Fed colleagues voted unanimously to boost the federal funds rate, the interest banks charge each other on overnight loans, by one-quarter percentage point to percent. It was the 13th consecutive increase of that size since June That's when the Fed policy-makers embarked on a credit tightening campaign to lift the funds rate -- which had been sliced to a 46-year low of 1 percent when the economy was faltering -- to more normal levels. In response to the rate increase, commercial banks began increasing their prime lending rate -- for certain credit cards, home equity lines of credit and other loans -- to 7.25 percent, also the highest in 4 1/2 years. -- AssocIATED Press In your response answer the following questions: a) What is the current federal funds rate? (fill in the blank in the article) b) How exactly does the fed raise this interest rate? That is who raises the rate and how. c) What impact will this increase have on the economy? Explain with a graph and words.

6 8. Here are hypothetical 1996 and 1997 prices and quantities in a simple 2-good economy Price 1997 Price 1996 Quantity 1997 Quantity Coke $3/gallon $4/gallon 20 gallons 30 gallons Pizza $5/pizza $7/pizza 25 pizzas 20 pizzas Assume that 1996 is the base year, so we calculate real GDP in 1996 dollars. a) What is the growth rate in nominal GDP between 1996 and 1997? b) What is the growth rate in real GDP between those two years? 9. Money Supply a) Milly Miser removes $250,000 from her mattress and opens a checking account. This single transaction increases the money supply by. Explain: b) If the banking system has $5 million in excess reserves, and the required reserve ratio is 25 percent, what is the maximum amount by which the money supply can be increased? Show all your work. c) The required reserve ratio is 10 percent, but banks actually keep 20 percent on reserve. The actual money multiplier will be.