Economics 207: Introduction to Macroeconomics Midterm 1: Answers Instructions

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1 Economics 207: Introduction to Macroeconomics Midterm 1: Answers Instructions: You have 110 minutes to complete the following exam. Be sure to write your name and student id ON YOUR SCANTRON AND BELOW. Failure to do so will result in the loss of points from your total score. When you are complete, please slip your scantron form behind the first page of this test and turn both in at the front of class. This exam is to be taken without the aid of notes, books, friends, neighbors, or other outside sources of information. This includes programmable calculators with notes typed into its memory. All multiple choice questions are worth 4 points. Points possible are in parenthesis at the end of each open ended question. Name: Student ID: 1. It is often true that as the economy begins to recover from a recession the unemployment rate rises. Which of the following statements would be the best explanation for this? a. The unemployment rate would rise because as the economy initially recovers from a recession the demand for goods and services falls, so the demand for workers falls. b. As the economy begins to recover from a recession, workers who were previously discouraged about their chances of finding a job begin to look for work again. c. The unemployment rate seems to rise as the economy begins to recover from a recession because of errors in the way the data are collected. d. As the economy initially recovers from a recession, firms do not immediately increase the number of workers they hire. Firms wait to hire more individuals until they are convinced that the recovery is strong. 2. Real GDP is a measure of a country s a. Wealth. b. Money. c. Physical output. d. Income. 3. Which of the following is NOT an example of a transfer payment in the sense of the national income accounts? a. Disability pensions paid from the social insurance system. b. Welfare payments made to out-of-work individuals. c. Purchases of machine guns made by the Army. d. Government tax refunds.

2 4. Which of the following policies would not be expected to reduce the unemployment rate? a. Reducing the duration of unemployment benefits. b. Providing relocation subsidies to unemployed workers. c. Increasing statutory minimum wages. d. Prohibiting new unions from forming in the workforce. 5. In the United States over the past 50 years, the proportion of employment dedicated to producing services has: a. Risen and fallen. b. Risen. c. Fallen. d. Stayed mostly constant. 6. Many foreigners own the capital used by countries such as Bahrain to produce oil. Because of this, it is a. Likely that Bahrain s GNP is greater than its GDP. b. Likely that Bahrain s GNP is smaller than its GDP. c. True that Bahrain s GNP is equal to its GDP. d. Likely that Bahrain s GDP is greater than Oman s GDP. e. Who owns capital has no impact on a country s GDP or GNP. 7. After a period of about one thousand years in which prices were stable, beginning in about 1500 and lasting for a century, world prices began to rise (something we know from tracking records of prices of land, horses, burial plots, and food). This century of inflation was most likely caused by: a. Martin Luther s 95 theses denouncing church abuses. b. The circumnavigation of the world by Magellan. c. The writings of Shakespeare. d. The mining of gold and silver in the Americas. 8. The GDP Deflator is an example of a. A measure of the amount of production in an economy. b. A measure of the income in an economy. c. A measure of the value added in an economy. d. A sum of consumption, investment, government spending, and net exports.

3 9. Over the past 8 years (or so), the United States labor force participation rate has a. Remained stable. b. Fallen. c. Risen. d. Gone up and down in large swings ending roughly where it started. e. Gone up and down in large swings ending higher than where it started. 10. The natural rate of unemployment is most easily determined by a. Surveying households about their employment status. b. Surveying businesses about the number of people they have hired. c. Averaging the unemployment rate for each month over the past 12 months. d. Creating a scatter plot of unemployment/inflation pairs and estimating the unemployment rate consistent with no inflation. 11. When plotting the average growth rate in GDP (on the vertical axis) and the variance of inflation rate (on the horizontal axis), one would expect to see a. No relationship between the two. b. A positive but imperfect relationship between the two. c. A perfectly positive linear relationship between the two. d. A negative but imperfect relationship between the two. e. A perfectly negative linear relationship between the two. 12. Consider the production function Y = K.6 L.6 a. This production function has diminishing returns to labor and constant returns to scale. b. This production function has diminishing returns to labor and increasing returns to scale. c. This production function has increasing returns to labor and constant returns to scale. d. This production function has increasing returns to labor and increasing returns to scale. 13. Consider an investment of $100 made today which in three years is worth $160. The average annual interest rate on this investment is: a. 20%. b.. 1 c.. 1 d

4 14. In 2006, the U.S. Federal government expended $2.3 trillion however these expenditures accounted for only 7% of American GDP. Which of the following explains this discrepancy? a. Federal military expenditures do not count when computing GDP. b. Federal expenditures made in foreign countries do not count in GDP. c. GDP in 2006 was approximately $33 trillion. d. Federal expenditures on transfer payments such as social security do not count in GDP. 15. I sign a loan contract for a nominal interest rate of 8% that lasts for a year. Over the course of that year, the money supply increases by 12% and real GDP increases by 10%. The real interest rate on this loan is most likely: a. 8%. b. 10%. c. 6%. d. 20%. e. 18%. 16. Consider James who owns an accounting business. For each tax return he works on, he makes purchases of one piece of tax software for $10, pays one secretary for an hour of time ($24), uses electricity to light his office ($2), and charges one lunch ($7) as a business expense. He also charges the customer $142 for filling out the tax return. For each tax return, how much did GDP increase? a. $43. b. $142. c. $143. d. $185.

5 1. Use the space provided below to re-create the circular flow of income. You will be graded on accuracy of your picture, as well as correctly labeling the location of each macroeconomic entity and market. (15)

6 2. Place each of the following transactions in one of the four components of gross domestic product: consumption, investment, government purchases, and net exports. (2 ea.) a. Boeing sells an airplane to Air France. NX b. Boeing sells an airplane to American Airlines. I c. Boeing sells an airplane to the Air Force. G d. Boeing sells an airplane to Amelia Earhart. C e. Boeing builds an airplane to be sold next year. I 3. Consider the following information regarding the country of Vikingtown. In 2012 Vikingtown produced a nominal GDP of $200 and a real GDP of $230. The following year (2013) Vikingtown produced a nominal GDP of $220 and a real GDP of $250. How much larger (in percentage terms) is the price level in 2013 relative to the price level in 2012? (8) 2012 GDP Deflator = 100*200/230 = GDP Deflator = 100*220/250 = 88 Inflation rate between 2012 and 2013 is 100 *( )/86.95 = 1.20%

7 4. Currently, the country of Vikingtown has a population of 300,000 people. Of these people, 12,000 are full time students, 33,000 are retirees, 50,000 are children, 1,000 work at Western, and 25,000 are stay-at-home parents. Of the rest, all are employed or looking for a job. a. If 12,000 are looking for a job, what is the unemployment rate? (4) Labor Force = 300,000 12,000 33,000 50,000 25,000 = 180,000 Unemployment rate = 100* 12,000/180,000 = 6.66% b. Because of the large number of workers in Vikingtown, there has been an increase in demand for domestic help. As a result, 5,000 foreigners immigrate into America and take up legal domestic jobs. As a result, what is the unemployment rate? (4) Labor force is now 185,000 Unemployment rate = 100* 12,000/185,000 = 6.49% c. Briefly give one reason that the unemployment rate might overstate the unemployment problem. (4) A number of potential reasons, most students discussed phantom unemployment.