Your name (please print) ECO202: PRINCIPLES OF MACROECONOMICS FIRST MIDTERM EXAM Summer 2017 Prof. Bill Even

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1 Your name (please print) ECO202: PRINCIPLES OF MACROECONOMICS FIRST MIDTERM EXAM Summer 2017 Prof. Bill Even 1. You may have access to a pen or pencil and a calculator. Cell phones, watches, notes, and all other items should not be within view during the exam. 2. There are 17 fill-in-the-blank or multiple choice questions followed by 6 short answer questions. You must answer 5 of the 6 short answer questions. Be sure to write legibly. If I can t read it, I must assume that the answer is wrong. 3. You have until 9:30 to complete the exam. If you want extended time, you may purchase it at a price of 5 percentage points per minute.

2 Unless indicated otherwise, each of the questions in this section are worth 3 points. 1. What are the four components of the expenditure side of GDP? Consumption, Investment, government purchases of goods and services, net exports. Suppose that an economy produces only apples and oranges and the prices and quantities of each are given in the table below. Price of oranges Quantity of Oranges Price of apples Quantity of Apples Assuming that 2010 is the base year. 2. What is nominal GDP in 2016? $ What is real GDP in 2016? $85 4. What is the GDP deflator in a b /85*100=152.9

3 To answer the next 5 questions, refer to the information for the U.S. economy provided below: Nominal GDP (in billions of $) Real GDP (2009 base year, in billions of $) Civilian Noninstitutionalized Working Age Population (in 1000s) Labor Force (in 1000s) Unemployed (in 1000s) ,285 12, , ,267 5, ,037 16, , , ,569 16, , , The unemployment rate for _8962/157022=.057=5.7% 6. The labor force participation rate for _157022/249723=.629=62.9% 7. The employment population ratio for ( )/249723=.593=59.3% 8. What is the GDP deflator in 2016? 100*18569/16662= How much higher (in percentage terms) are prices in 2016 than in 2000? Round your answer to the nearest one-tenth of a percent.. e.g. 1.2%. deflator in 2000=81.9; deflator in 2016=111.4 prices are 36.0% higher in 2016 than in 2000.

4 10. (9 points) In the table below, indicate how each of the following events would affect the unemployment rate, the labor force participation rate, and the employmentpopulation ratio using +, -, or 0 to indicate whether the event would cause the relevant statistic to rise, fall, or not change. Event Impact on unemployment rate Impact on labor force participation rate Impact on employmentpopulation ratio 1 million workers retire million discouraged workers start looking for jobs 1 million employed workers are laid off and start looking for work If business inventories increase during 2017, a. Business sales exceeded production during 2017 b. Business production exceeded sales during 2017 c. A proper estimate of GDP should subtract the increase in inventories from sales. d. a and c e. b and c Use the data in the table below to answer the next 3 questions. The CPI is the consumer price index. Median real weekly CPI ( =100) earnings ( base year) 1980 $ $ What is the nominal weekly wage in 2017? 350*2.442=$ How much did the purchasing power of weekly earnings change between 1980 and 2017? (Give your answer in percentage terms to the nearest one-tenth e.g. 1.2%). The real wage median weekly wage increased by 9.0% 14. Based on the information provided, how many dollars are needed in 2017 to buy as much as $100 would buy n 1980? (244.2/78)*100=$313

5 15. If the economy has an unemployment rate that is below the natural rate, GDP will be (above, below) potential GDP and firms will find it (easy, difficult) to hire more workers. a. Above; easy b. Above; difficult c. Below; easy d. Above; difficult 16. Indicate whether each of the following would cause the natural rate of unemployment to be higher (H) or lower (L) a. More generous unemployment insurance benefits H b. If the labor force ages (i.e. the average worker becomes older) L c. The minimum wage is increased H 17. Indicate whether each of the following workers is experience frictional (F), structural (S), or cyclical (C) unemployment. a. Workers at a textile plant lose their jobs when a company shuts down the plant and moves production overseas. S b. Construction workers lose their jobs when the housing market slows during a recession, but they expect to be called back for work when the economy recovers. C c. College students return home for summer and start looking for a summer job. F

6 Answer any 5 of the next 6 questions (6 points each) 18. During a recession, do you expect the labor force participation rate or the employment-population ratio to fall by a larger amount? Why? During a recession, many workers lose their jobs and start searching for work. This causes the employment population ratio to fall. If all the workers who lose jobs start searching for work, there is no change in the labor force participation rate. The LFPR would fall only if some of the workers who lost jobs exit the labor force and don t search for work. 19. If the nominal wage grows 10% over the next year, what would have to happen in order that the real wage falls over the next year? Be as precise as possible in describing the necessary conditions for this to happen. Since the real wage is the nominal wage divided by the price level (e.g. CPI/100), the only way the real wage can fall is if the price level rises by more than 10% if the nominal wage rise by 10%. 20. Economists believe that the rate of growth in the CPI is a biased measure of the true growth in the cost of living. Give two reasons for the bias and be sure to indicate which way the bias goes (i.e. does CPI growth over- or under-state the growth in the cost of living)? CPI in year t = cccccccc oooo cccccccccccccccc bbbbbbbbbbbb uuuuiiiiii yyyyyyyy tt pppppppppppp cccccccc oooo cccccccccccccccc bbbbbbbbbbbb uuuuuuuuuu bbbbbbbb yyyyyyyy pppppppppppp xx 100 Because the CPI is based on a comparison of the cost of a bundle that consumers bought in some base year, this can result in a biased estimate of the growth in the cost of living. First, consumers may switch to products that are less costly causing their cost of living to increase less than the CPI. Second, the quality of the goods may increase which partially offsets the rising cost of the bundle. Third, consumers may switch toward chain stores to reduce their cost. In all three cases, the growth in the CPI overstates the true growth in the cost of living. ent year prices

7 21. In no more than 3 sentences, explain why a switch from the CPI to a chained measure of the cost of living could save the federal government billions of dollars in Social Security payments. Unlike the CPI, a chained measure of the cost of living continually updates the bundle of goods and services that issued to compute changes in the price level. As a result, the chained CPI rises at a slower rate than the regular CPI. A switch to a chained CPI could save the government billions of dollars in Social Security payments that are indexed for changes in the cost of living since the chained CPI would lead to smaller cost of living adjustments. 22. According to the CIA factbook, GDP per capita in 2016 was $15,400 in China and $6,700 in India. Based on this, one might argue that the standard of living in China is 2.3 times better than it is in India. Give two possible reasons that this might be an overstatement of how much better off the people in China are relative to those in India. The difference in GDP per capita could overstate China s advantage in the standard of living if things that affect the standard of living but are not counted in GDP are worse in China than India. For example, if the average person in China was faced with a worse environment, less leisure, higher crime, or worked more hours per week than someone in India, the gap in the GDP per capita between the two countries would be an overstatement of China s advantage. 23. If the unemployment rate drops below the natural rate, how would we expect the Federal Reserve to change interest rates and why? If the unemployment rate drops below the natural rate, the economy is producing beyond potential GDP and firms will eventually find it difficult to produce what their customers want to buy. This creates inflationary pressures and the Federal Reserve is likely to respond by raising interest rates to reduce demand and inflationary pressures in the economy.