P($/pound) a. Neatly and carefully, draw the market supply curve on the appropriate diagram above.

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1 1. (20 points) The two graphs below describe the tuna industry. The typical tuna firm s marginal cost and average total cost curves are drawn on the graph to the left. The market demand curve for tuna is drawn on the right. There are 1,000 tuna firms. Assume that all are identical; that is, each firm has the same marginal cost and average total cost curves as drawn below. MC,ATC MC ATC P($/pound) Thousands of pounds q 5 D Millions of pounds Q a. Neatly and carefully, draw the market supply curve on the appropriate diagram above. b. What is the equilibrium price and quantity of tuna? Price = Quantity = c. Is the tuna industry in a long run equilibrium? Yes No If so, explain why. If not, would you expect entry or exit to occur? Entry Explain. Exit

2 The tuna firms now join together in a cooperative thereby monopolizing the production of tuna. The cooperative seeks to maximize the collective profits of the firms in the industry. The market demand, marginal cost, and marginal revenue curves of the cooperative appear below: P($/pound) 20 MC D MR Millions of pounds Q d. How much tuna would the cooperative produce? What price would be charged? Quantity = Price = e. Assume that tuna production is divided equally among the 1,000 cooperative members. How much tuna does each member produce? Quantity = f. Focus on a single firm. From the perspective on a single firm, what does the individual firm s 1) marginal revenue equal? 2) marginal cost equal? g. Does an individual firm have an incentive to cheat on the cooperative s policy? Yes No Explain.

3 2. (10 points) Assume that the following describes an economy: Total Population 250,000,000 Adult Population 200,000,000 Not in the Labor Force 50,000,000 Employed 144,000,000 Real GDP $10,000,000,000 GDP Price Deflator Consumer Price Index Velocity of Money 4.0 a. What is the value of the labor force participation rate? % b. What is the value of the unemployment rate? % c. What is the value of nominal GDP? d. What is the quantity of money, the money supply?

4 3. (10 points) A developing nation is considering the following policy alternatives. In each case, indicate which policy would be better from the standpoint of long run growth. Explain why the preferred policy would have the desired effect. NB: Do not forget to label the axes. a. A tax on the consumption goods that households purchase versus a tax on the interest households earn from their savings. Policy choice: Tax on consumption Tax on savings b. A reduction in government expenditures versus an increase in government expenditures. Policy choice: Reduction Increase

5 4. (20 points) Suppose that the following information fully describes the U.S. commercial banking system: Cash in vault $10 Deposits 400 Loans 360 Deposits at Fed 70 Borrowing from Fed 10 Required reserve ratio 20% = 1 5 a. Construct the balance sheet of the banking system. Assets Liabilities Is the banking system solvent? Yes No Explain. b. Are the banks loaned up; that is, is it impossible for the bank to (legally) issue additional loans? Yes No Explain. Individuals engaged in illegal activities typically do not use checks to conduct their transactions; instead they use cash, because it is much more difficult for law enforcement officials to trace cash transactions. No doubt, much of the cash in circulation is used for illegal transactions, such as drug dealing. Suppose that drugs were legalized in the U.S. Those individuals involved in the drug trade would no longer need to conceal their transactions. Hence, they would now use checks rather than cash for their transactions. Suppose that as a consequence of legalizing drugs, $25 of cash is deposited in banks.

6 c. First, show how the liabilities and assets will be affected immediately after the $25 of cash is deposited. Immediate effect: Assets Liabilities d. Next, indicate how banks would typically react to this situation. Banks reaction: Assets Liabilities Explain. e. Suppose that the Federal Reserve Board wishes to offset the effect that drug legalization has had on the banking system. Should it perform an open market sale or an open market purchase? Open market sale Open market purchase How large should the open market operation be?

7 5. (20 points) China, like many nations, restrict the Chinese assets that foreigners (non-chinese) can purchase. Suppose that China loosens the restriction on Americans. Use the appropriate concepts and diagrams to analyze how this will affect the U.S. economy. a. How will the policy change affect the U.S. interest rate? Rises Falls No change Cannot determine Explain. b. How will the policy change affect U.S. investment? Rises Falls No change Cannot determine Explain.

8 c. How will the policy change affect the exchange rate of Yuan per Dollar? Rises Falls No change Cannot determine Explain. d. Will U.S. produced goods sold in China become more or less expensive? More Less No change Cannot determine Explain.

9 6. (20 points) Currently, Real GDP in China equals 40,000 billion Yuan. GDP price deflator equals 140. Inflation rate equals 10 percent. (NB: These are approximate figures.) Suppose that the Chinese government plans to increase government expenditures to improve infrastructure. Assume that the inflation rate has been 10 percent for several years; accordingly, the expected inflation rate in China equals 10 percent. a. In China, the aggregate demand curve would Shift to the right Shift to the left Remain stationary Explain. b. In China, the short-run aggregate supply curve would Shift to the down Shift to the up Remain stationary Explain.

10 c. How would the following be affected in China? Real GDP Increase Decrease Remain the same Cannot tell Unemployment rate Increase Decrease Remain the same Cannot tell Inflation rate Increase Decrease Remain the same Cannot tell Explain. Suppose that the Chinese Central Bank (the Chinese equivalent to the Federal Reserve Board in the U.S.) is concerned about inflation and wishes to keep the inflation rate constant in China. d. Assume that the Chinese Central Bank has the same policy tools as the Fed. What are the three tools and qualitatively how they be used to accomplish the goals of the Chinese Central Bank: Tool Action

11 7. (20 points) Suppose that you were an advisor to President Obama who wants your assessment on how various events would affect the unemployment rate and the inflation rate next year. In each case, carefully explain your rationale in the space provided using the appropriate concepts and diagrams developed in class. Improved business confidence: Unemployment: Increases Decreases No change Inflation Rate: Increases Decreases No change Recessions strikes our major trading partners (Canada, Europe, Japan, etc.): Unemployment: Increases Decreases No change Inflation Rate: Increases Decreases No change

12 Increase in U.S. productivity growth: Unemployment: Increases Decreases No change Inflation Rate: Increases Decreases No change Oil prices decline: Unemployment: Increases Decreases No change Inflation Rate: Increases Decreases No change