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1 Name: Date: 1 A measure of how fast prices are rising is called the: A growth rate of real GDP B inflation rate C unemployment rate D market-clearing rate 2 Compared with a recession, real GDP during a depression: A increases more rapidly B increases at approximately the same rate C decreases at approximately the same rate D decreases more severely 3 Variables that a model tries to explain are called: A endogenous B exogenous C market clearing D fixed 4 The marginal product of labor is: A output divided by labor input B additional output produced when one additional unit of labor is added C additional output produced when one additional unit of labor and one additional unit of capital are added D value of additional output when one dollar's worth of additional labor is added 5 A competitive, profit-maximizing firm hires labor until the: A marginal product of labor equals the wage B price of output multiplied by the marginal product of labor equals the wage C real wage equals the real rental price of capital D wage equals the rental price of capital

2 6 If the consumption function is given by C = Y and Y increases by 1 unit, then C increases by: A 015 unit B 05 unit C 085 unit D 1 unit 7 If the consumption function is given by C = Y and Y increases by 1 unit, then savings: A decreases by 085 unit B decreases by 015 unit C increases by 015 unit D increases by 085 unit 8 All of the following actions increase government purchases of goods and services except the: A federal government's sending a Social Security check to Betty Jones B federal government's sending a paycheck to the president of the United States C federal government's buying a Patriot missile D city of Boston's buying a library book 9 The equation Y = C(Y T) + I(r) + G may be solved for the equilibrium level of: A income B consumption C government purchases D the interest rate 10 In the classical model with fixed income, if the interest rate is too high, then investment is too and the demand for output the supply A high; exceeds B high; falls short of C low; exceeds

3 D low; falls short of 11 The reduction in investment brought about by the increase in the interest rate caused by increased government spending is called: A a budget deficit B fiscal policy C the identification problem D crowding out 12 If an earthquake destroys some of the capital stock, the neoclassical theory of distribution predicts: A the real wage will rise and the real rental price of capital will fall B both the real wage and the real rental price of capital will fall C both the real wage and the real rental price of capital will rise D the real wage will fall and the real rental price of capital will rise 13 In a small, open economy, if net exports are negative, then: A domestic spending is greater than output B saving is greater than investment C net capital outflows are negative D imports are less than exports 14 In a small open economy, if exports equal \$20 billion, imports equal \$30 billion, and domestic national saving equals \$25 billion, then net capital outflow equals: A \$25 billion B \$10 billion C \$10 billion D \$25 billion 15 In a country with a small open economy, the real interest rate will always be: A above the world real interest rate

5 A exports will decrease but imports will be unaffected B imports will decrease but exports will be unaffected C exports will increase and imports will decrease D exports will decrease and imports will increase 21 In a small open economy, when the government reduces national saving, the equilibrium real exchange rate: A rises and net exports fall B rises and net exports rise C falls and net exports fall D falls and net exports rise 22 In a small open economy, if the world interest rate falls, then domestic investment will and the real exchange rate will, holding all else constant A decrease; decrease B decrease; increase C increase; decrease D increase; increase 23 The Solow growth model describes: A how output is determined at a point in time B how output is determined with fixed amounts of capital and labor C how saving, population growth, and technological change affect output over time D the static allocation, production, and distribution of the economy's output 24 In the Solow growth model of Chapter 7, for any given capital stock, the determines how much output the economy produces, and the determines the allocation of output between consumption and investment A saving rate; production function B depreciation rate; population growth rate C production function; saving rate D population growth rate; saving rate

6 25 In the Solow growth model, if investment is less than depreciation, the capital stock will and output will until the steady state is attained A increase; increase B increase; decrease C decrease; decrease D decrease; increase 26 If a war destroys a large portion of a country's capital stock but the saving rate is unchanged, the Solow model predicts output will grow and that the new steady state will approach: A a higher output level than before B the same output level as before C a lower output level than before D the Golden Rule output level 27 In a steady-state economy with a saving rate s, population growth n, and labor-augmenting technological progress g, the formula for the steady-state ratio of capital per effective worker (k*), in terms of output per effective worker (f(k*)), is (denoting the depreciation rate by δ): A sf(k)/( + n + g) B s/((f(k))( + n + g)) C f(k)/((s)( + n + g)) D (s f(k))/( + n + g) 28 In a Solow model with technological change, if population grows at a 2 percent rate and the efficiency of labor grows at a 3 percent rate, then in the steady state, output per effective worker grows at a percent rate A 0 B 2 C 3 D 5 29 In a Solow model with technological change, if population grows at a 2 percent rate and the efficiency of labor grows at a 3 percent rate, then in the steady state, output per actual

7 worker grows at a percent rate A 0 B 2 C 3 D 5 30 Other things being equal, all of the following government policies are likely to increase national saving except: A decreasing taxes on savings accounts B running a budget deficit C running a budget surplus D retiring part of the national debt 31 In the circular flow model, the flow of dollars from firms to households is paid and the flow of dollars from households to firms is paid A as wages and profits; for goods and services B for value added; as imputed values C in current dollars; in constant dollars D as interest and dividends; for depreciation and taxes 32 To avoid double counting in the computation of GDP, only the value of goods are included A final B used C intermediate D investment 33 If nominal GDP in 2009 equals \$14 trillion and real GDP in 2009 equals \$11 trillion, what is the value of the GDP deflator? A 079 B 103 C 127 D 130

8 34 If GDP (measured in billions of current dollars) is \$5,465, consumption is \$3,657, investment is \$741, and government purchases are \$1,098, then net exports are: A \$131 B \$131 C \$31 D \$31 35 The labor-force participation rate is the percentage of the: A adult population that is employed B adult population that is in the labor force C labor force that is employed D labor force that is unemployed 36 In the Solow growth model of an economy, with a given production function, depreciation rate, no technological change, and no population growth, a higher saving rate produces a: A higher MPK in the new steady state B higher steady-state growth rate of output per worker C higher steady-state growth rate of total output D higher steady-state level of output per worker 37 If an economy with no population growth or technological change has a steady-state MPK of 0125, a depreciation rate of 01, and a saving rate of 0225, then the steady-state capital stock: A is greater than the Golden Rule level B is less than the Golden Rule level C equals the Golden Rule level D could be either above or below the Golden Rule level 38 A reduction in the saving rate starting from a steady state with more capital than the Golden Rule causes investment to in the transition to the new steady state A increase

9 B decrease C first increase, then decrease D first decrease, then increase 39 An increase in the saving rate starting from a steady state with less capital than the Golden Rule causes investment to in the transition to the new steady state A increase B decrease C first increase, then decrease D first decrease, then increase 40 Assume two economies are identical in every way except that one has a higher population growth rate According to the Solow growth model, in the steady state the country with the higher population growth rate will have a level of total output and rate of growth of output per worker as/than the country with the lower population growth rate A higher; the same B higher; a higher C lower; the same D lower; a lower 41 a Suppose a government moves to reduce a budget deficit Using the long-run model of the economy developed in Chapter 3, graphically illustrate the impact of reducing a government's budget deficit by reducing government purchases Be sure to label: i the axes; ii the curves; iii the initial equilibrium values; iv the direction curves shift; and v the terminal equilibrium values b State in words what happens to: i the real interest rate; ii national saving; iii investment; iv consumption; and v output 42 Consider two competitive economies that have the same quantities of labor (L = 400) and capital (K = 400), and the same technology (A = 100) The economies of the countries are described by the following Cobb-Douglas production functions: North Economy: Y = A L 03 K 07 South Economy: Y = A L 07 K 03 a Which economy has the larger total production? Explain

10 b In which economy is the marginal product of labor larger? Explain c In which economy is the real wage larger? Explain d In which economy is labor's share of income larger? Explain 43 a In April 1995, Michel Camdessus, managing director of the International Monetary Fund (IMF), criticized US economic policy for allowing the dollar exchange rate to fall too low He recommended that the United States reduce its budget deficit in order to raise the exchange rate Use the long-run model of a small open economy to illustrate graphically the impact of reducing the government's budget deficit on the exchange rate and the trade balance Be sure to label: i the axes; ii the curves; iii the initial equilibrium values; iv the direction the curves shift; and v the new long-run equilibrium values b Based on your graphical analysis, explain whether Mr Camdessus's policy recommendation will work Specifically state what happens to the exchange rate and the trade balance as a result of the government budget deficit reduction 44 Explain why government budget deficits crowd out private investment spending in a closed economy, but crowd out net exports in a small open economy Assume prices are flexible and that factors of production are fully employed in both economies Assume there is perfect capital mobility for the small open economy 45 Suppose that two countries are exactly alike in every respect except that population grows at a faster rate in country A than in country B a Which country will have the higher level of output per worker in the steady state? Illustrate graphically b Which country will have the faster rate of growth of output per worker in the steady state? 46 The economies of two countries, Thrifty and Profligate, have the same production functions and depreciation rates There is no population growth or technological progress in either country The economies of each country can be described by the Solow growth model The saving rate in Thrifty is 05 The saving rate in Profligate is 03 a In which country is the level of steady-state output per worker larger? Explain b In which country is the steady-state growth rate of output per worker larger?

11 c In which country is the growth rate of steady-state total output greater? 47 Suppose a government is able to impose controls that limit the number of children people can have Use the Solow growth model of Chapter 8 to graphically illustrate the impact of the slower rate of population growth on the steady-state capital-labor ratio and the steadystate level of output per worker Be sure to label the: a axes; b curves; c initial steady-state levels; d terminal steady-state levels; and e the direction the curves shift 48 Assume that a country's production function is Y = AK 03 L 07 The ratio of capital to output is 3, the growth rate of output is 3 percent, and the depreciation rate is 4 percent Capital is paid its marginal product a What is the marginal product of capital in this situation? (Hint: The marginal product of capital may be computed using calculus by differentiating the production function and using the capital-output ratio or by using the fact that capital's share equals MPK multiplied by K divided by Y) b If the economy is in a steady state, what must be the saving rate? (Hint: The saving rate multiplied by Y must provide for gross growth of ( + n + g)k, where is the depreciation rate) c If the economy decides to achieve the Golden Rule level of capital and actually reaches it, what will be the marginal product of capital? d What must the saving rate be to achieve the Golden Rule level of capital? Answer Key 1 B 2 D 3 A 4 B 5 B 6 C 7 C 8 A 9 D

12 10 D 11 D 12 D 13 A 14 B 15 C 16 D 17 C 18 B 19 B 20 D 21 A 22 D 23 C 24 C 25 C 26 B 27 A 28 A 29 C 30 B

13 A A C D B D B B A C a b i real interest rate decreases ii national saving increases iii investment increases iv consumption is unchanged v output is unchanged, fixed because it is determined by the factors of production

14 42 43 a Output is the same in both economies, given the symmetry of the parameters of the production functions and the equal quantities of labor and capital b The MPL is larger in the South Economy The MPL depends on the value of (1 α) and the average productivity of labor (Y/L) Since the average productivity of labor is the same in both countries, differences in the MPL depend on the value of (1 α), which is larger in South Economy (07) than in North Economy (03) c Since factors are paid according to the values of their marginal products, the real wage is larger in South Economy, because the MPL is larger in South Economy than in North Economy (from part b) d Labor's share of income equals (1 α), which is larger in South Economy (07) than in North Economy (03) a b Mr Camdessus's policy will not have the intended effect The dollar exchange rate will decline and the trade balance will move toward surplus In the closed economy, the increase in the budget deficit reduces national saving and increases the interest rate, which crowds out (decreases) private investment spending In the small open economy, the budget deficit reduces national saving, which increases the real exchange rate The increase in the real exchange rate crowds out (decreases) net exports a Country B will have the higher level of output per worker

15 46 47 b In the steady state, the growth rate of output per worker will be zero in both Country A and Country B a Thrifty will have the higher level of steady-state output per worker With a higher saving rate in Thrifty, there will be more saving, more investment, and, consequently, a higher steady-state capital per worker ratio For the same production function, the higher capital per worker ratio will produce a higher level of steady-state output per worker b In the steady state in both countries, capital per worker is constant, so output per worker is constant The growth rate of output per worker is zero in both Thrifty and Profligate c Since there is no population growth or technological change in the steady state, total output will be constant in both countries The growth rate of total output will be zero in both Thrifty and Profligate

16 48 a MPK = 010 b s = 021 c MPK = 007 d s = 030

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