Economics 212

Intermediate Macroeconomics

Professor Rafferty
Fall 2010

Exam #2
ANSWER ALL TWENTY MULTIPLE CHOICE QUESTIONS (2
points each)
1. If the government increases income taxes then:
a. the aggregate demand curve will shift to the right causing output and the price level to
increase.
b. the aggregate demand curve will shift to the right causing output and the price level to
decrease.
c. the aggregate demand curve will shift to the left causing output and the price level to
increase.
d. the aggregate demand curve will shift to the left causing output and the price level to
decrease.
2. If the government builds new roads and bridges that make it easier to transport goods and
services around the country then:
a. Output and the price level will increase.
b. Output and the price level will decrease.
c. Output will increase and the price level will decrease.
d. Output will decrease and the price level will increase.
3. If the central bank increases the money supply then in the short run:
a. the aggregate demand curve will shift to the right causing output and the price level to
increase.
b. the aggregate demand curve will shift to the right causing output and the price level to
decrease.
c. the aggregate demand curve will shift to the left causing output and the price level to
increase.
d. the aggregate demand curve will shift to the left causing output and the price level to
decrease.
4. If the central bank increases the money supply then in the long run:
a. the aggregate demand curve will shift to the right causing output and the price level to
increase.
b. the aggregate demand curve will shift to the right causing the price level to increase, but
output remains constant.
c. the aggregate demand curve will shift to the right causing output to increase, but the price
level remains constant.
d. None of the above.

5. For the United Kingdom in 2004, the owners of software received 0.018 of national
income, real GDP was 956.8 billion, and the stock of software was 29.1 billion. Assuming
that the aggregate production function is Cobb-Douglas then the marginal product of
software is:
a. 0.59.
b. 0.69
c. 0.79
d. 0.89
6. Increases in the capital stock alone cannot explain why real GDP has increased steadily
over time due to:
a. diminishing marginal returns to capital goods.
b. constant returns to scale.
c. diminishing marginal returns to labor.
d. the importance of total factor productivity.
7. In the long-run, a new technology will:
a. shift the labor demand curve to the right and lead to higher real wages and higher
employment.
b. shift the labor demand curve to the left and lead to higher real wages and higher
employment.
c. shift the labor demand curve to the right and lead to lower real wages and lower
employment.
d. shift the labor demand curve to the left and lead to lower real wages and higher
employment.
8. The aggregate production function and the Solow model predict that Bolivia and the
United States should converge to the same level of output per worker hour if:
a. the two countries have the same labor force growth rate.
b. the two countries have the same level and growth rate of total factor productivity.
c. the two countries have the same investment rate.
d. all of the above.
9. Which of the following is not a potential reason for why the level of total factor
productivity differs across countries:
a. the level of education differs.
b. the level of government corruption differs.
c. one country suffers from poor geography.
d. the growth rate of the money supply is lower in one country.
10. After World War II, Germany and Japan grew very quickly because:
a. the capital-labor ratio was low so the rate of return to capital was high.
b. the capital-labor ratio was low so the rate of return to capital was low.
c. the capital-labor ratio was high so the rate of return to capital was high.
d. the capital-labor ratio was high so the rate of return to capital was low.

11. Robert Barros early work on economic growth and the level of real GDP per person
found that:
a. poor countries never catch up to rich countries.
b. poor countries catch up if the poor countries have high human capital.
c. poor countries catch up if the governments in poor countries invest heavily in
infrastructure projects such as roads and bridges.
d. poor countries catch up if they invest heavily in research and development.
12. Americans currently work more hours per year than Western Europeans.
a. This has always been the case as far back as data is available.
b. Has been true since around 1970.
c. Is not true since Western Europeans work more than Americans.
d. None of the above.
13. Which of the following is not a potential explanation for differences in the amount that
Americans and Western Europeans work?
a. Western Europeans have different preferences.
b. Tax rates differ between the United States and Western Europe.
c. There have been significant differences in monetary policy over the last 50 years.
d. Labor market regulations differ across the two regions.
14. M1 consists of:
a. bank reserves only.
b. currency plus demand deposits.
c. currency plus demand deposits plus savings accounts.
d. currency plus demand deposits plus savings accounts plus reserves.
15. The money multiplier is:
a. the ratio of the money supply to the monetary base.
b. the ratio of the money supply to bank reserves.
c. the ratio of the money supply to currency.
d. the ratio of the money supply to nominal GDP.
16. According to the quantity theory of money, the long-run effect of a one-percentage point
increase in the growth rate of the money supply is to:
a. decrease the inflation rate by one-percentage point.
b. increase the inflation rate by one-percentage point.
c. decrease the growth rate of real GDP by one-percentage point.
d. increase the growth rate of real GDP by one-percentage point.
17. The Fisher effect tells us that the long-run effect of a one-percentage point decrease in the
inflation rate is to:
a. increase the real interest rate by one-percentage point.
b. decrease the real interest rate by one-percentage point.
c. increase the nominal interest rate by one-percentage point.
d. decrease the nominal interest rate by one-percentage point.

18. Hyperinflation occurs when:

a. the government finances the budget deficit by issuing new bonds.
b. the government finances the budget deficit by printing money.
c. the government eliminates the budget deficit by raising taxes.
d. hyperinflation is a monetary phenomenon and so has nothing to do with budget deficits.
19. If the income effect is stronger than the substitution effect then:
a. an increase in the real wage will increase the quantity supplied of labor.
b. an increase in the real wage will have no effect on the quantity supplied of labor.
c. an increase in the real wage will decrease the quantity supplied of labor.
d. a decrease in the real wage will decrease the quantity supplied of labor.
20. Structural unemployment occurs when:
a. workers quit their jobs to look for a better one.
b. firms temporarily lay off workers due to the state of the economy.
c. there is a persistent mismatch between job skills or attributes of workers and the
requirements of jobs.
d. workers leave the labor force to go back to school or raise children.

ANSWER BOTH QUESTIONS (30 points each)

1. Capitals share of income is 0.30. The savings rate is 0.10, the depreciation rate is
0.10, the population growth rate is 0.02 and the initial level of total factor productivity is
5 and the growth rate of productivity is 0.02.
a. Graph the initial steady state. Solve for the steady-state values of y, k, i and c. (7.5
points)
b. Suppose that the writers of computer viruses become more skilled and write viruses
that completely destroy an infected computer. As a result, firms must replace computers
more frequently. Use the Solow growth model to graph the effect of a decrease in the
population growth rate. Explain the effect of this change on the growth rate of y and k.
(10 points)
c. The depreciation rate increases to 0.20. Solve for the new steady-state values of y, k, i
and c. (7.5 points)
d. Graph the effect of the increase in the depreciation rate on the growth rate of real GDP
per worker hour and the level of real GDP per worker hour as the economy moves from
the initial to the new steady state. (5 points)
2. For the 15 members of the European Union from 1980 to 2004, the share of income
going to labor was 0.68, the share of income going to the owners of Information
Technology capital was 0.03 and the share of income going to all other types of capital
was 0.29.
Over this time period, the average annual rate of real GDP growth was 2.1%, the average
annual growth rate of labor was 0.1%, the average annual growth rate of Information
Technology capital was 16.4% and the average annual growth rate of other types of
capital was 2.6%.
Suppose the following production function describes the economy of the European
Union:

Y = A K IT K NonIT L1

where K IT is the Information Technology capital stock and

types of capital goods.

K
Non IT

is all other

a. What was the growth rate of total factor productivity over this time period? (10 points)
b. What were the absolute contributions of the total factor productivity, both types of
capital, and labor to the growth rate of real GDP? (10 points)
c. What were the relative contributions of the total factor productivity, both types of
capital, and labor to the growth rate of real GDP? (10 points)

Answers to Multiple Choice Questions

1. D

11. B

2. A or C

12. B

3. A

13. C

4. B

14. B

5. A

15. A

6. A

16. B

7. A

17. D

8. D

18. B

9. D

19. C

10. A

20. C

Answers to Long Answer Questions

1. a and b.
k 1=

[ ] [
sA
n+ d 1

1
1

0.1 ( 5 )
0.02+0.10

1
10.30

=7.7

0.3

y 1= A ( k 1) =5 ( 7.7 ) =9.2
i 1=s y 1=0.10 ( 9.2 )=0.9
c 1= y 1i 1=9.20.9=8.3
y 1

y= A k
( n+ d2 ) k

y2

( n+ d1 ) k

i=sy=sA k

k 2

k 1

The increase in the depreciation rate causes the break-even investment line to pivot up.

At the initial capital-labor ratio, k 1 , break-even investment is now greater than

investment so the capital labor ratio decreases. The new steady-state is at point B and

GDP per work hour has decreased from y 1 to y 2 .

c.

[ ] [

sA
k=
n+d 1

1
1

0.1 ( 5 )
=
0.02+0.20

1
10.30

=3.2

0.3

y 2= A ( k 2 ) =5 ( 3.2 ) =7.1

i 2=s y 2=0.10 ( 7.1 )=0.7

c 2= y 2i 2=7.10.7=6.4
d.
ln y

BGP1
BGP2

1
( 1
)g

slope=

t=0
Since the steady-state value for output per worker hour has decreased, the economy moves to
a lower balanced growth path. The increase in the depreciation rate does not influence the
slope of the balanced growth path so the new balanced growth path is parallel to the original
balanced growth path.
2.
a. The growth accounting equation for this questions production function is:

gY =g A + gK + g K
IT

Non IT

+ ( 1 ) g L

This is one equation with 8 unknowns and you are asked to find the compound average
annual growth rate of total factor productivity. To find this growth rate, start by plugging in
the values given to you in the problem:

2.1= g A +0.03 ( 16.4 ) +0.29 ( 2.6 ) + ( 10.030.29 ) ( 0.1 )

Then just solve for

g A :

g A =0.8
b. You essentially answered this question in part a.
Absolute contribution of total factor productivity:

g A =0.8
Absolute contribution of IT capital:

g K =0.03 (16.4 )=0.49

IT

Absolute contribution of Non-IT capital:

g K

NonIT

=0.29 ( 2.6 )=0.75

Absolute contribution of labor:

( 1 ) g L =( 10.030.29 ) ( 0.1 )=0.07

c. The formula for the relative contribution is:

1=

g A gK g K
+
+
gY
g Y
g Y
IT

NonIT

( 1 ) g L
g Y

Relative contribution of total factor productivity:

g A 0.8
=
=0.381 or 38.1%
gY 2.1
Relative contribution of IT capital:

g K 0.03 ( 16.4 ) 0.49

=
=
=0.234 or 23.4%
g Y
2.1
2.1
IT

Relative contribution of Non-IT capital:

gK
gY

Non IT

0.29 ( 2.6 ) 0.75

=
=0.359 or 35.9%
2.1
2.1

Relative contribution of labor:

( 1 ) g L ( 10.030.29 ) ( 0.1 ) 0.07

=
=
=0.032 or 3.2%
gY
2.1
2.1