Navigating Macroeconomic Uncertainty

Indian School of Business

Professor Julen Esteban-Pretel

Midterm Exam
Sample

Part 1: Numerical, Graphical and Descriptive Questions

Instructions: Do all the exercises and write your answers in the space provided.
1. Growth in Bangladesh
Bangladesh was one of the highest growing countries in the years prior to the COVID-19 pandemic.
In this exercise we will try to analyze the growth of the country since the mid 1970s by decomposing
it into its different factors. Using the data from this table below, answer the following questions.

Year Y N K L H
1976 89,852 71.7 81,504 21.3 1.2
2019 756,356 163.0 2,843,307 65.5 2.1

Note: Aggregate output, GDP (Y ), and capital (K) are expressed in millions of 2017 PPP-adjusted US
dollars; population (N ) and employment (L) are in millions of people; and human capital (H) is proxied
by a human capital indicator.

a. Sources of Bangladesh’s Growth (10 points)

Fill the empty cells in the following table to calculate the contributions to Bangladesh’s GDP
per capita growth (gY /N ) by capital per worker (K/L, sometimes called capital-labor ratio),
employment to population ratio (L/N , sometimes called employment rate), Total Factor
Productivity (A) and human capital. Explain which one is more important and how this is
different or similar to some of the economies that we have studied in class. Assume that the
share of capital (↵) is 1/3.

Y /N A L/N K/L H
Growth Rate (%) 0.70% 5.65% 1.30%
Contributions to gY /N
Contributions to gY /N (% of Total)

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

b. Bangladesh’s Growth in Early versus Recent Years (10 points)

The figure below shows the percentage contribution of the each variable to the growth of
output per capita from 2005 to 2019. With the help of the graphical solution of the Solow
Model explain the reasons for the main differences from what you found in part (a). [Note:
Full credit for this question requires the correct graph]

Figure 1: Bangladesh’s Growth Accounting - 2005-2019

Percentage Contributions to GDP per capita growth
40%
35%
30%
25%
20%
15%
10%
5%
0%
Employment Rate Capital-Labor Ratio Human Capital TFP

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

{Space for Figure}

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 Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

2. Credit Markets and Future Expectations

a. Different Future Expectations for Households and Firms (10 points)
Assume that because Indian households do not fully understand the economy, whereas firms
hire highly trained ISB graduates who know how to navigate macroeconomic uncertainty, the
Indian economy is in situation in which consumers and businesses have different expectations
about the future. In particular, assume that consumers are pessimistic about the future
prospects of the economy, whereas firms, having done their due diligence, are actually very
optimistic about the future.
Use the credit market model covered in class to explain, both graphically and in words, how
such a situation may lead to an increase in the real interest rate and an increase in total
investment. Assume that government borrowing is zero. [Note: Full credit for this question
requires the correct graph]

{Space for Figure}

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 Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

3. Minimum Wage and Labor Markets Rigidities

Assume that the labor market of the fictional country of Ember is characterized by a labor demand
described by the function Ld = 16 s
w , and a labor supply described by the function L = w .
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a. Unemployment rate (5 points)

If the government of Ember imposes a minimum wage of 2.1, what would be the unemploy-
ment rate (u⇤ ) predicted by the model?

b. Shortage of Labor due to COVID-19 (10 points)

One of the issues facing the U.S. labor market after COVID-19 was the lack of available
workers to fill vacant positions in the service sector. This was in part due to some workers
rethinking their willingness to work in these risky environments for low pay. Use the frictionless
model, under the situation where the minimum wage is above the equilibrium wage, to
rationalize how workers requiring higher pay to work can lead to a simultaneous decrease in
unemployment, decrease in labor force participation and an increase in wages, as was seen
in the U.S. economy in the months following the re-opening after the Pandemic. [Note: Full
credit for this question requires the correct graph]

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

{Space for Figure}

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 Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

4. Trade and Its Benefits

a. Is Trade Beneficial? (5 points)
Assume that there are two countries, East and West, and two goods, mangos and oranges.
East has 100 units of labor available, and West has 150 units. To produce one unit of mangos
in East the country needs 8 workers, and it needs 2 workers to produce 1 unit of oranges.
The industry in West can produce 1 unit of mangos using 8 workers and 1 unit of oranges
using 4 workers.
Explain, providing numerical evidence, what country has the absolute advantage on the
production of which good. Explain, providing numerical evidence, also which country has
the comparative advantage on which good and whether they should specialize and, if so, on
what good?

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

b. Subsidies and Tariffs (10 points)

Read the article entitled “US-EU agree ceasefire in long-running trade war over aircraft sub-
sidies” written by Daniel Boffey and Jasper Jolly and published in The Guardian. Explain
why both regions saw the subsidies to the aircraft industry as unfair and how imposing tariffs
would compensate for the effects of such subsidies.
The authors write “About $11.5bn (£8.2bn) of tariffs had been applied on goods ranging from
EU wine to US tobacco and spirits over the issue of state subsidies for aircraft manufacturers
Boeing and Airbus. [...] Both sides said the disagreement had been a serious drain on
economic growth.” Explain why the dispute may have lowered economic growth in both
countries.

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 Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

Part 2: Multiple Choice Questions (2 points each)

Instructions: Do all 20 MC questions and transcribe your answer to the OMR.
(1) During the late 1990s, Japan experienced reductions in the GDP deflator. Given this infor-
mation, we know for sure that:

a. real GDP did not change during these periods

b. the overall price level in Japan decreased during these periods.
c. real GDP fell during these periods.
d. both real GDP and the overall price level decreased during these periods.

(2) Nominal GDP for 2019 is calculated using the prices in:

a. a designated base year.

b. 2018.
c. 2019.
d. the average of the previous decade.

(3) In 2016, real GDP was $13.2 trillion and the GDP deflator was 110.6. What was nominal
GDP for that year?

a. $14.6 trillion
b. $14.3 trillion
c. $12.1 trillion
d. $11.9 trillion

(4) A set of tires installed on a vehicle produced by an automobile factory is counted as:

a. a finished good and its market price is part of GDP.

b. a finished good and its market price is not part of GDP.
c. an intermediate good and its market price is part of GDP.
d. an intermediate good and its market price is not part of GDP.

(5) The Solow model features _____ returns to physical capital.

a. diminishing
b. constant
c. increasing
d. no

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

(6) All else equal, in the Solow model an increase in saving will cause capital stock to:

a. increase.
b. decrease.
c. remain unchanged.
d. increase and then decrease.

(7) In the Solow model, an earthquake that destroys half of a nation’s capital stock will cause:

a. an increase in the country’s growth rate in the years following the earthquake.
b. a decrease in the country’s growth rate in the years following the earthquake.
c. a decrease in the country’s steady-state capital stock.
d. an increase in the country’s steady-state output level.

p
(8) Imagine an economy with production function y = f (k) = k and 400 units of capital
per worker. If the fraction of output per worker invested in new capital is s = 0.2 and the
depreciation rate is = 0.05, how much total capital will be available in the next period?

a. 380 units
b. 384 units
c. 400 units
d. 404 units

(9) The supply of savings is positively sloped because:

a. firms borrow more when interest rates are low.

b. people are enticed to forego consumption when interest rates are higher.
c. when people have more incomes they save more.
d. higher interest rates cause people to save less.

(10) If the interest rate rises from 5% to 9%, the number of new businesses will:

a. increase.
b. decrease.
c. remain the same.
d. sharply increase, then level off.

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

(11) If consumer confidence increases, the interest rate _____ and the quantity of borrowing
and lending _____.

a. increases; increases
b. decreases; decreases
c. increases; decreases
d. decreases; increases

(12) What happens to investment in the private sector if the government has a budget surplus for
a particular year?

a. It increases.
b. It decreases.
c. It is not affected.
d. The effect is unknown.

(13) Which of the following individuals, all of whom do not have a job, can be counted as
unemployed?

a. Someone who retired 4 months ago.

b. Someone who is searching for a job, but is not collecting unemployment benefits.
c. A part-time student who would like a job, but gave up searching for one because they
could not find it.
d. A stay-at-home parent too busy to search for a job, but who would take one if offered.

(14) What happens to the separation rate in expansions?

a. It increases because of higher lay-offs

b. It drops because of lower lay-offs
c. It increases because of higher quits
d. It decreases because of lower quits

(15) According to the friction-less model of the labor market studied in the course, economies
with higher higher minimum wages should have

a. lower levels of youth unemployment.

b. similar levels of unemployment to economies with lower levels of minimum wages.
c. lower levels of unemployment than economies with lower levels of minimum wages.
d. higher levels of unemployment than economies with lower levels of minimum wages.

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Navigating Macroeconomic Uncertainty Midterm Exam
Indian School of Business Sample

(16) Given the inherent search and matching frictions in the labor market
a. it is not possible to know if unemployment can be reduced to zero.
b. it is possible and it would be optimal to reduce unemployment to zero.
c. it is not possible, although it would be optimal, to reduce unemployment to zero.
d. it is not possible and it would not be optimal to reduce unemployment to zero.

(17) Which of the following best characterizes the relationship between the parties to a trade and
the gains from trade?
a. Gains from trade are fueled by differences in preferences and differences in opportunity
costs of production.
b. Gains from trade are fueled by differences in preferences only.
c. Gains from trade are fueled by differences in opportunity costs of production only.
d. Gains from trade are greatest when there are no differences between the two parties to
a trade.

(18) Suppose that a country which has an absolute advantage on the production of all goods,
and was previously closed to trade, decides to open up, specialize and trade. Which of the
following statements is true after it starts trading?
a. The country’s Production Possibility Frontier will remain the same, but consumption
will decrease.
b. The country’s Production Possibility Frontier will shift outward, and consumption will
increase.
c. The country’s Production Possibility Frontier will remain the same, but consumption
will increase.
d. The country’s Production Possibility Frontier will shift inward, but consumption will
increase.

(19) According to the theory of comparative advantage:

a. some countries have a comparative advantage in producing every good.
b. every country can produce some good with a lower opportunity cost.
c. every country should produce goods that involve high opportunity costs.
d. some countries should import every good from other countries.

(20) Rani Mukerji can iron 20 shirts per hour. Her housekeeper can iron 12 shirts per hour. From
this information alone, we can infer that:
a. Rani has a comparative advantage in ironing.
b. the housekeeper has a comparative advantage in ironing.
c. Rani has an absolute advantage in ironing.
d. the housekeeper has an absolute advantage in ironing.

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US-EU agree ceasefire in long-running trade war over aircraft subsidies | World Trade Organization | The Guardian

US-EU agree ceasefire in long-running trade war

over aircraft subsidies
Daniel Boffey and Jasper Jolly

A five-year ceasefire in the long-running US-EU trade war over subsidies to aircraft makers has been
agreed during Joe Biden’s visit to Brussels, as the White House sought to focus attention on the greater
threat said to be posed by China.

Billions of euros and dollars worth of tit-for-tat tariffs imposed on the US manufacturer Boeing and its
European rival Airbus will be suspended after both sides committed to work on removing unfair subsidies.

As an EU member state, the UK had also been hit by US tariffs linked to the dispute and the government
had imposed its own on American goods. Those were mutually suspended in March.

It is understood the US trade representative, Katherine Tai, will meet the international trade secretary, Liz
Truss, on Wednesday and a longer-lasting ceasefire is expected, in the mould of Biden’s deal with the EU.

The European Commission president, Ursula von der Leyen, described the announcement of a suspension
of tariffs between the EU and the US as a “breakthrough”.

“This really opens a new chapter in our relationship because we move from litigation to cooperation on
aircraft – after 17 years of dispute,” she said.

Tai said it reflected the desire of the new administration to stop clashing with its allies in light of the challenge
posed by Beijing and ahead of Biden’s meeting with the Russian president, Vladimir Putin, on Wednesday.

“Today’s announcement resolves a longstanding trade irritant in the USEurope relationship,” Tai said.
“Instead of fighting with one of our closest allies, we are finally coming together against a common threat.

“We agreed to work together to challenge and counter China’s non-market practices in this sector in
specific ways that reflect our standards for fair competition.”

An Airbus spokesperson said: “Airbus welcomes news of an agreement between the European
Commission and USTR regarding the WTO dispute on large civil aircraft.

https://www.theguardian.com/world/2021/jun/16/us-eu-agree-ceasefire-in-long-running-trade-war-over-aircraft-subsidies Page 1 of 2
US-EU agree ceasefire in long-running trade war over aircraft subsidies | World Trade Organization | The Guardian

“This will provide the basis to create a level-playing field which we have advocated for since the start of
this dispute. It will also avoid lose-lose tariffs that are only adding to the many challenges that our industry
faces.”

The tariffs applied by both sides had been temporarily suspended since 11 March. The new agreement will
officially go into effect on 11 July.

A minister-level working group will be established to discuss limits on subsidies and both sides agreed to
ensure funding will not “harm the other side”. The two sides also pledged to work together in “addressing
nonmarket practices of third parties”.

The announcement came at the end of a summit in Brussels attended by Biden, Von der Leyen and the
European Council president, Charles Michel, the first such meeting in seven years.

“I think the future is very, very bright, we have the opportunity to do some very good things,” Biden said.

The US president, after attending the G7 meeting in Cornwall and a Nato gathering in Brussels, chose not
to join Von der Leyen and Michel at a postsummit press conference but he will travel next to Geneva to
hold talks with Putin.

Under a joint EU-US statement, it was further agreed that Brussels and Washington would establish a
forum on Russia to exchange ideas on tackling disruptive moves by Moscow, including cyber-attacks and
disinformation.

About $11.5bn (£8.2bn) of tariffs had been applied on goods ranging from EU wine to US tobacco and
spirits over the issue of state subsidies for aircraft manufacturers Boeing and Airbus. The row had become
the longest running dispute in the history of the World Trade Organization. Both sides said the
disagreement had been a serious drain on economic growth.

The French president, Emmanuel Macron, welcomed the deal, saying it would help French winemakers.
“This is effective cooperation. This is good news for our wine producers,” he said.

Tai said tariffs could be reapplied at any point, however, if it was found that US companies were not being
allowed to “compete fairly”. There was also no commitment by Biden to lift tariffs applied by Donald
Trump on EU steel and aluminium, part of a separate dispute.

Von der Leyen insisted she was confident a solution would be found before the end of the year on steel
and hailed a new understanding between Brussels and Washington. She said the EU would hold fire for six
months on countermeasures it could have imposed on US steel and aluminium.

Germany’s economy minister, Peter Altmaier, said the accord was “a great relief”. Bruno Le Maire,
France’s minister for economy and finance, said he hoped for a “permanent” end to the dispute.

https://www.theguardian.com/world/2021/jun/16/us-eu-agree-ceasefire-in-long-running-trade-war-over-aircraft-subsidies Page 2 of 2