Econ 387: Midterm 1
February 9, 2006
D. Andolfatto
Name
Instructions. Do not begin the exam until you are instructed to do so. Read the exam over carefully
and raise your hand if you need clarification. In answering the questions, limit your answers to the space
provided below each question. Do not write your answers on the back of the exam or in the exam booklets
(which are meant to serve as scrap paper only). Write (or print) your answers as neatly as possible—if I can’t
read it, I won’t mark it. Make sure to label your diagrams clearly.
[1] [10 Marks]. What is the definition of an indifference curve? Why are indifference curves an important
component of macroeconomic analysis? (Provide two reasons).
[2] [10 Marks]. Real wages have risen dramatically over the last century. Nevetheless, the aggregate level
of hours worked (per capita) has remained more or less constant. Is this observation inconsistent with
neoclassical theory? Explain (a diagram may be helpful).
1
[3] [10 Marks]. Consider the following data from the U.S. economy (1939—47).
Figure 3.4
GDP and Employment in the
United States During WWII
2000
1040
1000
1800
Billions 2000$
Billions 2000$
960
1600
1400
1200
920
880
840
800
1000
760
Gross Domestic Product
800
39
40
41
42
43
44
45
46
47
1400
58000
1200
56000
1000
54000
Thousands of Workers
Billions 2000$
Private Consumption
720
800
600
400
200
39
40
41
42
43
44
45
39
40
41
42
43
44
45
46
47
52000
50000
48000
46000
Employment
Government Spending
0
44000
39
40
41
42
43
44
45
46
47
46
47
If we interpret the U.S. entry into WW2 (December 1941) as an exogenous shock (together with the associated
increase in government spending, that was financed largely by debt), is the basic neoclassical model consistent
with the movements in GDP, consumption, and employment (from their trend levels)? Explain (a diagram
may be useful).
2
[4] [10 Marks]. Consider a small open economy that faces a world interest rate R. There is a representative
agent with an exogenous endowment of time-dated (and non-storable) output (y1 , y2 ), and preferences
for time-dated output given by U (c1 , c2 ) satisfying the usual restrictions. Using this model, identify
two separate shocks to output, each of which leads to an increase in the current account deficit, but
with each having different implications for economic welfare. Be careful to provide real-world examples
of the shocks you consider and to explain your results in words (draw a separate diagram for each
shock).
3