Macro Exam 1 Review
1. Consider the following model of the Macroeconomy:
Production function: Y = A K1/2 L1/2
a) What fraction of income do capital and labor receive?
b) Is the assumption that factor shares are ½ each reasonable? Explain your answer.
c) If g=10% and y0=150, what is the value of y at t=21?
2. Suppose the economy produces two good: sneakers and flip-flops. The prices and
quantities of these two goods are displayed below:
2012
2013
Quantity of sneakers
800
875
Quantity of flip-flops
68
91
Price of sneakers
$1.55
$1.95
Price of flip-flops
$1.05
$1.20
Nominal GDP
Real GDP (2012 prices)
Real GDP(2013 prices)
Real GDP (chained prices
benchmarked to 2012)
a) Fill out the table.
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b) Calculate 3 inflation rates (one for each index). Explain the differences.
3. Suppose the economy has the following production function: Y= AK1/2L1/2. The growth
rate of technology is 3%, the growth rate of capital is 2% and the growth rate of labor is
6%.
a. Is this economy’s production function operating at constant returns to scale? Why?
b. Calculate the growth rate of output, Y, in the economy.
c. Calculate the growth rate of output per person, y.
4. Consider a Solow economy that begins with a capital stock equal to $300 billion, and
suppose its steady-state level of capital is $500 billion. To its pleasant surprise, the
economy receives a generous gift of foreign aid in the form of $100 billion worth of
capital (electric power plants, machine tools, etc.).
a. Use the Solow diagram, other graphs, and the mathematics of the Solow model to
explain what happens to the economy, both immediately and over time. By what
proportion does consumption per person initially increase? What happens to
consumption in the long run? Show the transition dynamics.
b. Suppose instead of starting below its steady state, the economy begins in steady state,
with a capital stock equal to $500 billion. Answer part (a) for this case.
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c. Summarize what this exercise teaches you about the possible consequences of foreign
aid. In this example, does foreign aid exert a long-run effect on the welfare of poor
countries? What is the benefit of foreign aid?
5. Compare two countries. Suppose Peru has a savings rate of 18% and Italy saves at 12.5%.
a. Assuming the countries are identical in every other way, which country would the
Solow model predict to have higher per capita real GDP?
b. However, you find out that the steady state real per capita GDP in each country is:
Peru-$20,450 and Italy-$34,800. What is the primary factor that the Solow Model
uses to describe these differences?
c. In words, what does an increase in the savings rate in the Solow model do for an
economy? Is this an effective way to grow an economy’s output? What are the drawbacks
from increasing this parameter?
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Define the following terms:
GDP –
Capital –
Nominal GDP –
Real GDP –
Inflation rate –
Rule of 70 –
Increasing returns to scale –
MPK –
TFP –
Steady State –
Principle of transition dynamics –
6. A change in which parameters have the greatest effect on k and y in the Solow model
(assuming that the magnitudes of the change are all equal)? How do you know?
7. Give an example where the government spending money does not change G. Why does
this not change G? What component of the expenditure approach it does change?
8. Why do countries have different TFP values? What factors are included in TFP?
9. Which of the following will have an effect on GDP?
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a) Buying a 1976 Ford Mustang
b) A teenager who is paid in cash to babysit younger children
c) Fixing your car at an auto repair shop
d) Winning 1000 in Las Vegas
e) Fixing a friend’s car without purchasing additional parts
10. Labor as used by economists, means
a) Trade unions
b) Using resources to their full potential
c) Effort
d) All productive human activity
e) All natural resources
11. Capital used by economists means
a) Money
b) Best available option
c) Productive equipment or machinery
d) Seat of government
e) City with the highest GDP
12. Approaches to measuring GDP include all of the following except the
a) cost approach
b) production approach
c) income approach
d) expenditure approach
13. A furniture maker used to buy its wood, but has now bought the lumber company. How
does this impact GDP?
a) It reduces it
b) It does not change
c) It increases it
d) We cannot tell
14. Jim's Nursery produces and sells $1100 worth of flowers. Jim uses no intermediate
inputs. He pays his workers $700 in wages, pays $100 in taxes and pays $200 in interest
on a loan. Jim's contribution to GDP is
a) $900
b) $1000
c) $1100
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d) $1800
15. Value added is equal to the value of a firm's production minus
a) All of its costs of production
b) Labor costs
c) Investment expenditures
d) Intermediate goods used in production
16. Additions to inventory are
a) Not counted as an expenditure in GDP accounting
b) Counted as an intermediate input
c) Counted as a component of investment spending
d) Subtracted from sales revenue in calculating profit income
17. Even when measured accurately, GDP may be a misleading measure of economic welfare
because it cannot account for
a) the value of government spending and how efficiently we produce goods and services
b) how efficiently we produce goods and services and the value of non-market production
c) the value of non-market production and the consequences of an unequal distribution of
income
d) the consequences of an unequal distribution of income and the value of government
spending
18. When there is rapid inflation,
a) growth in nominal GDP exceeds growth in real GDP
b) growth in real GDP exceeds growth in nominal GDP
c) growth in real GDP and nominal GDP are roughly equal
d) there can never be any growth in nominal GDP
19. If real GDP grows faster than nominal GDP, it is a sign that
a) inflation is negative
b) there is no inflation
c) there is inflation, but little
d) there is galloping inflation
20. In the Solow growth model, how does steady state output per worker and capital per
worker change as
A.
The savings rate s increases?
B.
The technology level A increases?
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C.
The population growth rate n increases?
D.
The capital depreciation rate increases?
E.
The current labor force increases?
21. South Korea follows a Cobb-Douglas production function. In 20XX, South Korea reunites with North Korea. The current labor input doubles, but no capital is added (North
Korea has workers but no significant capital). There are no differences in the attributes of
South and North Koreans (same population growth rate, savings rates, ability to use
technology, and so forth). Assume the technology level does not change. Using Solow
diagram and appropriate equations answer the following questions.
a. What is the effect on current capital and capital per worker?
b. What is the effect on steady state capital and capital per worker?
c. What is the effect on the growth rate of capital and capital per worker in the
transition phase?
d. What is the effect on the growth rate of steady state capital and capital per
worker?
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22. If real per capita GDP increases at the rate of 3.5% per year, in about how many years,
will the standard of living double?
23. In the middle of the fourteenth century, an epidemic known as the black death killed
about t a third of Europe’s population, about 34 million people. While this was an
enormous tragedy, the macroeconomic consequences might surprise you: over the next
century, wages are estimated to have been higher than before the black Death.
(a) Use the production model to explain why wages might have been higher.
(b) Assume that this change in population was permanent, labor decreased permanently from
L to L’. Assuming that Europe’s economy starts in its initial steady state, use the Solow
model to explain what happens to the economy over time and in the long run. Your
answer must include 2 Solow diagraphs: one for aggregate GDP and one for GDP per
capita.
24. Consider the production model we used to predict GDP: y = k1/3 . What are the
shortcomings of using the production model 𝑦 = 𝑘1/3? What might you include in the
model to improve the fit? Remember it has to be something you can actually observe and
measure.
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