Psychology homework help. Economics 251: Spring 2020 Professor John V. Duca

Econ 251 First In-Class Exam, April 9, 2020 (Blackboard, item heading: Exam 1 April 9)

Ground Rules:

1) Closed book: No notes, no handouts, no books, and no use of electronic or information

technology to obtain answers. You are expected to remember key formulas as well as

graphical frameworks. You can use a device to make numerical calculations—nothing else.

2) Do not discuss or reveal information about the exam with any other student until I post the

answer key on Blackboard.

3) Either write on a hardcopy of the exam or on note paper (PRINT name and sign honor pledge.)

If you have a scanner, email your scanned answers into one pdf to jduca@oberlin.edu. If using

an I-phone you are responsible for sending legible images and all images in one email

message.

4) Students without accommodation: 1 hr. 50 minutes for exam plus 10 minutes to download

and scan answers. Either start downloading exam at 9:25 am and email back by 10:55 am or

start downloading exam at 9:30 am and email back by 11 am. (Students in the U.S. Pacific

time zone can start and end exams at these times but under the Pacific time zone (e.g., 3

hours after U.S. Eastern time). Others should have contacted me already.

5) Students with extended time were supposed to have contacted me in advance for timing.

6) I will monitor my email for questions in the rare event you have one during the test.

Print NAME:

Please PRINT above the line

Sign Honor Code Pledge:

I have adhered to the

Honor Code in this assignment:

Please SIGN above the line

1.) GDP Questions (12 points). 2 points each. Clearly indicate True or

False (no explanation needed).

i) In calculating U.S. GDP using the expenditure approach, airplane parts produced in the

U.S. and sold to the European plane manufacturer Airbus and used to assemble Airbus

planes do not count in U.S. GDP.

ii) The U.S. GDP ACME company spends $25 million developing a new machine that will be

later exported to Mexico to produce tequila. This spending shows up in the “NX” or “X”

component of U.S. national expenditure.

iii) Direct government financial assistance to laid-off airline workers during the coronavirus

epidemic would show up in the “G” component of national expenditures.

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iv) U.S. company purchases of imported capital equipment only shows up in the “M” or

import component of national expenditures.

v) While home on spring break, Oberlin student Pat spends 8 hours removing viruses from

the computers of family members who buy Pat a $20 gourmet pizza from a local takeout

restaurant. None of this will show up in the national income and product accounts (NIPAs)

vi) Terry and Pat spend $10,000 renovating their home. This shows up in the “C” component

of GDP using the expenditure approach.

2) Fiscal Policy/Loanable Funds Question (16 points)

Consider the following change in fiscal policy. Suppose that the U.S. federal government

sizably lowered lump sum taxes that had virtually no effect on the after-tax returns to

investment, and despite some temporary boost to short-run growth, notably raised the

budget deficit relative to GDP while having virtually no effect on private saving. Assume for

the sake of this question that these policies are implemented and are sustained for many

years in a closed-economy environment.

a. (16 points in total). Using a well-labeled loanable funds chart, depict what this change

in fiscal policy does and clearly state what happens to the level of private investment and

what happens 4 points each for (i) to (iii)) How would this affect the market for loanable

funds in the United States? Your answer should cover

i. …the supply curve for loanable funds,

ii. …the demand curve for those funds, and

iii. …the equilibrium real interest rate.

I am interested only in direction of movement so calculations are not required. For each

of these variables, your choices include

…no change (applicable in principle to any of the three),

…a shift right or left (applicable in principle to demand and supply curves),

…movement up or down an unchanged supply or demand curve,

…an increase or decrease (applicable in principle to the real interest rate), or

…not enough information to tell (applicable in principle to any of the three).

Briefly explain your reasoning for each, including what information is missing if you

choose the last option. (4 points apiece for a correct answer for each of the three items

requested, including 2 points for the correct direction and 2 points for the reasoning).

4 points for a well-labeled chart.

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3. Solow Model Growth Accounting Problems. (24 points).

For all parts of (3) assume that the Solow model holds for a perfectly competitive economy

with a Cobb-Douglas production function Y = AF(K,L) = AKα

L

1-α

in which both factors of

production are fully employed and 0 < α < 1.

3a) (6 points total) A researcher analyzes economic growth using the Cobb-Douglas

production function Y = AF (K,L) = AKα

L

1-α

, where α = .25. Suppose the output of an

economy had grown by 120% over the past 30 years, and that over the same time period,

the capital stock and labor force have grown by 80% and 20%, respectively.

i) (2 points) Write down the growth accounting equation.

ii) (4 points) What are the contributions to economic growth from growth in capital, growth

in labor force, and growth in productivity?

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3b) (6 points total) Return to the assumptions before section a. Consider the comparisons of

the following pair of countries under the assumptions and workings of the Solow Growth

Model. The savings and depreciation rates for countries SK and NK are identical, as is the

level of productivity/technology (“A” in the model), the coefficient α (exponent on K), their

population growth rates, and the growth rate of total factor productivity (A). Today, Country

NK has a capital-labor ratio that is .6 times that of Country SK and each ratio is below each

country’s steady state level (2 points each for a, b, & c).

i. How does today’s level of per capita output in Country NK compare with today’s per

capita level of output in Country SK?

ii. Fifty years from now, what does the Solow Model predict for the capital-labor

ratio of Country NK relative to that of Country SK?

iii. Fifty years from now, what does the Solow Model predict for the per capita

level of output in Country NK relative to that in Country SK?

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3c) (6 points total) Consider the comparisons of the following pair of countries under the

assumptions and workings of the Solow Growth Model. The savings, population growth,

and depreciation rates for countries SK and NK are identical, as are the level of

productivity/technology (“A” in the model), the initial level of the per capita capital stock,

and the initial capital-labor ratio. Up until today, assume that there has not been any

technological progress. After today, the growth rate of total factor productivity (A)

becomes positive and is half as fast in country NK as in country SK. (2 points each).

i) How does today’s level of per capita output in Country SK compare with today’s

per capita level of output in Country NK?

i) Fifty years from now, what does the Solow Model predict for the capital-output

ratio of Country SK relative to that of Country NK?

ii) Fifty years from now, what does the Solow Model predict for the per capita level

of output in Country SK relative to that in Country NK?

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3d) (6 points total). Assume that Country X is initially at its steady-state capital-output

ratio. Now assume that α = .20, and also that the capital stock (K) and level of technology

(A) stay at their initial level.

i) If the labor stock grows by 50 percent in the next period, what can we say about

how much output grows in that period compared to its initial level? (3 points—2

for showing the calculation)

ii) Does this reflect increasing, constant, or diminishing marginal returns to labor?

iii) (2 points—1 for showing the calculation) Instead, if the stock of labor grew by 30

percent, the capital stock grew at 40%, and technology grew by 8 percent in the

next period, what can we say about how much does output grow in that period

compared to its initial level?

4) (16 points) Solow Growth Model Problems

a. (5 points) Using the Solow Growth Model diagram that incorporates population

growth, Illustrate what happens to the steady state capital-to-labor ratio when the level

of technology (productivity) experiences a one-time drop to a permanently lower level (3

points). What happens to steady-state per capita output? (1 point) Does this result, in

general, help or hurt the ability of the Solow growth model to account for differences in

the income levels across major advanced economies and why (2 points)?

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b. (3 points) In a separate diagram, using the Solow Growth Model diagram that

incorporates population growth, illustrate what happens to the steady state capital-tolabor ratio when the rate of depreciation decreases to a new permanently lower rate (2

points). What happens to steady-state per capita output? (1 point).

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4c) (8 points in total)

i) (4 pts) True or False: in the Solow Model, the level of per capita output at the steady state ratio

of capital to labor is positively affected by the rate of population growth (2 points). Why? (2 points)

ii) (4 points) True or False In the Solow Model, the growth rate of output at the steady state ratio

of capital to labor is affected by the depreciation rate (2 points). Why? (2 points)

Short Answer Questions on Consumption (8 Points)

(8 points—respond to all of short answer questions.)

a) True or false (3 points in total: 2 points for T or F and 1 point for why). In general,

according to the permanent income hypothesis, an equal dollar rise in your base salary

has the same impact on consumption as an equal dollar rise in your bonus.

b) (3 points in total) According to the permanent income hypothesis and assuming there

were no inheritances, what happens (if anything) to the marginal propensity to consume

out of labor income as people age (2 points)? Why? (1 points)

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c) True or false (2 points in total: 1 point for T or F and 1 point for why). In general, according

to the permanent income hypothesis and assuming there were no inheritances, the

marginal propensity to consume out of wealth increases as people age.

6. User Cost of Capital Question (14 points).

As chief executive officer (CEO) of a business firm, you are considering two investment projects,

each costing $6 million. One is the purchase of 1,500 computers at $4,000 apiece; the other is

the purchase of 30 trucks at $200,000 apiece (for this problem, the choices are to buy 1,500 or 0

computers, and whether to buy 30 or 0 trucks). Your company’s after-tax borrowing rate is 13%

per year and assume throughout the problem that the tax rate and taxes on business income are

zero. Prices of new computers have been falling 12% per year and are expected to continue doing

so; in addition, you estimate that one-fifth of the computers will need to be replaced each year.

Meanwhile, prices of new trucks equivalent to the ones you are considering for purchase are

expected to rise 2% per year and annual maintenance costs (treat like depreciation) run $38,000

per truck.

a. (8 points) What is the rental cost of capital (user cost) for a computer in dollars per computer?

What is the rental cost of capital for a truck on the same basis?

Rental cost for computers: ___ or per computer (2 points)

Rental cost for trucks: or $ per truck (2 points)

Derivations (4 points—2 points for each type of equipment):

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b. (6 points) Estimates suggest that the investment in 1,500 computers will boost gross after-tax

revenues by $2.9 million per year while the investment in trucks will boost gross after-tax

revenues by $0.85 million per year. (Gross after-tax profits refer to the after-tax cash flow returns

generated from the investment before taking into account the cost of the investment.) Based on

the calculations from part a, should you invest in computers, in trucks, in both, or in neither? Why

(show some calculations)?

Invest in computers?

Invest in trucks?)

Explanations, including what information is missing if you said “not enough info” for either

investment

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7) IS Curve Questions 10 Points

a) Draw a well labeled IS curve diagram with an initial IS curve. Suppose that the mpc = .8 and that

lump-sum taxes on households fell by $100 billion. Depict any change in the position of the IS

curve and any magnitudes involved (show formulas and calculations). (4 points)

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b) Draw a well labeled IS curve diagram with an initial IS curve. Suppose that the mpc = .8 and that

lump-sum taxes were cut by $200 billion and government spending were cut by $200 billion.

Depict any change in the position of the IS curve and any magnitudes involved. (show formulas

and calculations). (4 points)

c) Draw a well labeled IS curve diagram with an initial IS curve. Suppose that the mpc = 0.8 in the

initial curve. If everything else about C, I, and G (closed economy model) stayed the same, except

that the mpc fell to 0.7, would anything about the IS curve change? If so, draw a second IS curve

under the lower mpc. (4 pts)