Sample Midterm 1 Solutions

PART A

  1. A

Unemployment rate is calculated from # of ppl unemployed / # of ppl employed. Therefore, when unemployment rate is greater than zero, more people are unemployed than those who are employed. No information is provided regarding other types of unemployment, and D and E do not make sense.

  1. C

A and D are unobtainable since we are not provided with the number of worker. D is wrong in math; 1 billion = 1000 million. Therefore, C is correct.

  1. D

Wage raised by 2%, and price level increased by 3%, meaning real income decreases by 1%. Therefore, the employees’ purchasing power falls. The employer, in this case the one “purchasing” the employees, actually gains purchasing power.

  1. A

Since the fisbess are imported good, only the firm’s profit, which is created domestically, counts towards GDP. A different approach would be to add $10000 to consumption in the equation, but subtract $5000 as import in the calculation for net export.

  1. B

GDP can be calculated based on either income or expenditure, and they should yield the same result. A would give twice the GDP. D and E are virtually self-contradictory. C descripts statistical discrepancy.

  1. C

Expenditure side should include purchases. C is not a purchase. In fact, C is an account transfer and is not included in GDP at all.

  1. E

Any increase in income would usually increase expenditure by less than the corresponding amount, because people don’t spend all their money; they also save.

  1. E

The formula for simple multiplier is 1/1-z, where z is the marginal propensity to spend. If z is one, then multiplier is not defined. However, when the denominator is infinitely close to zero, the value is infinitely large.

  1. C

A rise in domestic prices relative to foreign prices does a number of things. First, it increases the incentive to buy foreign products, therefore increasing import. As net export is export minus import, net export falls. This means, on the graph, the function shifts down. Also, more incentive to buy foreign products means an increase in GDP results in more imports. Hence, the slope of the function also increases, resulting in a steeper graph.

  1. B

Marginal propensity to spend is the slope of AE graph, which is the sum of all the given terms. However, IM is included as a negative. Therefore, by subtracting 0.08 from 0.84, we get 0.76.

  1. A

The headline clearly indicates that AE function should decrease. Hence, it shifts down. It is not a downward rotate (change in slope) because the question states “all things being equal”.

  1. C

GNP includes GDP, plus its accounts for income from assets abroad and payments to foreign assets. Since the nationality of asset is the only thing affected by foreign takeovers, therefore GNP decreases (increased outflow to foreign assets) and GDP remains unchanged.

  1. E

A change in price level causes a change in real income and consumption, hence shifting the AE curve. The same change causes a change in the y-coordinate on the AD graph, causing a movement along the line.

  1. E

In the AS model producers do not have control over price, but rather their quantity produced. Hence B C and D do not make sense. A is simply irrational. E is the only reasonable choice.

  1. C

In Economy B, it is clear that the aggregated supply remains the same regardless of the GDP. This means that the aggregated demand has absolute power over the output level. Hence, the economy will experience an incredibly volatile fluctuation due to AD shocks.

PART B

  1. The only difference between real and nominal GDP is that real GDP has taken account into inflation. Therefore, real GDP often appears to be higher than the corresponding nominal GDP. Based on this logic, an increase in real GDP should also appear smaller than a corresponding growth in nominal GDP. That being said, both should increase at the same time.
  1. GDP is short of Gross Domestic Production. When you purchase a stock option, no production is directly induced. Hence it doesn’t count.
  1. Living standard can be more effectively measure with real GDP per capita. This literally translates into how much of the GDP each person in that country gets. If a country has lots of GDP but also lots of people, its living standard would be lower than another country who has only slightly lower GDP but way fewer people. Simply put, each person enjoys a larger pieces of the cake.
  1. GNP. GDP does not take into account production by people/assets owned by but outside of the country. Hence, when we look at GDP, we do not know about these people. If the country has lots of people working abroad, its GDP would be dramatically different from GNP, and also very inaccurate in terms of the people’s well-being.
  1. A recession in foreign countries would reduce the demand for exports. As demand decreases, so does the price level, as well as AD and GDP.

In the long run, long-term unemployment would force workers to accept lower wages. This leads to a decrease in production cost and right-shifting of the AS curve. This would result in an even lower intersection with the AD curve, further dropping the price level.