Econ 102 Final

Chris Surro
March 18, 2024

Name:

Student ID:

TA:

Exam Rules
1. The exam starts at 8:00 and ends at 11:00.

2. There are 20 multiple choice questions worth 10 points each and four open response
questions worth 75 points each.

3. Make sure to fill in the scantron for multiple choice questions. You will not be given
extra time at the end.

4. Please put all materials other than your calculator, a pen or pencil, your cheat sheet
and your ID in your bag. If you have a phone or other item out for any reason you
will be given a 0 on the exam.

5. If you have a question or need to go to the bathroom raise your hand and a TA will
come help you.

6. On the open response questions you must SHOW ALL WORK. No credit will be given
for an answer with no work.

1
Multiple Choice (10 points each)
1. A car manufacturer in the US produces cars using domestically sourced steel and im-
ported electronics from Japan. It sells each car at a price of $20,000. The manufacturer
produces 500 cars in 2024, sells 400 of them domestically, and exports the rest. To
produce these cars, it purchases $5,000 worth of steel and imports $2,000 worth of
electronics per car. How much do these activities add to US GDP in 2024?

(a) $5,200,000
(b) $6,500,000
(c) $7,200,000
O
(d) $9,000,000
(e) None of these

2. Which of the following would increase the investment component of GDP?

(a) A company issues stock, which is purchased by an investment bank

(b) A company issues bonds, which are purchased by consumers

g
(c) A company produces 400 bicycles, but only sells 300 of them this year
(d) All of these would increase investment
(e) None of these would increase investment

3. Assume an economy produces only cookies and milk. Typically, consumers purchase
500 cookies and 200 cartons of milk per year, which is used as the consumption bundle
for calculating CPI. In 2023, the price of a cookie was $2 and the price of a carton of
milk was $4. In 2024, the price of cookies increased to $3 and the price of a carton of
milk stayed constant. In which case will inflation as measured by the CPI definitely
be higher than inflation measured by the GDP deflator?

(a) If consumers purchased more than 500 cookies and/or less than 200 cartons of
milk

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(b) If consumers purchased less than 500 cookies and/or more than 200 cartons of
milk
(c) If consumers purchase exactly 500 cookies and 200 cartons of milk
(d) CPI inflation will be higher in all of these cases
(e) CPI inflation would not be higher in any of these situations

2
4. A consumer has a utility function over leisure and consumption given by U (c, l) =
4c1/2 + 12l1/2 . Assume the consumer is currently working 12 hours per day and the
hourly real wage is 16. This consumer could increase their utility by

O
(a) Working more
(b) Working less
(c) They are already maximizing their utility
(d) Not enough information to decide

5. A firm has a production function given by F (K, L) = 12K 1/3 L2/3 and has a fixed
capital stock of K = 1000. It is currently hiring workers to work 512 hours (L=512)
and the hourly real wage is 15. This firm could increase its profits by

(a) Hiring more labor

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(b) Hiring less labor
(c) It is already maximizing its profits
(d) Not enough information

6. Assume there are 10 consumers in an economy that each have utility over leisure and
consumption given by U (c, l) = 3 ln(c) + 5 ln(l). Each consumer gets paid a wage w
and purchases a consumption good for price p and has 24 hours to split between work
and leisure. A single firm hires workers with production function F (K, L) = 720 ln(L).
What is the equilibrium wage?

O
(a) 8
(b) 10
(c) 12
(d) 15
(e) None of these

3
7. A new report from the Federal Reserve suggests that consumer spending is slowing
down. Many businesses see the news and decide to cut back on investment spending.
According to Keynes, what e↵ect would this likely have on the economy

(a) The decrease in demand for investment will cause interest rates to fall, which will
restore the economy back to full employment.
(b) The decrease in demand for investment will cause interest rates to rise, which will
restore the economy back to full employment.
(c) The decrease in investment will cause a decrease in GDP, but there will be no
changes to any other components of GDP.
(d) The decrease in investment will cause a decrease in GDP temporarily. In the long
run, prices will fall, which will increase spending and restore the economy back
to full employment.

O
(e) The decrease in investment will cause a decrease in GDP. Since the drop in GDP
means less income for the economy, consumers will consume less, which will cause
a further drop in GDP.

8. A Liquidity Trap is best described as a situation where

(a) The government is not providing enough liquid assets to the market
(b) The central bank has decreased the size of its balance sheet substantially

g
(c) Nominal interest rates are close to zero
(d) Inflation rates are close to zero
(e) The central bank is paying high interest rates on reserves

9. Which of the following best explains why the IS curve in the IS-LM model has a
negative slope

O
(a) Higher interest rates leads to a higher cost of borrowing for firms, which leads to
less investment and lower output.
(b) Higher interest rates lead to lower demand for money, which decreases spending
and output.
(c) Higher interest rates create higher borrowing costs for the government, which
decreases government spending and output.
(d) Higher interest rates lead to less demand for domestic assets, which causes money
to flow out of the country and decreases output.
(e) Higher output causes a larger supply of saving, which causes interest rates to fall.

4
10. An economy can be described by the following supply and demand equations
St = 200pet
Dt = 12, 000 400pt
Assume that p0 = 10. If firms in the economy form expectations using the rule pet =
pt 1 , what will be p2 ?
(a) 12.5
g(b)
(c)
17.5
20
(d) 25
(e) None of these
11. Given the same setup as the previous question, what is the rational expectations price?
(a) 15
g
(b) 20
(c) 25
(d) 30
(e) None of these
12. Assume an economy can be described by an expectations augmented Phillips curve and
people form expectations adaptively. A surge in government spending causes inflation
to rise. Which of the following would be most likely to occur
(a) No change in unemployment initially. Over time, inflation expectations would
rise, which would cause the unemployment rate to fall.
(b) Unemployment would rise initially. Over time, inflation expectations would fall,
causing unemployment to decrease back to to its original level
O
(c) Unemployment would fall initially. Over time, inflation expectations would rise,
causing unemployment to increase back to its original level.
(d) No change in unemployment initially. Over time, inflation expectations would
fall, which would cause the unemployment rate to rise.
(e) Unemployment will fall and remain low until inflation returns to its original level.
13. Which of the following kinds of economic models assumes that business cycles are
primarily driven by shocks to total factor productivity (TFP) and that government
intervention in the economy cannot help to restore full employment
(a) Classical model
(b) Keynesian models
(c) New Keynesian models
(d) Monetarist models
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(e) Real Business Cycle models

5
14. A US citizen exchanges $100 dollars for 100 Euros and uses the Euros to purchase
clothing from a European seller. If these are the only changes in the economy, this will
cause which of the following changes in the US balance of payments
(a) An increase in the current account and a decrease in the capital account
(b) An increase in the current account and an increase in the capital account
(c) A decrease in the current account and a decrease in the capital account

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(d) A decrease in the current account and an increase in the capital account
(e) A decrease in the current account and no change in the capital account
15. New developments in artificial intelligence cause a surge in foreign investment in Amer-
ican companies. According to our model of the foreign exchange market, how would
this impact exchange rates (in foreign currency per dollar units) in the US?

O
(a) Demand for dollars would increase and exchange rates would rise
(b) Demand for dollars would decrease and exchange rates would rise
(c) Demand for dollars would decrease and exchange rates would fall
(d) Demand for dollars would increase and exchange rates would fall
(e) No change in exchange rates
16. Which of the following best describes the relationship between the Federal Reserve and
the Federal Government in the United States
(a) The Federal Reserve and the Secretary of the Treasury work jointly to determine
fiscal and monetary policy
(b) Federal Reserve officials need direct approval from Congress and the President
before changing monetary policy
(c) The Federal Reserve chooses policy to maximize its own profit with no input from
the government

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(d) The government provides the Fed with a mandate and members of Fed’s Board
of Governor’s are nominated by the President and confirmed by the Senate, but
otherwise the Fed operates independently
(e) The Fed operates primarily independently, but its actions can be vetoed by the
president
17. Which of the following decades in the United States saw the highest average inflation
rates?
(a) The 1930s
(b) The 1950s
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(c) The 1970s
(d) The 1990s
(e) The 2010s

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18. Before 2008 the Fed was most likely to change interest rates to meet its target by
. After 2008, it is more likely to change interest rates by

(a) Changing the discount rate; Conducting open market operations

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(b) Conducting open market operations; Changing interest paid on reserve balances
(c) Changing reserve requirements; Conducting open market operations
(d) Conducting open market operations; Changing reserve requirements
(e) Changing interest paid on reserve balances; Conducting open market operations

19. Which of the following best describes the trend of real GDP following the Great Re-
cession and the Covid Recession?

(a) Real GDP did not return to its previous trend after either recession
(b) Real GDP returned to its previous trend after the Great Recession but not after
Covid

g
(c) Real GDP returned to its previous trend after Covid, but not after the Great
Recession
(d) Real GDP returned to its previous trend after both recessions

20. Which of the following is NOT true of the current US economy (as of March 2024)?

(a) Wages have on average increased faster than inflation since 2020
(b) The unemployment rate is roughly 4%

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(c) Consumer sentiment is at an all time high
(d) Inflation remains above the Federal Reserve’s target but is lower than a year ago
(e) All of these are true

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Open Response Questions
1. (75 Points) Assume a Solow model with production function given by F (K, L) =
AK 1/2 L1/2 . Assume the saving rate is 40% and the depreciation rate is 5%. Population
grows at 3% per year and technology (A) grows at 1% per year

(a) (25 points) If k̃0 = 100, what is k̃1 ? Draw a graph that shows how k̃ will change
over time from its initial value.

5 = c(w) = 26
=
2%

~
L
5)E
n4e
+
↑,
-

(1 F + m)+

*
(100) + (1 -
0 , 05) (100)
=
= 94 285
.

1 ,
05

100

-
-

K ------------

8
 (b) (25 points) Calculate the steady state value of capital per e↵ective worker, output
per e↵ective worker, and consumption per e↵ective worker. When the economy
is in steady state, what is the growth rate of output per worker and aggregate
output?

= (o) * ( =
=
/

it 16t =
4
j
=
=

(1 3)y (0 6)(4) 2 4
=
= .

c
- .

Output per
works =
y
=
(5) ( *)

constant so
In steady
state
, if is
y
rate as # which is I
at sure
grous
,

or 2 %

Outport y =
(y)(E)(c)
y at rate of F
so
grows growth +
growth
rate of L
,
which is 5+ M =
20 + 30 =
5%

9
 (c) (25 points) Policymakers are considering two policies that they hope will increase
consumption per e↵ective worker. One side wants to pass incentives to increase
the saving rate hoping to increase consumption by growing the economy. The
other side hopes to decrease the saving rate so that the economy consumes a
larger fraction of output. Using the Solow model, evaluate these two arguments.
Your answer should comment on how each policy a↵ects consumption in both the
short run and long run and it may be helpful to include two graphs to explain
your answer.

but
= Temporary
decrease in consumption
↑S
,

will increase
consumption
in the
long run

as

-
long as S40 5 .

----S

↓ S = Temporary increase in
consumption ,
but in

the consumption will decrease

long ran

level
belor its original
-

Optimal choice depends

on if Short wan

: long ran
or more

important
-

--------

t
10
 2. (75 Points) Assume that 2 consumers in an economy have utility function over con-
sumption in 2 periods given by

U (c1 , c2 ) = ln(c1 ) + ln(c2 )

Consumers are given an endowment of income in each period

y1A = 48, 000 y1B = 32, 000

y2A = 52, 000 y2B = 68, 000

(a) (25 points) Assume that consumers are not allowed to save or borrow and must
just consume their initial endowment of income. Which consumer has higher
utility in this scenario? Explain why. If consumers are allowed to borrow or save
at a fixed interest rate, which consumer would like to borrow more (or save less)?
Explain the intuition.

1 would like equal consumption

Since B =
,
consumers

across periods (Consumption Smoothing)

ideal the is so
is closer to this
A

A has higher utility

actual calculation
Confirming with

uA =
11(48 000),
+ 1n(52, 000)
=
h(48000)(52000
=
In (2 , 496, 000)

uB 1n(32 000)
=

,
+ 1(68, 000) =
1(32, 00 % (68 000,

1)2
=

,
176
,
000)

both would like to

Other things equal ,
consumers

more some income from period 2 to 1 (borrel

,
but B would like to borrow more since

income is less Smooth

11
 (b) (25 points) Calculate the equilibrium interest rate and consumption and saving
for each consumer (you do not need to write down the Lagrangian but you should
show all other steps in calculating the answer). Which consumer is a borrower
and which one is a saver in equilibrium? Explain the intuition.

MRS === G = 4,(( + )

y+ = y
+ =
2, =c =
+
B
y,
A A +
+ C
Clearing
=
C,
Market => , y ,

=> =
y, + y,

B
)
A
y + y 2(y g,
, , + =
+
,

= y+

=> ir
= 15
2000 5 74 our
C,
%= 24, 000 + =
41, 333 .

c, B = 16
, 000 + + = 38
,
666 5 ,

1 5 ,

cut =
(41 ,
333 .
51(1 5).
= ,000
62 C,
B =
(38 666 5) (1 5)
,
·

. = 58
,000

6666 5 SB 6666 5
St
= -

.
= .

and is is ,
borrower
A is a saver a

rf desire to
As both consumers increase sore .

close to smooth
Since A was already
rate will push
consumptio ,
the
higher the

B
before
to start soving

12
 (c) (25 points) The government decides to tax consumers in period 1 by taking 5,000
from each of their incomes. It will then pay the consumers back 5,000 each in
period 2. Calculate the new equilibrium interest rate and consumption and saving
for each consumer. Compare the interest rate and saving to the values in part
(b). How did they change? Explain the intuition.

000
3000 -
000 + 73,
- ,
1 8577 E85 .
7%
It
=
5 ,

43, 000 + 27 000 ,

57, 000
A 40
000
, + =
36 . 15
846
C, =
,
2 857)

2-
* =
(36 ,
847 .
3)(1 857) .
= 68 428 6
,
.

SA =
43, 000
-

36, 847 356153 .

. 8

B
C
=

12
000
,
+
, 000
123
,
= 33 153 C
2( 857)
.

2 ,
,

B=
C
= (39 ,
155 . 8) (1 857) .
= 61571 4 .

SB =
-

6153 .
8

in period I and
The reduced income
policy
both
This makes
increased it in period 2 .

wat to borrow more (gove less), which requires

consumers
to offset the
the interest rate to increase

demand for
burrencing
A sures L bit less and B barrows a

bit less the before

13
3. (75 Points) Assume an economy is described by the following equations:

C = 10, 000 + 0.5(Y T)

I = 15, 000
G = 12, 000
T = 8, 000

(a) (25 points) Calculate a Keynesian equilibrium for this economy. If government
spending increases by 3,000, how much does output increase? Does it increase by
more, less, or equal to the increase in G? Explain the intuition.

y = 2+I + 6

=> y =
10 , 000 + 0 . 5 (1 -

8, 000) + 15, 000 + 12, 000

=> , 5%
0
=
33 , 000

% 66, 000
=

64 by 3, 000 = 0 .
5% =
36, 000

=> y =
72, 000

Y much 6 The intial

increasestwice as as .

increase in 6 increases income, which increases

consumption , which further increases income

The total increase is 3000 (3) =

3000(2)

14
 (b) (25 points) Return to the initial level of government spending and now assume
that the investment curve changes to

I = 20, 000 500r

And that money supply and money demand are given by

M s = 320, 000

M d = 5Y 1000r
Calculate the new equilibrium output and interest rate. If the government spend-
ing again increases by 3,000, what happens to equilibrium output? Is the increase
in output more or less than in part (a)? Explain the intuition.

Is ! Y =
10 000 + 0 .
52/ -

8000) + 20, 000 -

500 + 12, 000

,

38 000
-

500r
6 5%
=
.

y 76, 000 1000

-

: Ms = md => 320 000 =

51 - 1000
Lm ,

=>
=
64 000 + 200r
,

000 + 2001
76
, 000 + 000r = 64,

=> 12001
=
12,000 = v =
10 =) y = 66,
000

16 by you => IS : % = 82
, 000
-

1000

82, 000 -

1000
=
64, 000 + 200r

1200r = 18 000
,
= =
15 = % = 67 00
,

I
Here only increases by 1, 000

↑ 6 Pr =& I so the decrease in I crowds

out some of the increase in G
15
 (c) (25 points) Again return to the original level of government spending. Now assume
the economy opens to trade and that Net Exports are described by the equation

N X = 38, 000 0.5Y 1000"

Assume the world interest rate is set at r⇤ = 10 and that there is perfect capital
mobility. Calculate the new equilibrium output, interest rate, and exchange rate.
Once again, assume government spending increases by 3,000 and compare the
increase in output to part (a). Explain the intuition.

IS : Y =
10, 000 + 0 . 5(1 -

8000) + 20000
-
500 + 12 000 + 38, 000
,

- 0 5%
,
-

100E

=> y =
71, 000
-

1000d

20008 66
, 000
64, 0004
=

From 2m :%
=

71, 000
-
1000472 =
5
66
=

, 000
inflor
in IS =) V > r = Capital
↑ G = Shift right
↑ E = UNX]) Shift left
for dollars =
"
=> demand in IS

~ Again
we have
crowding

·
out but now it occurs
,

through NX as the

exchange rate increases

IS
Y

16
 4. (75 points) Assume an IS-MP-PC model can be described by the following equations:

⇡t = ⇡t 1 + 0.5(yt 100)

yt = 100 2(it ⇡t 2)
it = 4 + 2(⇡t 2)

(Note that these equations are equivalent to the model described in class with ⇡ ⇤ = 2,
y ⇤ = 100, r⇤ = 2, ↵ = 2, = 0.5, ⇡ = 2, and ⇡te = ⇡t 1 )

(a) (25 points) Assume that inflation in period 1 was above the central bank’s target
and was equal to 4% (i.e. ⇡1 = 4). Calculate inflation, output, and interest rates
in periods 1 and 2.

Ni =
4 = i = 4 + 2(4 2) -

=
3 .
=
100
-

2(8 -

4 -

2) =
59

In period 2 =
) ? =
#
,
=
4

=> πz = 4 + 0 .
5(y2 100) -

3
Y2 =
100 -

2(i -

Tz -

2)
-
=> Ye -100 = -

2(4 + 2(π 2) -
-

nz
-

2)
in I
4 +
2(πz -
2) = -

2(πz -

2)
= - 2π +
4

#z =
4 + 0 ,
5( 2π +
4)
2 =

6 Eic =
4+ 2 =
6
y2
=
100 - 6 +4 =a

17
 (b) (25 points) Explain in words what happened in the economy to generate the
outcomes you found above. Your answer should explain intuitively how the central
bank responded to the high inflation and how that policy impacted inflation and
output in each period. If you were not able to calculate exact numerical results
in part (a), you can still get full credit for this question by getting the intuition
correct.

The central bank responds to inflation by increasing

I 2
nomical interest rates .
In period ,
with inflation

increased rates
the
percentage points above target ,

4
percentage points .

real interest rates

The increase in rate - Pushed up S

in output due to the IS

which caused a
drop
,
curve

output then caused inflation

The-tcrease
in full

to 3% doe to the Phillips Curve relationship.

In period 2 ,
the CB began to ease
policy and output

began to rise back to

potential

18
 (c) (25 points) Assume the central bank decided to change their monetary policy rule
to
it = 4 + 0.5(⇡t 2)
Explain how this would change the intuition you outlined in part (b). If the
central bank’s goal is to eventually restore inflation back to its target, would this
be an e↵ective policy change? Explain why or why not. You can calculate exact
numbers if it helps you answer the question, but you do not need any explicit
calculation to get full credit on this question.

4% inflation wate the CB would have

With the same ,

rates to 5%
only increased

i = 4+ 0 , 5(4 2)- = 5

The real interest rate in this case decreases

-

v
,
= i -
N, = 5 -

4 =
1
,

below potential ,
Rather than
felling output increases

above
potential
9,
= 100 -

2(5 -

4 -

2) = 102

This will the push inflation even higher next

period
and be able to contain inflation
the CB will never

19
(Extra Space)

20
(Extra Space)

21