Prof. Ashenmiller: Economics 101: Exam 3 Sample Questions Be clear and concise. Write in complete sentences, both in English and in math. Show all of your work when possible, fully label your graphs, and be sure to answer all of the questions. 1. a) What is the difference between nominal GDP and real GDP? If we are using GDP to measure the economic well-being of a country over time, which of these should we look at? Nominal GDP measures the final value of current goods and services at current prices. Real GDP measures the final value of goods and services at constant prices. Over time we should look at real GDP. b) Over time people have come to rely more on market-produced goods and less on goods that they produce for themselves. Give an example of this and explain how this phenomenon would affect GDP. The final value of market-produced goods is higher than the final value of goods that have a lot of labor adding value in the home. This would result in a higher GDP, but might not reflect a higher quality of life. c) In the graphs below start with the market for loanable funds in equilibrium. Clearly label all of your graphs. d) Suppose the government goes from a surplus to a deficit. Show the effect in the graph and clearly mark the effect on the new equilibrium interest rate and level of investment. This would be the supply curve moving to the left from the dotted S’ to the S. The interest rate would increase and the quantity of loanable funds would decrease. Supply Interest Rate Demand . . . Supply Supply' . Demand Supply' . . Loanable Funds 2. a) Why don’t banks hold 100% reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates? If banks hold 100% reserves then they cannot lend money and increase the money supply. The less banks hold in reserve the higher the money multiplier. b) Why can’t the Fed control the money supply perfectly? What are two things that the Fed can not control? The Fed can not make people put their money in the bank. The Fed can not control who the bank lends money to. c) What are the three policy tools that the Federal Reserve can use to increase the money supply? Open market operations – buy bonds Reserve Ratio – decrease Discount Rate - decrease d) List the three major problems in using the CPI as a measure of the cost of living. Substitution Bias Increased quality of goods not reflected in a price change Introduction of new goods 3. Use the table below to answer the following two questions. year 2000 2001 peaches $11 per bushel $9 per bushel pecans $6 per bushel $10 per bushel Suppose that the typical consumer basket consists of 10 bushels of peaches and 15 bushels of pecans and that the base year is 2000. a) Compute the cost of the basket of goods in each year. (11*10)+(6*15) = $200 (9*10)+(10*15) = $240 b) What is the consumer price index for 2001? (240/200)*100 = 120 c) What was the inflation rate in 2001? (120-100)/100 = 20% 4. Residents of the town of Los Locos (population 900) like to drive noisy off-road vehicles, but they hate the disturbance and dust caused by each others' vehicles. Each vehicle that is purchased causes $15 worth of damage to each of the 900 residents. There are 300 residents who are willing to pay up to $19,000 for an off-road vehicle. There are 200 residents who are willing to pay up to $11,000 for an off-road vehicle and there are 400 residents who are willing to pay up to $3,000 for an off-road vehicle. The price of off-road vehicles is $5,000. a) In the absence of any governmental interference, how many residents of Los Locos would buy off-road vehicles and which buyer values do they include? BV’s $19,000 and $11,000 Q=500 b) How many people in Los Locos would be better off if off-road vehicles were outlawed and which buyer values do they include? $11,000 and $3,000 or 600 people as they would both have negative buyer’s profit c) Suppose that the town of Los Locos want to impose a Pigouvian tax on off-road vehicles. This is a tax equal to the total environmental damage caused by each off-road vehicle to the town. How much would the tax per off-road vehicle be? ($15)*(900)= $13,500 d) With the Pigouvian tax in place the town distributes the revenues collected from the tax equally among all residents of Los Locos. In the presence of the tax, what is the total environmental damage to each resident and how big is the subsidy distributed by the government to each resident? Pollution damages = (300)*($15) = $4,500 Tax Rebate = [(300)*(13,500)]/(900) = $4,500 5. The country of Tigertown produces two goods: footballs and basketballs. Below is a table showing prices and quantities of output for three years: Year 2002 2003 2004 Price of Footballs $10 12 14 Quantity of Footballs 120 200 180 Price of Basketballs $12 15 18 Quantity of Basketballs 200 300 275 (a) Compute nominal GDP for each year. (6) Nominal GDP in Year 1 = ($10 × 120) + ($12 × 200) = $3,600 Nominal GDP in Year 2 = ($12 × 200) + ($15 × 300) = $6,900 Nominal GDP in Year 3 = ($14 × 180) + ($18 × 275) = $7,470 (b) Compute Real GDP for each year using 2002 as the base year. (6) Using Year 1 as the Base Year: Real GDP in Year 1 = ($10 × 120) + ($12 × 200) = $3,600 Real GDP in Year 2 = ($10 × 200) + ($12 × 300) = $5,600 Real GDP in Year 3 = ($10 × 180) + ($12 × 275) = $5,100 (c) Compute the GDP deflator for each year. GDP deflator for Year 1 = ($3,600/$3,600) × 100 = 1 × 100 = 100 GDP deflator for Year 2 = ($6,900/$5,600) × 100 = 1.2321 × 100 = 123.21 GDP deflator for Year 3 = ($7,470/$5,100) × 100 = 1.4647 × 100 = 146.47 (d) What is the change in the price level between 2002 and 2003? ((146-123)/123)*100= 18.7% 6. Give one or two sentence answers to each of the following parts of this question. (a) Give an example of a common resource. What are the characteristics of the good that make it a common resource? Be sure to explain yourself clearly. A common resource is both rival and non-excludable, like fish in the ocean. They are rival because if you catch one someone else can not catch that fish and non-excludable because it is hard to keep anyone from catching fish in the ocean. (b) Suppose that technology has increased the quality of a good available at a given price over time. How accurate will the CPI be as an estimate of the change in the cost of living in this situation? If there is a bias explain the direction of the bias. If the quality of the good has increased but the price has stayed constant then the CPI will overestimate the change in the cost of living. (c) Over time people have come to rely more on market-produced goods and less on goods that they produce for themselves. For example people eat at restaurants relatively more and prepare their own meals at home relatively less. How does this change affect GDP? The final value of market-produced goods is higher than the final value of goods that have a lot of labor adding value in the home. This would result in a higher GDP, but might not reflect a higher quality of life. (d) If the price of the “candy basket” in the base period of the CPI experiment cost $0.50 and the price of the candy basket in period 1 was $0.75. Calculate the CPI in the base period? Calculate the CPI in period 1? Calculate the inflation rate between the base period and period 1? (5) CPI=[.75/.5]*100 = 150 Inflation=[(150-100)/100]*100= 50% (e) GDP is equal to public savings plus private savings. Write the equation that defines GDP in this way and be sure to define each of the variables (for example: Y = GDP). (5) Y = C+I+G+NX NX=0 Y=C+I+G I=Y-C-G I=S S=(Y-C-T)+(T-G) S=private savings + public savings