Midterm #2 from previous terms
This is the second midterm from Prof. Olney's Fall 2017
offering of Economics 1. The exam was written as a
50 minute exam but administered over 80 minutes.
Question 1 (12 points; 6 minutes)
Suppose the economy can be described by the following equations
(all values are billions of dollars per year)
C = 900 +
0.6YD G =
800 EX =
200 TR = 100
I = 300
IM =
300 TA = 600
What is the equilibrium level of output and income? Show
all your work or you will receive zero (0) points on this
question. If you cannot solve this problem without a
calculator, set it up and go as far as you can to receive as
much partial credit as possible. No calculators allowed
during the exam.
Question 2 (15 points, 8 minutes)
A) (5 points) Provide an example of an
activity that would be recorded in both C and IM in the U.S.
expenditure accounts. Your example should have $ values
associated with it. What $ amount would be recorded in C?
What $ amount would be recorded in IM?
B) (5 points) Is the U.S. economy
currently in an unemployment equilibrium? Defend your
answer.
C) (5 points) Real GDP is tightly linked to
(that is, correlated with) employment. Explain why nominal GDP
is not tightly linked to employment.
Question 3 (20 points total; 10 minutes total)
Part b of this question is based on two articles:
• #10b, “Economic Growth in the United States:
A Tale of Two Countries,” by Thomas Piketty, Emmanuel Saez, and
Gabriel Zucman. Washington Center for Equitable Growth blog,
December 6, 2016.
• #18, “Wealth Inequality and the
Marginal Propensity to Consume,” by Nick Bunker, Washington
Center for Equitable Growth, December 17, 2014.
A) (10 points) A cut in taxes boosts
disposable income, leading households to increase consumer
spending. Explain why the total increase in GDP should be larger
than the initial increase in consumer spending triggered by a
tax cut. Be clear and be complete. Simply mentioning
the name of a concept is insufficient.
B) (10 points) Suppose that the top 1 percent
income earners studied in the work by Piketty, Saez, and Zucman
(shorthand “PSZ,” #10b) have much greater wealth than the bottom
50 percent studied by PSZ. Over the period 1962-2014, what
were the patterns of the share of income accruing to the bottom
50 percent and the top 1 percent of income earners? Based on the
findings in the Bunker article (#18), what is the effect of
those patterns shown in PSZ on the size of the multiplier over
the period 1962-2014? Explain your answer. (Your answer should
make it clear that you read the articles.)
Question 4 (25 points total; 13 minutes total)
Inspired by
https://ww2.kqed.org/news/2017/10/30/is-a-hollywood-tax-credit-still-needed-to-protect-industry-jobs/
Consider the activity “filming a movie or TV series.” Hollywood
film studios employ a large number of people when they make a
movie or shoot a television series. Although the studios have
their headquarters in Hollywood, CA, they can choose where to do
the filming – in California or elsewhere. Starting in
2014, the state of California offered large subsidies to film
studios that chose to do their filming in California rather than
elsewhere.
A) (4 points) Give and defend one example of a
positive externality associated with filming a movie or TV
series in California.
B) (5 points) Is filming a movie or TV series
a situation in which the Coase Theorem applies? Defend
your answer.
C) (10 points) California pays subsidies
of $330 million annually to Hollywood film studios who choose to
film in California. Draw graphs that illustrate the positive
externality associated with filming in California and,
separately, the effect of the subsidy. The quantity is the
number of movies or TV episodes filmed in CA per year.
D) (6 points) State legislators have to decide
soon whether to extend the subsidy program beyond its expiration
in 2020. What do they need to know in order to determine if the
subsidy is the optimal size? Explain.
Question 5 (16 points; 8 minutes)
A) (8 points) Why does a decrease in interest
rates typically lead to an increase in investment spending? In
your answer, be sure to distinguish between the interest rate(s)
that are relevant for firms using internal finance versus the
interest rate(s) that are relevant for firms using external
finance.
B) (8 points) The expected rate of return on a
potential investment project is 2 percent. That 2 percent is a
mean (or, average) of a distribution of possible returns ranging
from -1 to +3 percent. If the business owners are loss averse,
will a drop in interest rates from 2.5 to 1.5 percent
necessarily lead to an increase in investment spending? Explain
your answer. (Your explanation should make it clear to your GSI
that you know what it means to be “loss averse.”)
Question 6 (12 points total; 6 minutes total)
A) (6 points) At the right, draw a graph that
shows a monopolistically competitive firm in long run
equilibrium.
B) (6 points) For a monopoly, profit can be
greater than zero in the long run. Explain why profit is equal
to zero in the long run for a monopolistically competitive firm
but not for a monopolist.
This is the second midterm from Prof. Olney's Fall 2016
offering of Economics 1. The exam was written as a
50 minute exam but administered over 80 minutes.
Question 1 (15 points; 8 minutes)
Suppose the economy can be described by the following equations
(all values are billions of dollars per month)
C = 180 +
0.4YD EX = 200 TR = 400
I = 100
IM = 100 TA = 600
G = 300
What is the equilibrium level of output and income? Show
all your work or you will receive zero (0) points on this
question. If you cannot solve this problem without a
calculator, set it up and go as far as you can to receive as
much partial credit as possible. No calculators allowed
during the exam.
Question 2 (6 points, 3 minutes)
Where are each of the following activities recorded in the U.S.
GDP expenditure accounts? (Possible answers: C, I, G, EX,
IM, or not recorded) Defend your answers. (And then
choose a mix of two)
A California resident buys a copy of today’s New
York Times
A small business in California buys a copy of today’s New York
Times
The Berkeley Public Library buys a copy of today’s New York
Times
An international student attending UC Berkeley buys a copy of
today’s New York Times
Question 3 (17 points total; 9 minutes total)
During World War II, the U.S. federal government increased its
purchases of good and services from $6.5 billion in 1940 to
almost $100 billion in 1944. GDP in 1940 was $101 billion, so
you can see what an enormous increase in G this was.
a) (10 points) Explain why the total increase
in GDP should be larger than the initial increase in government
spending. Be clear and be complete. Simply
mentioning the name of a concept is insufficient.
b) (7 points) During World War II, U.S.
consumers faced “consumer rationing.” Consumers were not
allowed to purchase cars and appliances. Consumers could
purchase other items such as sugar, flour, and meat, only in
limited amounts. Explain why the change in GDP from each
additional $1 billion in government spending is smaller when
there is rationing during World War II than when there is no
rationing after the war.
Question 4 (20 points total; 10 minutes total)
An oil or gas pipeline laid across land creates the risk of
environmental damage from leaks or explosion and fire (such as
the explosion in Alabama on October 31). A large private oil
company wants to construct a pipeline across land in the upper
midwest of the United States. Thousands of people who live near
the proposed pipeline are opposed to its construction and want
construction stopped.
a) (6 points) Is this a situation in
which the Coase Theorem applies? Why or why not?
b) (14 points) Two proposals have been offered
to address the concerns of people opposed to the pipeline
construction.
• Proposal 1: Make the oil
company pay a penalty now to offset the expected costs of future
leaks or other environmental damage
• Proposal 2: Stop
construction of the pipeline
Under what conditions would proposal 1 generate the socially
optimal quantity of pipeline construction? Is there a situation
in which proposal 2 would generate the socially optimal quantity
of pipeline construction? Explain your answers. Draw
a graph at the right that demonstrates a situation in which
proposal 2 is optimal.
Question 5 (10 points; 5 minutes)
Under the Affordable Care Act (also known as Obamacare),
everyone is required to do one of two things:
• Have health insurance
coverage
• Pay a penalty for not
being insured. The minimum penalty for 2017 is $695
The population can be divided into two groups of people: [1]
healthy people under the age of 30 and [2] everyone else,
including the unhealthy people. If healthy people under
the age of 30 choose to pay the penalty rather than buy
insurance, use asymmetric information concepts to explain what
will happen in health insurance markets over time.
Question 6 (6 points; 3 minutes)
Based on the article “The Problem with Poor Countries’ GDP,” by
Bill Gates, Project Syndicate, May 6, 2013, discuss why
household surveys would provide better information than official
GDP statistics for policy makers working in very poor countries.
Question 7 (10 points; 5 minutes)
This graph shows actual real GDP
(dashed line) for the U.S. and the Congressional Budget Office
(CBO) estimate of potential real GDP (solid line). The CBO
estimate is the official estimate of what the U.S. economy could
produce at full employment. Based on the graph, in what
time periods was the U.S. economy operating on its production
possibilities frontier? Is the U.S. economy currently in
an unemployment equilibrium? Defend your answers.
Question 8 (16 points total; 8 minutes total)
The restaurant industry can be described as monopolistically
competitive.
a) (6 points) Draw a graph that depicts a
typical restaurant in the restaurant industry in long run
equilibrium.
b) (10 points) When the economy entered the
Great Recession, job losses and income cuts lowered the demand
for restaurant meals. What is the effect on the typical
restaurant in the short run? In the long run?
Explain your answers.
This is the second midterm from Prof. Olney's Fall 2015
offering of Economics 1. The exam was written as a
50 minute exam.
Question 1 (15 points; 7 minutes)
Suppose the economy can be described by the following equations
(all values are billions of dollars per year):
C = 2,800 +
0.4YD EX = 3,000
TR =
1,000
I =
2,000
IM = 1,000 +
0.1Y TA = 3,000
G = 1,000
What is the equilibrium level of output and income? Show
all your work or you will receive zero (0) points on this
question. If you cannot solve this problem without a
calculator, set it up and go as far as you can to receive as
much partial credit as possible. No calculators allowed
during the exam.
Question 2 (5 points, 2 minutes)
Where is the following activity recorded in the U.S. GDP
expenditure accounts? (Possible answers: C, I, G, EX, IM,
or not recorded) Defend your answer.
Google pays $200,000 per month to a bus company that will drive
Google employees to and from work
Question 3 (10 points; 4 minutes)
Many economists think the U.S. economy is at full employment
whenever the unemployment rate is 5 percent or lower. The
unemployment rate for October 2015, announced Friday morning,
was 5.0 percent.
a. (4 points) Are we in an “unemployment
equilibrium”? Explain.
b. (6 points) Referring to article #16
(“Yellen's Philosophy: The More Jobs Data, the Better”), what
are 2 other items of jobs data you could gather to determine
whether the U.S. economy is on or inside of its production
possibilities frontier (PPF)? For each item, what
information does it provide about the economy?
Question 4 (10 points, 4 minutes)
a. (4 points) Why can’t monopolistically
competitive firms earn economic profit in the long run?
b. (6 points) Why is the adjustment to
long run equilibrium shown as a shift of demand in monopolistic
competition but as a shift of supply in perfect competition?
Question 5 (35 points; 16 minutes) In Fall 2008, interest rates
in the U.S. were decreased.
a) (6 points) How should investment spending
have reacted to the Fall 2008 drop in interest rates?
Explain why.
b) (7 points) In Fall 2008, the economy was
collapsing rapidly and most people were surprised and
confused. Business uncertainty rose dramatically.
With reference to article #20 in the reader (“Holding on for
Tomorrow: How Economic Uncertainty Dulls Investment,” explain
why a rise in uncertainty affects investment spending.
c) (12 points) Assuming only U.S. interest
rates were decreased in Fall 2008, how should net exports (EX -
IM) have reacted to the drop in interest rates? Explain
why.
d) (10 points) Explain why the total change in
real GDP would be larger than the initial change in investment +
the initial change in net exports.
Question 6 (10 points; 4 minutes)
According to the study by Chris Carroll et al cited in article
#17a by Nick Bunker (“Wealth Inequality and the Marginal
Propensity to Consume”) middle-income families have a larger mpc
than do wealth families. In which case below would the
multiplier be larger? Explain why.
• (Today) When the wealthy
owners of consumer goods companies are paid 300 times as much as
the typical worker in their companies, as is true today, or
• (50 years ago) When the
wealthy owners of consumer goods companies are paid 20 times as
much as the typical worker in their companies, as was true fifty
years ago
Question 7 (15 points, 7 minutes)
San Franciscans who work at tech companies such as Google and
Apple can ride to work for free on “tech shuttles” – large
luxury busses that seat 120 people.
• Fans of the shuttles note
that each 120-seat bus represents 120 fewer cars commuting on
the freeways, decreasing pollution and traffic
• Opponents of the shuttles
argue that the large busses allow tech workers to live far from
the office, promoting gentrification.
Tech companies pay the entire cost of providing the
shuttle. In addition, they also pay San Francisco a fee to
operate in The City.
Instead of being charged fees, should the tech shuttles be
subsidized by local government? Defend your answer, using
economic language. State any necessary assumptions
explicitly. Draw graph(s) as appropriate.
This is the second midterm from Prof. Olney's Fall 2014
offering of Economics 1. The exam was written as a
50 minute exam.
1. (15 points total; 7 minutes total; 5
points per graph) For each of the three graphs below,
provide (a) a title for the graph; (b) 1 sentence that describes
current values in historical perspective; (c) 1 sentence that
describes any pre-2007 feature of the graph.
2. (15 points total; 7 minutes total) Based on
the reader articles #11a, “Striking it Richer: The Evolution of
Top Incomes in the United States,” by Emmanuel Saez, and
#11b.,“Treating Inequality with Redistribution: Is the Cure
Worse than the Disease?,” by Jonathan D. Ostry and Andrew Berg,
answer these questions.
a. (8 points) Describe any 2 aspects to the
pattern of income inequality in the United States. Your answer
should clearly indicate that you read and remembered the reader
article.
b. (7 points) The article (blog entry)
by Ostry & Berg is a summary of some of their
research. According to their work, do redistribution
policies lower economic growth? What are any two nuances
in their results?
3. (25 points total; 11 minutes total).
These quick questions are designed to take no more than 2
minutes each. Pace yourself! Don’t spend lots of
time on any one question.
a. (5 points) Where is the following activity
recorded in the U.S. GDP expenditure accounts? Defend your
answer.
• A California bookseller
sells $100 in new books produced in California to a professor
who is a resident of Japan.
• A California lawyer bills
a client from Seoul, South Korea $2,000 for legal services.
• A Berkeley restaurant
sells a $20 pizza to a family visiting from Sweden.
b. (5 points) When Prof. Olney buys $800 worth
of stock for her retirement fund, why isn’t that $800 purchase
recorded as consumption expenditure in U.S. GDP accounts?
c. (5 points) Why do most people think the
economy is still in bad shape when economists say “the economy
is now in the recovery phase”?
d. (5 points) Are all Econ 1 students out of
the labor force? Explain your answer.
e. (5 points) The CPI at the end of year 1 was
230. The CPI at the end of year 2 was 235. Set up
(but don’t simplify) the equation that calculates the inflation
rate.
4. (20 points total; 9 minutes total) Entire
Foods is a grocery store in a monopolistically competitive
industry.
a. (6 points) Entire Foods, like all grocery
stores, is initially in long-run equilibrium. At the
right, draw a graph that shows this initial condition. Use
subscripts “1” to label your points, curves, and areas.
b. (5 points) Entire Foods changes its
advertising campaign. Rather than advertise prices, its
new motto is “Values Matter.” (It doesn’t spend any
additional money; it just changes the focus.) The campaign
works! Some customers leave their usual grocery store and
start shopping at Entire Foods. Briefly explain why
and how the successful ad campaign affects Entire Foods prices,
quantity, and profit. On your graph, show these short-run
effect. Use subscripts “2” to label your points, curves, and
areas.
c. (5 points) What will happen in the grocery
store industry in the long run? What will happen to Entire
Foods prices, quantity, and profit in the long run? Why?
No graph is necessary.
d. (4 points) Suppose instead that Entire
Foods was a monopolist which implemented a successful
advertising campaign. Would your answer to part (c) still
be the same? Explain.
5. (10 points; 5 minutes)
As of October 25, health care workers returning to New York
after assisting Ebola patients in West Africa must be
quarantined for 21 days. When the quarantine policy was
announced, NY Governor Cuomo said “It's too serious a situation
to leave [avoiding contact with others] to the honor system of
compliance.” But critics of the quarantine policy “worry
that the new rules will discourage health care workers from
volunteering to fight the Ebola epidemic in West Africa.”
Is the quarantine the optimal policy? Reference both
statements above and use economic concepts in your answer.
No graph is necessary.
6. (15 points total; 7 minutes total)
Loans extended to homeowners who later defaulted (could not pay
back the loans) was a key contributor to the Great
Recession. Usually when a borrower defaults, the bank
loses money. But banking rules in 2007 allowed banks to sell the
loans to private investors, which meant the banks were not hurt
when borrowers defaulted.
a. (6 points) When the banks offered to lend
money to homeowners at very high interest rates, why did this
create adverse selection problems? Be clear.
b. (6 points) When the banks were allowed to
sell the loans to private investors, why did this create moral
hazard problems? Be clear.
c. (3 points) Should the banking rules require
the banks to have more “skin in the game” – that is, should the
banking rules require that the banks risk losing money if the
borrowers default? Defend your answer.