Finance

Midterm 1 In-class Review Session Guideline: Questions and Answers

Your Graduate TA will go over the following assigned questions in class on Thursday 9/28. These questions are assigned 1 per chapter as practice problems. I append answers in this document for your convenience. However, I strongly recommend you attend the review session to ask any clarifying questions you may have.

Your TA may not get to solve all these in a single session. Please follow up during other review sessions and the office hours we have scheduled.

Recommended order of questions for the 9/28 in-class review session: 3,4,5,2,1.

On the day of the review, you do not have to sign with the attendance app.

Questions:

1. Chapter 2, Numerical Q.6

1. Chapter 3 Suppose the marginal product of labor in the economy is given by MPN = 200 - 0.5 N, while the supply of labor is 100 + 4w.

(a)        Find the market-clearing real wage rate.

(b)        What happens if the government imposes a minimum wage of 40? Is there involuntary unemployment?

(c)        What happens if the government imposes a minimum wage of 60? Is there involuntary unemployment?

1. Chapter 4, Numerical Q. 8

1. Chapter 5, Numerical Q. 5

1. Chapter 6 Consider the Solow growth model. A country has the per-worker production function

        yt = 5[pic 1],

where yt is output per worker and kt is the capital—labor ratio. The depreciation rate is 0.2 and the population growth rate is 0.05. The saving function is

        St = 0.2Yt,

where St is total national saving and Yt is total output.

(a)        What is the steady-state value of the capital—labor ratio?

(b)        What is the steady-state value of output per worker?

(c)        What is the steady-state value of consumption per worker?

Answers:

1. Chapter 2, Numerical Q.6

(a)        Nominal GDP is just the dollar value of production in a year at prices in that year. Nominal GDP is $56 thousand in the base year and $200 thousand in the current year. Nominal GDP grew 257% between the base year and the current year: [($200,000/$56,000) − 1] × 100% = 257%.

(b)        Real GDP is calculated by finding the value of production in each year at base-year prices.
Thus, from the table above, real GDP is $56,000 in the base year and $178,000 in the current year. In percentage terms, real GDP increases from the base year to the current year by

[($178,000/$56,000) − 1] × 100% = 218%.

(c)        The GDP deflator is the ratio of nominal GDP to real GDP. In the base year, nominal GDP equals real GDP, so the GDP deflator is 1. In the current year, the GDP deflator is $200,000/$178,000 = 1.124. Thus, the GDP deflator changes by [(1.124/1) − 1] × 100% = 12.4% from the base year to the current year.

(d)        Nominal GDP rose 257%, prices rose 12.4%, and real GDP rose 218%, so most of the increase
in nominal GDP is because of the increase in real output, not prices. Notice that the quantity of oranges quadrupled and the quantity of bananas more than doubled.

1. Chapter 3 Suppose the marginal product of labor in the economy is given by MPN = 200 - 0.5 N, while the supply of labor is 100 + 4w.

1. Find the market-clearing real wage rate.

1. What happens if the government imposes a minimum wage of 40? Is there involuntary unemployment?

(c)        What happens if the government imposes a minimum wage of 60? Is there involuntary unemployment?

Answer:

1. The market-clearing real wage rate equates the demand and supply of labor. Setting w = MPN = 200 - 0.5 N and solving for N gives N = 400 - 2w, which represents labor demand. Equating labor demand to labor supply gives 400 - 2w = 100 + 4w, or 300 = 6w, or w = 50.

1. A minimum wage of 40 has no effect, as it is below the market wage, so involuntary unemployment is 0.

1. A minimum wage of 60 is binding, as it is above the market wage. At w = 60, labor demand is 400 - (2 × 60) = 280, while labor supply is 100 + (4 × 60) = 340. So unemployment is 60 workers.

1. Chapter 4, Numerical Q. 8

                (a)        PVLR = y + [yf/(1 + r)] + a

= 90 + (110/1.10) + 20

= 210.

(b)        c + [cf / (1 + r)] = PVLR.

c + (cf / 1.10) = 210.

When c = 0, cf = 231; this is the vertical intercept of the budget line, shown in Figure 4.4.
When cf = 0, c = 210; this is the horizontal intercept of the budget line.

[pic 2]

Figure 4.4

(c)        c = cf: c + (c/1.10) = 210.

1.10c + c = 210 × 1.10.

2.1c = 231.

c = 110.

s = y − c

= 90 − 110

= −20.

(d)        y increases by 11, so new PVLR = 221.

2.1c = 221 × 1.1 = 243.1.

c = 115.76.

s = y − c = 101 − 115.76 = − 14.76.

So part of the temporary increase in income is consumed and part is saved.

(e)        yf increases by 11, so PVLR rises by 11/1.10 = 10. New PVLR = 220.