_________________ __________________

LAST NAME FIRST NAME

PRACTICE Midterm
(Answer Key)
GLEC
SUMMER 2014
Prof. Max Croce
Important Notes:
You are allowed 2 ours to !omplete tis e"am#
All of your a!"er! #u!$ %e &ro'()e) ( $*e !&ace allo$$e) %elo" eac* +ue!$(o. Ay$*(, ou$!()e
$*(! "(ll o$ %e ,ra)e). I all ca!e! $*e !&ace &ro'()e) (! !uff(c(e$ for a &erfec$ !core.
In$ormation tat is in!orre!t or not pertinent to te %uestion will result in a redu!ed s!ore#
-ou #ay u!e ou$!()e &u%l(!*e) #a$er(al a! "ell a! cla!! o$e! $o a!!(!$ you ( your a!"er!. -ou
are o$ allo"e) a!!(!$ace fro# ay ()('()ual.!/.
P(c0 $*e 1%e!$2 !(,le a!"er $o $*e #ul$(&le c*o(ce +ue!$(o!.
Noe of $*e +ue!$(o! are )e!(,e) $o $r(c0 you. 3o"e'er !o#e of $*e +ue!$(o! you *a'e !ee
%efore4 %u$ "($* (#&or$a$ )e$a(l! $*a$ are )(ffere$55!o )o o$ 6u!$ &u$ )o" fa#(l(ar a!"er!7
-our exa# !*oul) *a'e 888 u#%ere) &a,e!.
G99: LUC;7
3oor Co)e A,ree#e$<
I &le),e $o e($*er ,('e4 or rece('e4 uau$*or(=e) a() for $*(! exa# ___________________
!(,a$ure
1
PARTI: M&'TIP'E C()ICE (*+ points, * points $or ea! %uestion)#
Put answers on te $ront pa-e.
1. T*e CPI ()ex<
A. I! u!ually *(,*ly correla$e) "($* $*e G:P )efla$or
>. Mea!ure! $*e &r(ce of a co!u#&$(o %a!0e$? $*e G:P )efla$or4 (!$ea)4 #ea!ure! $*e co!$ of a
%a!0e$ of locally &ro)uce) ,oo)!
C. I! !e!($('e $o $*e *(,* 'ola$(l($y of $*e &r(ce of foo) a) eer,y
:. All o$ te a/o0e
2. Loo0(, a$ $*e co#&o!($(o of G:P ( $*e la!$ @0 year!4 "e ca cla(# $*a$<
A. 1ot in India and te &2 te !onsumption sare as /een !on0er-in- to a/out 3+4
>. T*e ('e!$#e$ !*are *a! a &o!($('e $re) ( I)(a a) e,a$('e $re) ( $*e US
C. >o$* US a) I)(a are e$ ex&or$er!4 a) $*e(r ex&or$! re&re!e$ a lar,e !*are of G:P
:. T*e ,o'er#e$ ex&e)($ure !*are *a! )ecl(e) %o$* ( I)(a a) $*e US
A. B*e a cou$ry %eco#e! r(c*er<
A. T*e )e#a) cur'e of la%or !*(f$! $o $*e r(,*$ .(.e.4 ($ ex&a)!/ %ecau!e #ore "eal$* al"ay!
(#&l(e! *(,*er &ro)uc$('($y
>. T*e )e#a) cur'e of la%or !*(f$! $o $*e lef$ .(.e.4 ($ co$rac$!/ %ecau!e #ore "eal$* al"ay!
(#&l(e! lo"er &ro)uc$('($y
C. Te supply !ur0e o$ la/or si$ts to te le$t (i#e#, it !ontra!ts) /e!ause o$ in!ome e$$e!t:
people re%uire i-er wa-es as teir opportunity !ost o$ leisure is i-er
:. T*e !u&&ly cur'e of la%or !*(f$! $o $*e r(,*$ .(.e.4 ($ ex&a)!/ %ecau!e of !u%!$($u$(o effec$!<
&eo&le feel r(c*er a) "a$ $o "or0 #ore
4. T*e !0(ll &re#(u#<
A. Refer! $o $*e fac$ $*a$ *(,*er5!0(ll "or0er! ear *(,*er "a,e! &er *our $*a lo"er5!0(ll "or0er!
a) (! a f(r!$5or)er )e$er#(a$ of (e+ual($y
>. I $*e US ($ *a! (crea!e) !u%!$a$(ally ( $*e la!$ 40 year!? ( I)(a ($ *a! (crea!e)
!u%!$a$(ally ( $*e la!$ 2@ year!
C. I! a ,lo%al &*eo#eo "*(c* ecoo#(!$! ex&la( $*rou,* $*e $ec*olo,y !*(f$ occurre) "($*
$*e IT re'olu$(o
:. All o$ te a/o0e
@. T*e )e!(re) ('e!$#e$ le'el<
A. (crea!e! "*e e($*er $*e real ra$e ( $*e ecoo#y or $*e &r(ce of e+u(&#e$ (crea!e
>. )ecrea!e! (f ex&ec$e) &ro)uc$('($y (crea!e!
C. (crea!e! (f $*e Effec$('e Tax Ra$e (crea!e!
5# none o$ te a/o0e#
C. T*e curre$ e,a$('e Ne$5Ex&or$! .ND/ ( I)(a<
A. I#&l(e! $*a$ $*e re!$ of $*e "orl) .$a0e $o,e$*er/ *a! e,a$('e ND
2
>. I! *(!$or(cally $*e lar,e!$ co#&oe$ of G:P
C. Ma6es domesti! in0estment -reater tan domesti! sa0in-s
:. oe of $*e a%o'e
E. B*(c* oe of $*e follo"(, !$a$e#e$! (! $rueF
A. T*e $o$al !u&&ly of #oey (! !#aller $*a $*e currecy %a!e.
1# 1an6s !an alter te total supply o$ money trou- teir lendin-7/orrowin- a!ti0ity
C. A ce$ral %a0 ca co$rol $*e $o$al !u&&ly of #oey "($*ou$ car(, $oo #uc* a%ou$ &r('a$e
%a0!G ac$('($y4 e!&ec(ally )ur(, cre)($ cr(!e!.
:. >era0e ca )(rec$ly $a0e o'er &r('a$e %a0!.
H. U!(, our !(#&le #o)el of $*e #oey #ar0e$ !u&&o!e $"o $*(,! *a&&e<
(. T*e #oe$ary au$*or($(e! )ecrea!e $*e #oey !u&&ly4 a)
((. Pr('a$e %a0! (crea!e $*e(r re!er'e!.
;ee&(, e'ery$*(, el!e co!$a$4 $*e e+u(l(%r(u# ($ere!$ ra$e .R/ "(ll
A# In!rease#
>. :ecrea!e.
C. Icrea!e a! lo, a! $*e c*a,e ( $*e #oey !u&&ly (! ,rea$er $*a $*e c*a,e ( I.
:. :ecrea!e a! lo, a! $*e c*a,e ( $*e #oey !u&&ly (! ,rea$er $*a $*e c*a,e ( I.
E. I$ (! o$ &o!!(%le $o )e$er#(e "($* $*e a'a(la%le (for#a$(o.
I. A f(r# &ro)uce! AC u($! for 100M of INR %u$ )oe! o$ !ell $*e# r(,*$ a"ay. T*e u($! are !$ore)
( $*e co#&ay )e&o$. Accor)(, $o a$(oal accou$(,<
A. G:P (crea!e! %ecau!e co!u#&$(o of )ura%le ,oo)! (crea!e!
>. G:P (crea!e! %ecau!e $*ere (! a &o!($('e c*a,e ( ('e$or(e! a) *ece ( co!u#&$(o
C# 85P in!reases /e!ause tere is a positi0e !an-e in in0entories and en!e in in0estment
:. Noe of $*e a%o'e
10. Accor)(, $o $*e ar$(cle 13o" $*e US Lo!$ 9u$ o (P*oe Bor02 fro# T*e Ne" -or0 T(#e!<
JJI$ (!G$ 6u!$ $*a$ "or0er! are c*ea&er a%roa). Ra$*er4 A&&leG! %el(e'e $*e 'a!$ !cale of
o'er!ea! fac$or(e! a! "ell a! $*e flex(%(l($y4 )(l(,ece a) ()u!$r(al !0(ll! of fore(,
"or0er! *a'e !o ou$&lace) $*e(r A#er(ca cou$er&ar$! $*a$ 1Ma)e ( USA2 (! o
lo,er a '(a%le o&$(o for #o!$ A&&le &ro)uc$!GG
T*(! ar$(cle<
A. Co$ra)(c$! $*e coce&$ of ($era$(oal co#&e$($('e a)'a$a,e!
>. (#&l(e! $*a$ $*ere (! co!e!u! o $*e !u%!$a$(al "ea0e!! of elec$ro(c! #aufac$ur(, ( A!(a
C. Refer! $o $*e %roa)er $*e#e of ($era$(oal #oe$ary &ol(cy
:. None o$ te A/o0e
Answers: _599 9A99 99C9 9599 9599 9C99 9199 9A99 9C99 9599
:uestion: 1 2 A 4 @ C E H I 10
A
PART II: 'A1)R MARKET (;+ points total)
T*e Economist ar$(cle 1La%our &a(!2 .Se& 21
!$
4 2000/ *a! a &a!!a,e !$a$(, $*a$
Economists have put forward [several] explanations for the increase in wage inequality: (1)
technological change (new technology); () increased imports from low!wage developing
economies; (") higher immigration of low!s#illed wor#ers$ most economists rec#on that new
technology is %y far the most important factor&
I $*e )a$a4 $*e e#&loy#e$ of *(,*5!0(lle) "or0er! *a! (crea!e)4 a! o&&o!e) $o $*e e#&loy#e$ of
lo"5!0(ll "or0er! $*a$ *a! )ecl(e). Al!o4 "a,e! for lo"5!0(lle) "or0er! *a'e )ecl(e)4 a) "a,e! for
*(,* !0(lle) "or0er! *a'e r(!e.
G('e $*(! )a$a4 "*a$ ar,u#e$! "oul) co'(ce ecoo#(!$! $*a$ e" $ec*olo,y (! $*e #o!$ (#&or$a$
fac$or ( ex&la((, a (crea!e "a,e (e+ual($yF B*a$ are $*e cou$erfac$ual (#&l(ca$(o! of $*e o$*er
$"o *y&o$*e!e!F
Answer:
Increased imports from low-wage developing countries would mean a decline in the demand for
low!s#illed la%or as production shifts to other countries& 'he #ey prediction in this case would %e a
decline in low!s#illed wages and a decline in the quantity of low!s#illed wor#ers in the wor#force&
'his hypothesis produces a s#ill premium and a decline in low!s#ill employment( %ut does not explain
the increase in wage and employment of high!s#ill wor#ers&
Higher immigration of low-skilled workers would manifest itself in an increase in the supply of low!
s#illed la%or& 'he #ey prediction in this case would %e a decline in low!s#illed wages and an increase
in the quantity of low!s#illed wor#ers in the wor#force&
4
La%or !u&&ly
La%or )e#a) Ba,e!
U!0(lle) La%or
La%or !u&&ly
La%or )e#a) Ba,e!
S0(lle) La%or
La%or !u&&ly
La%or )e#a) Ba,e!
U!0(lle) La%or
La%or !u&&ly
La%or )e#a) Ba,e!
S0(lle) La%or
'his is inconsistent with the data for two reasons: (1) employment of lower!s#ill wor#ers has declined;
() wages and employment of high!s#ill wor#ers has increased&
Technological change would shift demand away from low!s#illed la%or and toward high!s#illed la%or&
'he #ey prediction in this case would %e a decline in low!s#illed wages( an increase in high!s#illed
wages( a decrease in the quantity of low!s#illed wor#ers( and an increase in the quantity of high!s#illed
wor#ers&
'hus( of the three explanations offered( the technological change explanation uniquely suggests that
(i) the quantity of high!s#illed wor#ers rise( (ii) rising s#ill!premium results from %oth lower wages
for low!s#illed wor#ers and a rise in wages for high!s#ill wor#ers&
PART I<: M)NETARY P)'ICY (;+ points total)
A! a &ol(cy re!&o!e $o $*e rece$ f(ac(al cr(!(!4 $*e Fe) %ou,*$ %o)! a) al!o ra(!e) $*e ($ere!$ ra$e
($ offere) %a0! o re!er'e!.
.a/ 3o" )oe! $*(! &ol(cy affec$ $*e #oe$ary %a!eF Ex&la( carefully
'his policy should increase the monetary %ase& )hen the *E+ %uys %onds( effectively it
reduces the supply of %onds availa%le to private investors and in,ects liquidity %y paying with
cash& 'his is the essence of a monetary expansion: the *E+ expands the monetary %ase to
exchange illiquid assets with relatively more liquid ones (money)&
@
La%or !u&&ly
La%or )e#a) Ba,e!
U!0(lle) La%or
La%or !u&&ly
La%or )e#a) Ba,e!
S0(lle) La%or
.%/ 3o" #(,*$ !uc* a &ol(cy affec$ $*e !u&&ly of M2F
Recall M2 = M2 multiplier * Monetary Base . To understand the efects of this
policy on M2 we need to focus on both the monetary base and the multiplier. As
mentioned in the previous point the monetary base has increased. The multiplier
however has declined. The hi!her rates ofered on reserves in fact !ive a
stron!er incentive to ban"s to hold reserves. This increases li#uidity in the
economy but reduces the M2multiplier. $o for M2 supply to rise the monetary
base has to e%pand faster than the decline in the M2 multiplier.
(c) What is the likely impact on infation if banks continue to hold large reserves
with the central bank?
Accordin! to the #uantity theory of money if money supply !rows faster than
&'( )assumin! that the velocity chan!e is ne!li!ible* it is li"ely to lead to
in+ationary pressure in the lon! run. ,f ban"s continue to hold lar!e reserves with
the central ban" the M2 multiplier remains low and the overall !rowth of M2
declines possibly producin! de+ation.
-owever if the central ban" e%pands the monetary base .ust enou!h the !rowth
rate of the monetary base will be ali!ned with &'( !rowth preventin! de+ation
and "eepin! in+ation ris" at a moderate level.
C
2!rat! 2eet
Tis pa-e as /een le$t intentionally /lan6 = Notin- on tis pa-e will /e -raded.
E