Econ 103 Mid

103 Midterm Answer (Fall 09)

Q1:
1a)
Economic growth occurs when a country chooses to allocate some of its resources to the production of capital goods, instead of consumption goods. This expands the resource base, allowing the country to produce more goods and services thus furthering economic growth. Economic growth can also occur when more productive technology is used. Technology makes the production process more efficient so more goods and services can be produced without increasing the amount of available resources.

The economic growth can be seen as an outward shift of the PPC as seen in the graph.

b) Vicious circle of poverty – A country is poor because it does not produce capital goods and it does not produce capital goods because it is poor. The country channels all its available resources to the production of consumption goods in order for the people to survive and have subsistence level of living.

Q2:
2. the shape of the AS curve is based on employment level and resource availability (1) horizontal part indicates a high level of unemployment because the resource of labor is available, employers can hire without increasing wages. This cause GDP to increase without an increase in price (2) upward slop is a strain on resources that are now not as commonly available. Firms can still increase production but not without increasing price. Both GDP and price increase. (3) vertical part represents full employment. There are no more resources available to increase production. So GDP remains constant. Inflation occurs because firms increase prices without increasing GDP.

Q4:
4) The following example on how consumers and producers behave will illustrate what happens when S> Ii. Suppose autonomous consumption is $60 and MPC is 0.8

Consumers Producers
Y=$900 Y=$900
Y=C+S Y=C+I
C=a+bY Ii = $100 (planned investment)
C= 60 + 0.8 (900)= $780 C=$800
S=120 Ia = $120 (actual investment)

In this example, at Y=$900, when S> Ii consumption goods demanded by the consumers of $780 is less than the consumption goods produced at $800 The excess supply of consumption goods create an accumulation of unwanted inventories. Actual investment ends up being more than intended investment. Producers lay off workers to get rid of the unwanted inventories driving down the national income.

Q5:
5) Income multiplier – change in national income generated by a change in AE. Suppose AE increases by $100 where the increase comes from a bookstore that decides to increase its shelf space. It hires a carpenter who producers the shelves for $100. The carpenter with an additional income of $100, uses $80 (assume MPC=0.8) to purchase a pair of boots. That creates $80 of new income for the bootmaker who in turn uses $64 to buy some other good. This goes on and the mutual interaction of income and consumption generates a series of new incomes and consumption that end up totaling a multiple of initial increase in AE where the income multiplier becomes 1/1-MPC. In this example with an MPC of 0.8, the multiplier =5. An increase of $100 in AE increases national income by $500

b) Tax multiplier measures the amount by which equilibrium national income changes in response to a dollar change in taxes. Its given by –MPC/1-MPC. Income multiplier + tax multiplier = 1. The tax multiplier is negative and its absolute value is smaller than the income multiplier. For instance with an MPC of 0.8, the income multiplier will be 1/1-0.8 = 5 while the tax multiplier will be -0.8/1-0.8= -4.

c) Budget deficit occurs when G>T. Here is a situation where the equilibrium is at $800b and its $200b short of full employment. Since the government is prepared to accept any level of deficit, suppose it increases its government spending without changing its taxes. If for instance MPC =0.8 with an income multiplier of 5, for a $200b increase in national income, government spending has to increase by $40b ($200b/5). If there is no accompanying increase in taxes, the budget deficit will be $40b. Alternatively, if the government decides to reduce its taxes without changing G, with a tax multiplier of -4, the government has to reduce taxes by $50b ($200/-4), and the budget deficit in this case will be $50b

Q6:
6. (a) frictional unemployment - brief periods of unemployment experienced by people who quit their job to find a better one or by people who enter the labor force for the first time. Example: college students looking for a job
(b) Structural unemployment – people who become unemployed because they have been replaced by new technological advancements. Ex: factory worker who are replaced by machines.
(c) Cyclical unemployment – people who lose their job in according to downturns or recessions in the business cycle. Ex: restaurant owner who has to close his restaurant because majority of customers cut back on eating out during a recession.
(d) Discouraged worker – people who stop looking for jobs after they have been repeatedly rejected by different employers. Ex: people who can no longer handle not getting job after job so they stop trying.
(e) Underemployed – people working at jobs that do not utilizing their full skill level, qualifications, or human capital. Ex: engineer working as a waitress.

Q9:
9 the major time that changes took place and the GDP skyrocketed was in the early 1900s. This is when the industrial revolution began and new technology was coming out that made things easier. Also during this time people began using the scientific method to experiment with ideas and productions that contributed to this change.