Econ 102 Midterm

Chris Surro
July 16, 2024

Name:

Student ID:

Exam Rules
1. The exam starts at 10:45 and ends at 12:50.

2. The exam is out of 250 points. There are 4 open response questions worth 60 points
each. The final 10 points come from filling out the post-midterm survey.

3. Please put all materials other than your calculator, a pen or pencil, your cheat sheet
and your ID in your bag. If you have a phone or other item out for any reason you
will be given a 0 on the exam.

4. If you have a question or need to go to the bathroom raise your hand and a TA will
come help you.

5. On the open response questions you must SHOW ALL WORK. No credit will be given
for an answer with no work.

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1. (60 points) In this question we will study a small economy that consists of only 4 indus-
tries: A mine that produces iron, a blacksmith that produces iron goods, a farmer that
produces wheat, and a baker that bakes bread. There is also a small local government
that collects taxes, prints currency (we’ll call it dollars), and provides defense services.
In one year, the following activities take place

1. The mine produces 100 pounds of iron, which it sells to the blacksmith for $5 per
pound.
2. The blacksmith uses all of the iron to produce pitchforks, which it sells to the
farmer for $200, swords, which it sells to the government for $100, a new oven,
which it sells for $200 to the baker, and hammers, which it sells for $300 to the
blacksmith
3. The government pays its soldiers $200 to provide defense services
4. The farmer produces $400 worth of wheat, which it sells to the baker
5. The baker uses all of the wheat to produce $800 worth of bread. Of the $800,
$600 is purchased by private individuals, $100 is purchased by the government,
and $100 is shipped to a neighboring country.

(a) (20 points) Using the expenditure approach, calculate GDP for this economy and
classify into the 4 components of GDP expenditure (Hint: note that the iron and
wheat is entirely used up in the production process, while pitchforks, swords, the
oven, and hammers are not)

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(b) (20 points) Using the value added approach, calculate the value added for the 4
industries and the government in this economy.

(c) (20 points) Assume that in the following year, the farmer decides to import its
pitchforks rather than buy them from the local blacksmith. However, the black-
smith is not prepared for this change and still produces the same amount of
pitchforks, which it puts in storage to sell in the following year. Explain how this
would change your calculations in (a) and (b).

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2. Assume a Solow model with production function given by F (K, L) = AK 1/2 L1/2 .
Assume the saving rate is 40% and the depreciation rate is 5%. Population grows at
3% per year and technology (A) grows at 1% per year

(a) (20 points) If k̃0 = 100, calculate k̃1 and k̃2 (round to the nearest tenth). What
value will k̃ reach in the long run? Draw a graph showing how k̃ will change over
time from k̃0 = 100

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(b) (20 points) Assume the saving rate increases to 50%. Calculate consumption per
effective worker before the change, immediately after the change and in the long
run (steady state). Draw a graph showing how consumption per effective worker
changes over time.

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(c) (20 points) In 1960, Japan had a very low GDP per capita compared to other more
developed countries. In the following decades, Japan experienced rapid growth in
GDP per capita and by 1990 had a level of GDP per capita among the highest in
the world. Since 1990, Japan’s GDP per capita has significantly slowed, growing
only about 1% per year. Could such a growth pattern be explained by the Solow
model? If so, explain what the parameter values could look like to explain this
pattern. If not, explain what is inconsistent between the model and data.

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3. (60 Points) Assume that 2 consumers in an economy have utility function over con-
sumption in 2 periods given by

U (c1 , c2 ) = ln(c1 ) + ln(c2 )

Consumers are given an endowment of income in each period

y1A = 48, 000 y1B = 32, 000

y2A = 52, 000 y2B = 68, 000

(a) (20 points) If the interest rate were 0%, how much would each consumer optimally
choose to consume in each period? At this rate, would there be an excess supply
of saving or an excess demand for borrowing?

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(b) (20 points) Calculate the equilibrium interest rate and consumption and saving
for each consumer (you do not need to write down the Lagrangian but you should
show all other steps in calculating the answer). Which consumer is a borrower
and which one is a saver? Explain the intuition.

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(c) (20 points) During the Covid pandemic, the government gave each person in the
economy a stimulus check, increasing their income by 2,000. Assume that this
happened in period 1 in the model above. Without calculating the new equilib-
rium interest rate, would you expect the interest rate to increase or decrease?
What would happen to total saving in the economy? Explain.

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4. (60 points) An economy consists of 140 identical consumers and two firms, a fast food
restaurant and a retail store. Assume that each firm sells its output at a price of 1 so
real and nominal wages are equivalent.

(a) (15 points) Assume that each consumer has utility function over consumption and
leisure given by
U (c, l) = c − (24 − l)2
They can work for a wage w, which they spend on the consumption good c
and have 24 hours in a day to split between leisure l and labor h. Derive each
consumer’s labor supply function (you do not need to setup a Lagrangian but
must show all other steps)

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(b) (15 points) The two firms in the economy each have the same production function
given by
1
Y = 120L − L2
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Calculate each firm’s labor demand function (must show all steps in deriving your
answer).

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(c) (10 points) Assuming that workers can move freely between industries (meaning
the wage should be equal in the two firms), calculate the equilibrium wage and
total number of hours worked in the economy.

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(d) (20 points) In 2024, California imposed a $20 minimum wage that only applied
to fast food firms. According to the model described above, what would be the
effects of this intervention? In particular, calculate how many workers would work
at each firm and what wage each firm would pay. How does this compare to the
equilibrium in part c? (Hint: Start by calculating how many hours the fast food
firm would want to hire at a wage of $20 and how many hours each worker will
want to work at a wage of $20)

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Extra Space

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Extra Space

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