ECON 1220 Semester A, 2019-2020 Final Exam (online): Suggested Answer

Part A Multiple Choice Questions

Question Answer Question Answer
1 A 11 D
2 D 12 B
3 C 13 D
4 C 14 B
5 B 15 E
6 C 16 B Ignore Q16
7 D 17 D
8 C 18 A
9 B 19 B
10 D 20 B

Part B Short Answer Questions

Q.1
An implication of the “catch-up prediction” is that the higher the real per capita GDP, the lower the
subsequent average growth rate of the real per capita GDP.
The data given in the table is consistent with the “catch-up prediction” because:
 the ranking of the real per capita GDP, from highest to lowest, is B, C and A, and
 the ranking of the subsequent average growth rate of the real per capita GDP, from lowest to
highest, is B, C, A.

Q.2
Let t denote the number of years that the two countries will have the same real per capita GDP:
𝑡 𝑡
$1000 1 8% $800 1 12%
$1000 1 12% 𝑡
⇒ $800 1 8%
1000
ln
⇒ 𝑡 800
1.12 ≅ 6.14 years.
ln
1.08

The value of the real GDP 6.14 years afterwards will be:
6.14
$1000 1 8% ≅ $1604.06.
6.14
Or equivalently, $800 1 12% ≅ $1604.31.
(Note: the slight difference between the two numbers above is due to the rounding up errors)

1
Q.3 Labor Force = 100 x 80% = 80
The number of persons employed when the unemployment rate is equal to the Natural Rate of
Unemployment: 80 x 5% = 4
Therefore, the number of employed person at full employment is: 80 - 4 = 76
Potential real GDP = 10 50.5 760.5 = 194.94

Q.4 Y = C + I + G + NX
⇒ Y – C – G – I = NX (1)
where (Y – C – G) represents the national saving.
Therefore, as (Y – C – G) and I increase at the same time, we cannot unambiguously predict how the
LHS (left hand side) of equation (1) will change, and hence, we cannot unambiguously predict how NX,
the trade position of the country will change.
It is possible for the trade surplus to turn into a trade deficit.
Consider the following.
 Initially in 2017, (Y – C – G) is larger than I, thus, the LHS of equation (1) is positive which
implies NX is positive (i.e., trade surplus).

 When both (Y – C – G) and I increase, if the increase in I is much larger than the increase in
(Y – C –G) in such a way that I becomes larger than (Y – C –G), then the LHS of equation (1)
becomes negative implying that NX becomes negative (i.e., a trade deficit).

Q.5
(a) Along a given SRAS curve, the productivity parameter (A), the amount of capital goods (K) and the
Answer
nominal wage (W) are fixed.
(a) A, K, and W are constant moving along the same SRAS
(b) w=W/P
(b) As we move frommoving
drops from
A to B, the number of A
point employed P increases
to B, aspersons while P stays constant
(N) increases.
𝑊
The real wage w, which is 𝑃 , decreases. It is because from A to B, the nominal wage (W) is fixed but
the price level (P) increases.
Q.6 Ignore Q6
The Aggregate Demand Curve is derived from the equilibrium of the market of money for a given
nominal supply of money (𝑀𝑆 ). In the equilibrium in the market of money, the real balance of money
𝑀𝑆
held by the public is equal to the amount of money supplied in real terms ( 𝑃 ).
𝑀𝑆
From A to B, the price level (P) drops which implies that the real supply of money is 𝑃 increases.
Equilibrium in the market of money would imply that the real balance of money held by the public is
equal to the amount of money supplied in real terms. Thus, the real balance of money held by the public
would increase.

2
Q.7 The intersection of the SRAS curve and the AD curve in the P-Y space represents the short-run
equilibrium of an economy. However, as long as the employment level in the short-run equilibrium
deviates from the full-employment level, the nominal wage in the labor market will adjust and the
employment level will have a tendency to evolve to the full-employment level.
Once the short-run equilibrium occurs at the full employment output level, there will not be any force in
the economy for the equilibrium and the employment level to adjust, i.e., the SRAS and the AD curve
will not shift and the employment level will stay at the full-employment level.
Hence, the full-employment output represents the equilibrium output in the long-run.
Furthermore, the above argument holds for any given price level. Thus, the vertical line in the P-Y space
where the output is the full-employment output represents the LRAS.

Q.8
In order for point B to be to the right of point A, the LRAS must have shifted to the right.
In order for point B to be above the initial SRAS, the SRAS must have shifted upwards.
Examples of factors that shift the LRAS curve to the right: increase in the working age population,
“permanent” positive productivity shock, increase in capital stock, etc.
Note however, these factors will also shift the SRAS to the right (or downwards) at the same time.
Therefore, in order for the SRAS to shift to upwards, there must have been “temporary” factors that
shifts the SRAS upwards and the effect is large enough to offset the rightward shift of the SRAS
mentioned in above.
Examples that shift the SRAS to the left: temporary negative productivity shock (e.g., bad weather).
Note: In this question, we simply ask you to propose a factor that could have led to the shift of the SRAS
and the LRAS. We did not ask you to explain how the change in the factor you propose will lead to the
shift of the curve you have stated. If we do ask you to present the explanations, then you have to use the
“reasons” we have presented in Table 1 in Handouts 9 (for the shift of the LRAS) and Table 1 in
Handout 10 (for the shift of the SRAS).
Similar comments apply to Q. 10, 11 and 12. In particular, if there are shifts of the AD curve, and if we
do ask you to explain how the AD curve shifts as a result of the change in the factor that you have
proposed, then you need to present the “reasons” stated in the Table on p.5 of Handout 12.

3
Q.9
(a) From E to G:
(i) the capital per labor employed, K/N has increased, and
(ii) the production function has shifted upwards.
Item (i) could be due to an increase in the amount of capital.
Item (ii) could be due to an improvement in technology that leads to an increase in the overall
productivity of the whole economy.
(b) We cannot make an unambiguous comparison:
 the Marginal Product of Capital at point B is higher than that at point E because the technology
parameter A at point B must be higher than one at point E, and yet
 the Marginal Product of Capital at point G must be lower than that at point B due to diminishing
marginal product of capital.

Q.10
(a) AD and SRAS must have both shifted to the right such that the equilibrium output increases while
the equilibrium price level remain the same.
A factor that might have shifted the AD curve to the right:
firms expects the capital good to be more productive in the future
A factor that might have shifted the SRAS to the right:
a temporary positive productivity shock.
(b) In the short-run equilibrium, the economy is producing beyond the full-employment output. Thus,
the unemployment rate must be lower than the NRU. As a result, the bargaining power of labor
increases and drives up the nominal wage. As the labor cost goes up, the firms will produce less and
hence the SRAS will shift to the left.
As the SRAS shifts to the left, the real GDP decreases, the general price level increases and the
unemployment rate increases.

Q.11
(a) There must have been be a negative AD shock: the AD curve shifts downwards.
A factor that could have led to the downward shift of the AD curve is that the firms expects the
capital goods to be less productive in the future.

(b) In the short-run equilibrium, the economy is producing below the full-employment output. Thus, the
unemployment rate must be higher than the NRU. As a result, the bargaining power of labor
decreases and drives down the nominal wage. As the labor cost goes down, the firms will produce
more and hence the SRAS will shift to the right.

As the SRAS shifts to the right, the real GDP increases, the general price level decreases and the
unemployment rate decreases.

4
Q. 12
(a) There must have been a negative AS shock shifting the SRAS curve to the left.
A factor that could have led to the SRAS curve to shift to the left: a temporary negative productivity
shock.
(b) No. Monetary policies will shift the AD curve only.
To bring the economy back to the full employment output, the central bank has to adopt expansionary
monetary policy which will shift the AD curve upwards. However, as the AD curve shifts upwards, the
real GDP will increase but the price level will increase as the same time.
On the other hand, if the Central Bank adopts contractionary monetary policies, the AD curve will shift
downwards, and the price level will decrease but then the real GDP will drop further below the full-
employment output.