ECON 305-D100/ ECON350: FIRST MIDTERM EXAM – ANSWER KEY | Latest 2025 - Simon Fraser University.

1 Department of Economics ECON 305-D100 Simon Fraser University February 9, 2024 FIRST MIDTERM EXAM – ANSWER KEY PART 1: Multiple Choice Questions (1.25 points each, 30 points total) THERE IS ONLY ONE CORRECT ANSWER PER QUESTION 1. The theory of efficiency wages can help explain: (a) Why competition from immigrants reduces low-skilled wages (b) Why many unemployed workers find a new job within a few weeks (c) Why Canadian unemployment increased by less than US unemployment in 2008 (d) Why Canadian unemployment was so high in early 2020 (e) None of the above 2. Under what circumstances does real GDP equal nominal GDP? (a) In the base year (b) Whenever all prices are unchanged (c) Whenever all quantities are changed by the same factor (d) All of the above (e) None of the above 3. Unemployment increases when: (a) Fewer employed workers are laid off (b) More unemployed workers find jobs (c) More young graduates enter the labour force (d) Fewer old workers retire (e) None of the above 4. Nonrivalry means that ideas created: (a) Can benefit only similar economies (b) Can benefit only a few economies across the world (c) Can be used only in the economy that devised them (d) Can benefit virtually all economies across the world (e) None of the above 5. Over the long run of human history: (a) Technological progress exceeded 0.1% before the Industrial Revolution2 (b) Capital was the most important factor of production (c) Living standards never exceeded the bare-survival level (d) Human populations grew steadily, with few interruptions (e) All of the above 6. As an economist working at the International Monetary Fund, you are given the following data for Iceland: per capita GDP is 9% higher than in Canada, and the saving rate is the same as in Canada. If α=1/3, what do you conclude about TFP? (a) Canada’s TFP is approximately 3% larger (b) Iceland’s TFP is approximately 3% larger (c) Canada’s TFP is approximately 6% larger (d) Iceland’s TFP is approximately 6% larger (e) None of the above 7. According to the rule of 70, if an economy averages a 5% growth rate, it will take about _____ years to double in size. (a) 140 (b) 14 (c) 0.06 (d) 35 (e) 3.5 8. If MPLw, a competitive firm: (a) Should fire some workers until MPL = w (b) Should hire some workers until MPL = w (c) Should rent more capital until MPK = w (d) Should rent more capital until MPL = w (e) None of the above 9. “Big push” development policy is most likely to be effective when: (a) Human capital and physical capital are complements in production (b) There are negative externalities between different industries (c) The market fails to allocate inputs efficiently due to positive externalities (d) Workers are well educated (e) Everyone in society (businesses, labour unions, the government) supports it and pushes in the same direction 10. In the frictionless model of a labour market, what would explain the existence of vacant jobs? (a) Increasing returns to scale3 (b) Decreasing returns to scale (c) Wages are too high (d) Wages are too low (e) None of the above 11. As an abstract concept, investment is best understood as: (a) Household expenditure on durable goods plus any expenditure by firms (b) Any expenditure by firms (c) Expenditure, by anyone, on goods that are useful in future production (d) Expenditure, by anyone, on goods that give utility (e) None of the above 12. In Jones and Klenow’s alternative measure of economic welfare… (a) Higher inequality increases welfare (b) Higher inequality decreases welfare (c) A larger population causes faster growth in the stock of ideas (d) A larger population causes slower growth in the stock of ideas (e) None of the above 13. A Korean car manufacturer sells $1.2 M worth of cars in Canada, $7 M in China, and $1.8 M in Korea. The company spent $2 M on parts imported from China, $500,000 on software imported from Canada, and pays $4 M in wages to Korean workers (all measured in Canadian $). Which of the following are true in this scenario? (a) Canada’s GDP increases by $0.7 M (b) China’s GDP increases by $5 M (c) Korea’s GDP increases by $7.5 M (d) All of the above (e) None of the above 14. Why do we use chain weighting to measure real GDP growth over time? (a) To correct for the bias introduced by using net rates of change instead of gross (b) Because the Laspeyres and Paasche indexes tend to understate true growth (c) Just to make things more complicated (d) All of the above (e) None of the above 15. If your stock portfolio does well and as a result your non-wage income doubles, you would expect: (a) The income effect of wage changes to become stronger (b) The income effect of wage changes to become weaker4 (c) The substitution effect of wage changes to become weaker (d) The substitution effect of wage changes to become stronger (e) Need more information to answer 16. A society is vulnerable to the “Malthusian trap” when: (a) Families have more than two children on average, so the population grows (b) Population growth depends negatively on the population size (c) Population growth depends positively on living standards (d) Productivity growth depends positively on the population size (e) There is no fixed factor in production 17. If the current capital stock in Vietnam is smaller than the current capital stock in China (per person), but their level of TFP is the same, then according to the principle of transition dynamics: (a) China initially will grow slower than Vietnam, but will have the same steady state (b) China will grow faster than Vietnam at first, but slower eventually (c) China will grow faster than Vietnam and overtake it eventually (d) China will grow faster than Vietnam but never catch up completely (e) Both China and Vietnam will grow at the same rate because TFP is the same 18. Which of the following is/are essential for economic development? (a) Property rights (b) The rule of strength (c) Redistributive taxes (d) All of the above are essential (e) None of these are essential 19. Which of the following can be used to give firms incentives to innovate? (a) Backward and forward linkages (b) Decreasing average cost functions (c) Efficiency wages (d) All of the above (e) None of the above 20. One of the costs of economic growth is: (a) Resource depletion (b) Global inequality (c) Lower child mortality (d) Decreasing labour shares (e) None of the above5 21. If overall inflation is 3%, this implies: (a) That all prices increased by exactly 3% (b) That all prices increased (c) That some prices increased and others decreased (d) That people are worse off (e) None of the above 22. How many surviving children per mother do we observe in the world today, on average? (a) Between 2 and 3 (b) Between 3 and 5 (c) Between 5 and 7 (d) More than 7 (e) Not sure because of data issues 23. Unemployment due to which of the following is NOT considered “structural”? (a) The constant hiring and firing that is part of the structure of the labour market (b) High minimum wages (c) An oversupply of highly educated workers when there is high demand for manual labour instead (d) Firms pay high wages to motivate their workers, which causes unemployment (e) All of the above are structural 24. Which of the following is true about factors of production? (a) There are three: land, labour, and capital (b) Human capital refers to the accumulated knowledge of a society, which is a nonrival good (c) Intermediate goods are a form of capital (d) All of the above (e) None of the above PART 2: Long Questions (30 points total) 1. (9 points total) Global growth (a) How much has income of the average person changed in rich countries, over the past 200 years? Give two reasons for this trend. (3 points) About a 50-fold increase (I’ll count anything between 20x and 100x as correct). Reasons include the increased pace of technological improvement, the increased share of capital versus land in the production function, the demographic revolution (no more6 Malthusian trap where population increases soak up the gains from better technology), and maybe others (reasonable arguments will be counted). (b) How much has income of the average person changed in poor countries, over the past 200 years? Which one of these trends would have been more surprising if you predicted it 250 years ago? Explain. (3 points) If you define “poor” as “the very poorest”, then growth has been zero or slightly negative. If you define it a little bit more broadly (the global lower-middle class), you could say a 2-fold to 10-fold increase. A zero-or-small increase would not have been surprising at all to people 250 years ago, because they believed (with good reason!) that growth was fleeting and usually didn’t trickle through to the poorer members of society. They would have been astonished that nowadays, even the poor members of rich societies live much more affluent lives than everybody’s ancestors used to. (c) Discuss the statement: “industrialization entails capital accumulation, therefore stimulating investment is critical for growth of industry in a country”. (3 points) The Solow model explains pretty clearly why this is a fallacy: capital accumulation (and thereby industrialization) is a consequence of improved productivity, not a cause of it. On the other hand, the Solow model is not the only model, and there are others where an exogenous increase in industrial investment causes persistent growth. For example, the model of industry linkages and externalities (the “Big Push” model), or the model of R&D and innovation (the Romer model). What these models have in common is increasing returns to scale. 2. (11 points total) The bathtub model of unemployment is based on two equations: E + U = L ΔU = s*E – f*U (a) Interpret the equations in words. (2 points) E is the number of employed workers, U is the number of unemployed workers. Together, they make up the labour force (L). In this model, unemployment can change for two reasons: either employed workers lose their jobs (at “separation rate” s), or unemployed workers find jobs (at “job finding rate” f). Therefore, the change in the number of unemployed workers can be calculated as total separations minus total hires. (In reality, there are also flows into and out of the labour force to consider. But this model simplifies.)7 (b) Suppose that 2% of all employed workers lose their jobs in a given month, while 38% of all unemployed workers find jobs in a given month. What is the steady state percentage of unemployed workers? Show your work. (2 points) Steady state means the unemployment rate doesn’t change. Set the change to zero, this means that s*E = f*U. Using the first equation, E=L-U; plug this in and solve for U to find the steady-state unemployment rate U/L = s/(s+f). Here, s=2% and f=38%, so the unemployment rate is 2%/(2%+38%)=2/40 = 5%. (c) Suppose the government introduces a policy that makes it harder for businesses to lay off workers, and as a result the job separation rate decreases to 1% per month. Draw a graph with the unemployment rate on the Y-axis and time on the X-axis, and indicate what happens to the unemployment rate both in the short run and in the long run. (3 points) There is no immediate impact of the policy, since all that changes is the rate at which workers are laid off. Over time, the lower separation rate results in a decrease in the unemployment rate, to the new level of 1%/(1%+38%)=1/39 ≈ 1/40 = 2.5%. (The exact number is not required here, but your graph should make clear that the new long-term unemployment rate is lower than the old one.) (d) The answer to (c) assumes that the job separation rate stays low forever, and the job finding rate stays unchanged after the policy is introduced. Is that realistic? What do you think the long-run effect of the policy would be on the job finding rate, the job separation rate, and the unemployment rate? (4 points) It’s not very realistic. Making it harder to fire workers would likely result in employers being very picky about whom they hire, hence the job finding rate will decrease as well. Even the job separation rate may not stay at 1% forever, as over time employers learn how to work within the rules and lay off unproductive workers. Overall, the likely effect on the frictional unemployment rate could be positive, negative, or zero. This question is pretty open-ended, so well-reasoned answers get points whether or not they agree with what I just said. 3. (10 points total) Suppose a country takes in a large population of refugees, and this causes the population (and labour force) to increase from L1 to L2. Assume the economy starts in its initial Solow Model steady state, the increase in L is immediate and permanent, and no other parameters change. (a) Give the formula for output per person in steady state, and explain how the size of the labour force affects it. (2 points) In steady state, y=A1/(1-α)[s/δ]α/(1-α). No L on the right-hand side! Which is to say, in the long run living standards do not depend on the size of the population or labour force8 (assuming a constant proportion of the population is active in the labour force, but this is not something you need to say in the exam). (b) Assume α=0.5. Draw a graph showing how output evolves over time after the change. Draw another graph showing the growth rate of output over the same period of time. (3 points) (c) In the short run, does the invention change affect the level of per-person income, or its growth rate, or both? Explain. (2 points) (d) In the long run, does the invention change affect the level of income and/or its growth rate? What would happen if we relaxed the assumption of constant returns to scale? Explain. (3 points) See the formula in part (a): in the long run, neither the level nor the growth rate of perperson income depends on the size of the labour force [1 point]. However, this is only true in the basic Solow model with constant returns to scale in the production function. With decreasing returns to scale, income per person would be permanently lower [1 point]. With increasing returns to scale, income would be higher in the long run [1 point],