Study Outline for Econ S10b Midterm Exam Harvard University, Summer School

Study Outline for Econ S10b Midterm Exam Harvard University, Summer School Note: The assigned readings are potential sources for exam questions. I will NOT ask narrow factual questions about these readings, but you should be able to relate their main arguments to the material we have discussed in class. Note: The following outline does NOT cover everything we have studied in the class. All concepts and applications that we have discussed in class are possible exam topics. Good items to study would be the class slides, the class notes, and the solutions to the problem sets. If something seems unfamiliar, check your notes, the posted notes, and then, if you still have questions, email me or stop by TA office hours. 1. Basics economic concepts a. Cost-benefit analysis, especially when applied to “how much” decisions b. Absolute and comparative advantage c. Supply and demand; Efficiency and surplus 2. Measuring GDP: Definition and methodology a. “Production” definition: value of final goods and services… b. Principles for measuring GDP: utilize market prices i. In a period: value-added method ii. What is NOT counted? c. Expenditure on final goods and services i. Y = C + I + G + NX  what are these different components? d. Equals total income arising from production of goods and services i. Income from labor AND income from capital e. GDP not the same as economic well-being 3. Measuring costs of living  prices, price levels, and price changes a. Calculating a CPI-type of price index b. What is inflation? Inflation rate? c. Real vs. nominal values; indexing (i.e. dividing a nominal amount by the relevant price index) d. Difficulties of measuring “true” inflation: quality and substitution biases e. Why is inflation costly? Hyperinflations? 4. Labor Productivity and Inequality a. How does economic growth relate to labor productivity and living standards?  through the labor market!! i. What determines labor productivity growth? ii. Labor demand-supply model: understand the curves and what shifts them! b. How have real wages / labor productivity behaved since 1970s? i. Why has growth in real wages been slow for some workers? c. What factors help explain the rise in inequality over the last forty years? 5. Economic Growth: Growth in Real GDP Per Capita a. Compound growth formula b. Why do we care about changes in GDP per capita? c. What are the proximate determinants of economic growth? i. Specialization and trade ii. Physical capital accumulation iii. Natural resource exploitation iv. More labor or higher quality labor (human capital accumulation) v. Entrepreneurship and managerial skills vi. Technological Change vii. Culture and institutions d. Neoclassical (exogenous technological change) vs. “New Growth Theory (endogenous technological change) e. What makes knowledge / ideas especially important for economic growth? Why might governments have a special role in promoting knowledge development? f. Fundamental Determinants of Growth  influence incentives for accumulation and innovation i. Institutions vs. Geography: The work of Acemoglu on what good institutions do g. Policies to encourage economic growth h. Why are some nations stuck in poverty traps? Role of foreign aid? 6. Savings and Investment  accumulation of capital (human and physical) + better technologies in production a. Savings vs. Wealth b. Why do people save? c. How do we define national savings? i. Closed economy: S = Y – C - G 1. personal + business + public savings 2. (Y – T – C) + (T – G) [assume business savings in personal] ii. Government budget deficit  public dissavings 1. How is one financed? d. Market for loanable funds  match up savers and [investment project] borrowers i. Investment demand  comparing the marginal benefits and costs from investment in capital 1. Benefit – value of the (marginal) product of capital…or in discrete terms, the value of a project in terms of revenues 2. A key part of the opportunity costs of the funds that could be used to finance the investment = r, the real interest rate in the economy 3. Overall cost = cost of the project + the interest cost in borrowing to fund the project [when a discrete project] ii. What determines that shape of supply and demand curves for loanable funds; what could make these curves move around? 7. Government Spending, Taxation, and Savings [Public Savings] a. What types of things does the U.S. government spend money on and why? b. Ricardian equivalence c. More fundamental budget problems in the U.S.: i. Social Security ii. Medicaid/Medicare  impact on G? 8. The open economy version of the loanable funds market a. KI  external source of loanable funds! i. Responsive to interest rates ii. What forms do KI come in? b. Small and large economy versions of the open economy loanable funds market c. S + KI = I: foreign savings as another source of funds for investment d. NX and KI in the United States  what sign are each? i. What do they imply about the flow of capital around the world (does it flow to where returns are the highest?)? 9. Financial Markets a. Calculating net present value of assets b. Financial systems: matching savings to investment projects 10. Money and Money Creation a. Definition of money b. Banking and money multiplier process i. Balance sheet approaches c. Why do we care about the money supply? i. Quantity theory of money 11. Understanding different types of financial assets that are traded in financial markets a. Money: asset with zero nominal interest rate b. Loans c. Bonds: legal promise to repay i. Pricing a bond  present value calculation d. Stocks: claims of ownership over capital or profits i. Returns to ownership: dividends and capital gains ii. Pricing a stock (the role of risk / risk premium) 12. Some preliminaries of the financial crisis: housing bubble, securitization, and leverage Practice Problems for Ec S10b Midterm Note: The exam will include a mix of short answer questions, True and False questions (where the explanations matter), and analytical (problem set-like) questions that might be quantitative or qualitative. The questions provided here are only meant to be suggestive of what you might see on the exam. They are more important as a check on your conceptual understanding of the material. 1) In a closed economy, suppose that U.S. households and corporations save $1 trillion and the government runs a $500 billion budget deficit. What is the value of investment? 2) In 2010, a student takes out a $10,000 loan with a fixed yearly interest rate of 10%. If inflation averages 2% per year, how much will she expect to repay in year 2014 (4 years later), assuming she has to pay both total interest and principal only at the end of the four years, IN CONSTANT YEAR 2010 DOLLARS? 3) [True/False] Over the last thirty years, housing prices have generally risen (with some sharp downturns). This trend led to an increase in the household savings rate in the U.S. 4) Intelligence Incorporated produced 100 computer chips and sells them for $200 each to Bell Computers. Using the chips and other labor and materials, Bell produces 100 personal computers. Bell sells the computers, bundled with software that Bell licenses from Macrosoft at $50 per computer, to PC Charlie’s for $800 each. PC Charlie’s sells the computers to the public for $1000 each. Calculate the total contribution to GDP using the value-added method. Do you get the same answer by summing of the market values of the final goods and services? 5) Prior to 2007, the federal minimum wage was $5.15 per hour. In 1981, the minimum wage was $3.35 per hour. The CPI in 1981 was 90.9, and the CPI in 2006 was 187.6. If Congress decided that it wanted to change the federal minimum wage in 2006 so that it would have the same purchasing power as the minimum wage did back in 1981, at what level would it have to set the minimum wage? 6) The table below shows the average annual percentage growth rates of average labor productivity per worker in the U.S. for 1960-73, 1973-79, and . Average annual growth rate (%) 1960-73: 2.3 1973-79: 0.6 : 1.7 Suppose that the growth of average labor productivity in the United States had continued at its 1960-73 rate until 2000. Proportionally, how much higher would U.S. average labor productivity in 2000 have been, compared to its actual value? (Note: you do not need to know the actual values of labor productivity in any year to solve this problem.) Does your answer shed light on why economists consider the post- 1973 productivity slowdown to be an important issue? 7) Consider a closed economy with the following characteristics: • GDP (Y) = 8000 • Consumption (C) = 5000 • Government Purchases of Goods and Services (G) = 2000 • Taxes Minus Transfers (T) = 1800 a) [10 points] Calculate the following: i. National saving ii. Private saving iii. Public saving iv. Investment b) [10 points] Now suppose that the government increases purchases of health care services, increasing G to 2200. Suppose that the supply of saving curve is a vertical line, but the demand for investment curve is downward sloping. i. Calculate the new value of national saving. ii. Illustrate the effect of the increase in G on a carefully labeled diagram of the supply and demand for saving and investment, with real interest rate on the vertical axis. iii. State what happens to the equilibrium real interest rate and quantity of investment. 8) The change in inventories in 2005 was $19.6 billion, meaning that firms accumulated $19.6 billion worth of unsold goods in that year. If the firms sell off the full value of this change in inventories in 2006, how will this affect GDP in 2006? 9) Suppose you are willing to pay $150 today for a stock that will pay no dividends in either of the next two years. If the current interest rate on U.S. treasury bonds is 5% and the risk premium is 5%, what do you expect to be able to sell the stock for after two years? 10) According to the Bureau of Economic Analysis, in 1990, real GDP in 2000 dollars was $7,112.5 billion and nominal GDP was