You are encouraged to attempt these questions by yourself first, and check your answers against the provided model answers. To get a HD in the exam, you will need to provide detailed explanation.

1. Evaluate whether ”True”, ”False”, or ”Uncertain” the statements in Italic in the sub-questions and explain. Use a diagram if need be.

(a) Suppose a country is in the expansion part of the business cycle but the current level of

output is below its potential level.

If a government conducts an expansionary fiscal policy, the economy will reach to a full employment.

(b) Suppose a country is in the recession part of the business cycle and is experiencing an

increasing level of inflation above its target level.

The  Central  Bank  will face  a  trade- off between  controlling  inflation  and  supporting growth.

2. In Econtropica, only three goods, popcorn, movie shows, and drinks are being produced.  The table shows prices and quantities produced of these goods in 2000, 2010, and 2011:

(a) Find a growth rate between 2010 and 2011, using 2000 as a base year. Explain your working.

(b) The Statistical Office of Econtropica constructed a consumer basket based on a survey that

reports a typical family consumes 5 popcorn, 3 movie shows, and 3 drinks.  Calculate the consumer price index for each of the three years, using 2000 as a base year.

(c) Find the rate of inflation from 2010 to 2011.

(d) Is the inflation rate different if you use 2010 as a base year? Explain.

3. Consider a closed economy with no government. The annual production function of the economy is given by Yt  = AKt(1)/2Ht1/2  where A = 8.  The economy saves 10% of its income and capital depreciates 5% a year.

(a) Find the production function per capita and draw a capital accumulation diagram.

(b) Calculate the country’s income and consumption per person for an initial level of capital

per person of $144.

(c) Suppose the country introduced a new technology that changes A to 10.  Calculate the income growth caused by this technological advance for the initial level of capital. Explain.

(d) Show the transition dynamics to the new steady-state of the economy. The question continues in the next page.