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ECON 211

Intermediate Macroeconomics

Midterm test

Semester 1, 2023

Total marks: 20

Duration: 60 minutes

Time: 5 minutes reading time, 50 minutes writing time, and 5 minutes submission time.

This is open book and open notes. Do not consult or collaborate with others through any medium. Identical answers (approximately 75% or more match verbatim) detected by software will receive zero marks.

Only calculators are allowed; all other electronic devices are prohibited.

The test has FOUR questions. Each question has five parts, and each part is worth 1 mark.

Include suitable diagrams in your answers. For numerical calculations, show your steps and indicate whether the number increases, decreases, or remains unchanged.

Q1

Consider an economy with a production function involving three inputs: capital (K), labour (L), and human capital (H). People without tertiary education possess only L, while those with tertiary education possess both L and H. The production function is given by

a) Derive the marginal product of labour (MPL).

b) Determine the effect of decreased human capital on MPL.

c) What is the wage ratio between people with and without tertiary education?

d) If all labours in the economy have tertiary education, what are the respective share of total income for capital owners and labours?

e) Consider a production function where  where E denotes the efficiency of labour. Using the Solow model, find the steady-state output per effective worker ( for the following country:

Country P: saving rate of 40%, population growth rate of 3% per year, technological growth (g) of 4% per year, and depreciation rate  of 1%.

Q2

An economy with the money demand function:

where  is money demand,  is price level,  is output, and  is the nominal interest rate.

a) If output (Y) is 1500 units, the nominal interest rate (i) is 7%, and the money supply is $2000, calculate the price level.

b) Suppose the central bank's new governor adopts a hawkish stance and lowers expected inflation by 3 percentage points as a result. Determine the new nominal interest rate according to the Fisher equation.

c) Calculate the new price level and explain the factors contributing to the change.

d) If the governor wants to achieve a $30 price level at the new nominal interest rate calculated in part (b), what money supply level should he set?

e) If output grows at 1% yearly and the central bank aims for a long-run target inflation rate of 2%, calculate the necessary money supply growth rate.

Q3

Analyse the effects of the following scenarios on a small open economy's saving, investment, interest rate, trade balance, net capital outflows, real exchange rate, and nominal exchange rate. Assume the country starts with a balanced trade position.

a) Decreased consumer confidence leads to increased saving.

b) Global preferences shift, causing the local economy's exports to become less popular.

c) The local government raises tax on imported goods.

d) The local central bank of the small open economy reduces money supply.

e) Foreign countries reduce investment incentives by eliminating investment tax credits.

Q4

A Big Mac burger sells for 5.2 US dollar (USD) in the United States, and the exchange rate between US dollar and Chinese Yuan (CNY) is  

(a) If the law of one price holds, what is the price of Big Mac in China, measured in CNY?

(b) If the actual price of Big Mac in China is 24 CNY, compute the relative price of a Big Mac in China versus the US.

(c) Does your answer in part (b) suggest the CNY is overvalued or undervalued relative to the US dollar? Explain.

(d) Determine where traders would buy and sell Big Macs if free and frictionless trade is possible.

(e) How will these transactions in part (d) affect Big Mac prices in China and the US?