Section 2 – Trade (15 points)

Nantucket and Martha’s Vineyard are islands just off the coast of Massachusetts . In the 1700s they were farming and fishing communities . Consider the following data, a selection of

corn/lobster production possibilities for the two islands . Note: For both islands the corn/lobster tradeoffs are linear .

1.   In the spaces below draw the Nantucket and Martha’s Vineyard production possibilities curves: (2 points)

2.   Which island is better at producing either product (Corn, Lobster)? (1 point)                  Economists would say that this island has an                           in the production of corn and lobster . (1 point)

3.   Calculate opportunity costs of producing Corn and Lobster separately in each place . (4 points)

4.   Despite the realities noted in question 2, economists argue that Nantucket and Martha’s Vineyard can enact trades that benefit both islands . Briefly explain, invoking the two    concepts that capture the reason these islands can successfully trade . (3 points)

5.   In the space below, draw the combined production possibilities of the two islands, and be sure to label your axes . (4 points)

Section 3 – Supply and Demand (15 points)

In Bertrand people drink cappuccino or espresso . In 2019, both markets were in equilibrium .   Espresso cost $2 and 6 thousand were sold . The supply and demand curves for the cappuccino market are as follows:

Qs = 3Pc – 12

Qd = 20 – Pc

where Pc is the price per cup of cappuccino .

1.   Label the graph below and draw the supply and demand curves for the cappuccino market . (3 points)

2.   Algebraically derive the equilibrium price and quantity in the cappuccino market . Label the equilibrium price and quantity on the graph . (3 points)

3.   It turns out that cappuccino manufacturers have an issue with milk suppliers . This raises the costs, and the new equilibrium price for cappuccino shifts to $12.

a .   Does this cause a shift of the supply curve or a movement along the supply curve for cappuccino? Please explain your answer . (2 .5 points)

b .   Derive the new equilibrium value for the quantity of cappuccino sold . (2 .5 points)

4.   Assume that in Bertrand, consumption remains the same . Therefore, overall demand for drinks remains steady . Draw a rough sketch below for the initial supply / demand           equilibrium for espresso . Add the shift that occurs after the cost of production increases for cappuccino and identify the new equilibrium . Provide an explanation for this change in espresso market . (4 points)

Section 4 – GDP (15 points)

Suppose the following data characterizes domestic production and prices in Westeros:

1.   What is nominal GDP in both 2010 and 2014? (4 points)

2.   Calculate real GDP in Westeros in both years in 2010 prices . (4 points)

3.   What is the percentage change in real GDP (in 2010 prices) between 2010 and 2014? (3

points)

4.   What was the annualized growth rate of real GDP (in 2010 prices) between 2010 and

2014? (4 points)

Section 5 – Aggregate Expenditure Model (25 points)

Consider an open economy with these characteristics in 2020 ($ trillions):

•    Autonomous consumption = 2

•    MPC = 0.8

•    Planned investment = 3

•    Government expenditures = 2

•    Net Exports = -3

1.   Create a graph, in the space below, label the two axes, label equilibrium income/AE, and

draw lines for C, C+I, C + I + G + NX .  (5 points)

2.   Derive algebraically, the equilibrium level for income . (3 points)

3.   During the pandemic autonomous consumption decreased to $1 trillion . Also, marginal propensity to save increased to 0.3. Find the new equilibrium level for income . (3 points)

4.   Furthermore, suppose that planned investment also declined to $2 trillion . Find the new equilibrium level for income . (3 points)

5.   Part b and c shows that economy is suffering against the pandemic . On the other hand, policy makers want to respond using fiscal policy to recover the income level in the economy . How much should government increase G to return income back to its value in part a? (5 points)

6.   Suppose  that  Republicans  and  Democrats  agree  to  only  a  doubling  of  government spending, G . Policy makers, however, can affect the MPC poitively by controlling the pandemic with rapid and successful COVID- 19 testing/tracing policies . What level for the MPC would result in a fully recovered equilibrium income, one that returns income to its pre-pandemic level? (6 points)

Section 6 – Financial Markets (20 points)

The following data were obtained on Oct 23, 2020.

1.   According to the expectations theory of the term structure, what do market participants expect the 1-year US Treasury rate to be 1 year from now? (ignore term premium) (3

points)

2.   Why is the 10-year Treasury rate lower than the 10-year rate on Tesla bonds? (3 points)

3.   Tesla currently must pay 200 basis points more per year than the U .S . treasury, if it chooses to borrow money for 10-years . Tesla announces it has developed a new battery that will propel its cars 1,000 miles on one charge . Choose the most likely new value for the spread between the Tesla bond and the 10-year treasury? (3 points)

(i)        250 basis points                      (ii) 100 basis points                (iii) -50 basis points