Answers to AP/ECON 2400B Final Exam Fall 2010
1. (a) Gross Domestic Product (GDP) is the market value of all the nal output newly produced
during a given period of time within a countrys border.
(b) The income-expenditure identity states that the aggregate income equals aggregate expenditure,
Y = C + I + G + NX:
It illustrates that all sales of output provide income somewhere in the economy, and that we
can measure total output in the economy in dierent ways.
(c) Nominal GDP measures current production at the market prices in the current year. A change
in nominal GDP consists of
(i) a nominal change due to a change in the price level and
(ii) a real change due to a change in the physical quantity of output.
Real GDP measures current production at the market prices that prevailed in the base year.
Hence, real GDP is a weighted average of individual production levels, with the weights being
determined by the relative prices in the base year. A change in real GDP measures the change
in the physical quantity of output.
(d) Besides persistence, the three important features of the deviations from trend in real GDP are
i. The time series of deviations from trend in real GDP is quite choppy.
ii. There is no regularity in the amplitude of
uctuations in real GDP about trend.
iii. There is no regularity in the frequency of
uctuations in real GDP about trend.
(e) The three features of comovements in macroeconomic time series are
i. whether a series is procyclical or countercyclical (positively or negatively correlated to real
ii. whether the series leads or lags real GDP, and
iii. whether the series is more or less volatile than real GDP.
2. (a) i. The representative consumers budget constraint is C = w(h l) + T. The optimal
consumption bundle is where the budget line is tangent to an indierence curve, w =
MRS , l;cthat the consumer attains the highest possible utility level.
ii. An increase in the real wage has two eects. First, a substitution eect leads the consumer
to consume more consumption goods and less leisure (to work more) as leisure becomes more
expensive. Second, a positive income eect leads the consumer to increase consumption of
both the consumption good and leisure (work less). The total eect of an increase in w is
increasing c but having an ambiguous eect on leisure (and labor supply N ).
(b) i. The representative rms real prot, = zF(K;N) wN.
ii. The rm maximizes its real prot, , by hiring workers until MP = w. Once the optimal
d N s
labor demand, N , is determined, we can pin down the optimal output supply, Y =
zF(K;N ), and the maximized prot, = zF(K;N ) wN . d
iii. A decrease in z reduces the marginal product of labor at any given level of N, the MP N
curve shifts downward proportionally. The rms optimal labor demand N corresponding
to each w is now read from the new MP N curve by following the condition MP N = w.
Hence, the new N curve is identical to the new MP N curve. That is, the N curve shifts
leftward because of a decrease in z.
1iv. With the subsidy, the representative rms eective real prot becomes = zF(K;N)
(w s)N. It maximizes by hiring workers untiN = w s. The subsidy reduces the
eective real wage faced by the rm and encourages more labor input. Hence, the subsidy
to the hiring of labor increases the optimal labor demand, N , the optimal output supply,
e s ed ed ed
Y = zF(K;N ), and the maximized eective prot, = zF(K;N ) (w s)N .
(c) i. The equation of PPF: C = zF(K;h l) G.
ii. The slope of the PPF is the negative of the marginal rate of transformation (the marginal
product of labor).
iii. The competitive equilibrium of the economy is at point E.
w h + Tq
e slope= w = MRT E = MRS E
e l;c l;c
C e r