110 points total.  90 minutes maximum.  Please write legibly and show your work onevery problem and label graphs. Use two decimal places of precision when necessary. Attempt all questions!

Please read the following statement from the Department of Economics:

Academic integrity is the cornerstone of the Department’s rules for student conduct and evaluation of student learning.  Students accused of academic misconduct will be referred directly to the Office of Community Standards and Student Conduct for disciplinary action pursuant to the Student Conduct Code and, if found guilty, will be subject to sanctions. Sanctions range from a disciplinary warning to academic probation, to immediate dismissal for the Department and the University, depending on the seriousness of the misconduct. Dismissal can be, and has been, applied even for first offenses.  Moreover, a grade of zero can be assigned by the instructor for the course.

1.   (20 points) Suppose that US and Canada produce bread and butter. There are 100   workers in US and 50 workers in Canada, who can each work up to 40 hours per    week. It takes each US worker 4 hours to produce one loaf of bread or 8 hours to   produce one pound of butter. For Canadian workers, it takes each worker 10 hours to produce one loaf of bread or 5 hours to produce one pound of butter.

a.   (5 points) Depict graphically the weekly production possibilities frontier (PPF) of butter and bread for US and Canada.

b.   (2 points) Who has a comparative advantage in producing bread and why?

OC of one loaf bread for US = ½ pound of butter

OC of one loaf of bread for Canada = 2 pounds of butter

OC of one pound of butter in US = 2 loaves of bread

OC of one pound of butter in Canada = ½ loaf of bread

½ < 2, so US has a comparative advantage in producing bread.

c.   (2 points) In autarky, if US wants to consume 900 loaves of bread, how many pounds of butter can it consume?

To consume 1 loaf of bread, US must give up ½ pound of butter. So, to

consume 900 loaves of bread, US must give up 1/2*900 = 450 pounds of butter. It can therefore consume (500-450) = 50 pounds of butter.

d.   (2 points) In autarky, if Canada wants to consume 200 pounds of butter, how many loaves of bread can it consume?

To consume 1 pound of butter, Canada must give up ½ loaf of bread. So, to consume 200 pounds of butter, US must give up 1/2*200 = 100 loaves of    bread. It can therefore consume (200- 100) = 100 loaves of bread.

e.   (9 points) Calculate the gains from trade if both countries specialize in the

production of the good in which they have comparative advantage. Hint: use a price (of one good in terms of another) that is mutually beneficial for both  countries.

US specializes in bread, produces 1000 loaves. Canada produces 400 pounds of butter. Suppose the ‘no trade’ point is as in part c) and d) above, i.e. US is consuming 900 loaves of bread and 50 pounds of butter and Canada is

consuming 200 pounds of butter and 100 loaves of bread. Price of butter in

terms of bread for trade will be between the OC of butter in Canada (1/2 loaf of bread) and US (2 loaves of bread). Let’s assume this is 1 (it lies between    ½ and 2). So, 1 pound of butter is traded for 1 loaf of bread. If US sells 100   loaves of bread to Canada and buys 100 pounds of butter in return, it has

900 loaves of bread and 100 pounds of butter. On the other hand, Canada    will have 100 loaves of bread that it has bought from US, and (400- 100) =  300 pounds of butter. Gains from trade are 50 pounds of butter for US, 100 pounds of butter for Canada.

2.   (15  points)  The  market  for  eggs  in  the  US  is  a  competitive  market  and  is  in equilibrium.

a.   (5 points) Depict this market graphically.

Simply draw  a market in  equilibrium, with  axes,  curves  and  equilibrium labeled clearly.

b.   (10  points)  Suppose  this  market  is  opened  to  international  trade  (it  was previously an autarky) and as a result, the domestic price of eggs falls. Give an example of a government intervention by the US that will offer trade protection  in  this  case.  Graphically  depict  the  effect  of this  government intervention on consumer surplus, producer surplus and total surplus (label all areas).

This is a case of imports. The government intervention is either import tariff or import quota. See pages 25-26 of lecture 3 for graphical depiction.

3.   (5 points) A country produces candy and wheat and is operating at a point that is feasible but not efficient. What is the opportunity cost of producing candy at such a point? What about the opportunity cost of wheat at the same point?

OC of both is zero. To produce more of one good, no amount of the other good needs to be given up.

4.   (15 points) Explain whether each transaction reflects an increase or

decrease in 2023 US GDP, and which part of aggregate spending in the US in 2023 is affected.

a.   (5 points) An American buys Irish coffee in Ireland in 2023.

Decreases GDP; import

b.   (5 points) Boeing opens a new manufacturing plant in Seattle in 2023.

Increases GDP; I

c.   (5 points) Ted, an American, buys 100 shares of Amazon stock in 2023.

Not included in GDP

5.   (15 points) The market for loanable funds is currently in equilibrium, with zero capital inflows or capital outflows and zero government budget deficit.

a.   (10 points) Suppose the government’stax revenue increases and its

expenditure decreases. Assuming everything else remains the same, depict the effect of this on the loanable funds market on the graph above. Clearly explain the reasons for your answer. (Show the effect on either curve(s),

equilibrium interest rate and quantity of loanable funds traded in the market.)

Government runs a budget surplus, so there is an increase in the supply of loanable funds (rightward shift). Interest rate falls, quantity of loanable funds traded increases.

b.   (5 points) What effect will this have on the amount of lending for private investment and why? Show the change in the graph above.

i has fallen and quantity of loanable funds traded has increased as in part a. Since  all  borrowings   are   for  private  investment  (government  is  not borrowing), private investment increases.

6.   (10 points) Analyze the following statement: “GDP has increased by 5% from last year. This is a good indicator of economic well-being as it represents an average increase in incomes.”

Some questions to think about: is this real GDP, nominal GDP, real GDP per capita or nominal GDP per capita? Is GDP a good indicator of economic well-being?

7.   (10 points) Consider the following information about a simple economy that produces tables, chairs, and chalk.

a.   (5 points) Using 2023 as the base year, find the GDP deflator for 2022 and 2023.

Nominal GDP 2022 = 10*400 + 4*100 + 7* 200 = $5800

Real GDP 2022 = 12*400 + 7*100 + 10* 200 = $7500

GDP deflator 2022 = (5800/7500) *100 = 77.33

GDP deflator 2023 = 100 (it is the base year)

b.   (5 points) Using the GDP deflator calculated in part b above, calculate the rate of inflation from 2022 to 2023.

Inflation = (GDP deflator 2023 – GDP deflator 2022) *100 / GDP deflator 2022

= {(100 – 77.33) / 77.33} * 100

= 29.316%

8.   (10 points) For the economy below, does the unemployment rate understate the true level of unemployment, overstate it, or neither? Why or why not? If yes, by how much?