WI25 - Midterm 2 White - Solutions

Page 1: Exam Instructions

1. Students need to accurately fill in their identification information to maintain order.

2. The instructions highlight the importance of reading questions carefully to avoid any misunderstandings.

3. Clearly labeling graphs is crucial for effectively communicating visual information.

4. Knowing the exam comprises 8 pages helps students manage their time promptly.

5. The reminder regarding the scratch paper ensures it remains attached for use during the exam.

6. The prohibition on leaving the room is to maintain academic integrity and focus during the 120-minute duration of the exam.

Page 2: Multiple-Choice Questions

1. Question: What is Employment Rent?Answer: A. The economic benefit a worker receives from having a job compared to their next best alternative.Explanation for Correctness: This answer defines employment rent accurately; it refers to the extra satisfaction and financial conditions provided by current employment over alternatives.Explanation for Incorrectness: Other options may not relate directly to the worker’s perceived benefits or could define unrelated economic concepts.

2. Question: What is Reservation Wage?Answer: D. The lowest wage a worker is willing to accept for a job.Explanation for Correctness: This directly answers the definition of reservation wage, essential in labor market economics.Explanation for Incorrectness: Incorrect answers would fail to describe the threshold wage necessary for an individual to agree to work.

3. Question: What is Labor Force Participation Rate?Answer: B. The percentage of the working-age population that is employed or actively seeking work.Explanation for Correctness: It accurately reflects the metrics used to quantify engagement in the labor market.Explanation for Incorrectness: Alternative options may misrepresent concepts of workforce engagement or relate to employment statistics or unemployment rates instead.

4. Question: What is the Unemployment Rate?Answer: A. The percentage of the labor force that is unemployed and actively seeking work.Explanation for Correctness: This defines unemployment correctly by emphasizing the aspect of active job seeking amongst those without employment.Explanation for Incorrectness: Other options may define unrelated indicators or terms, thus failing to characterize unemployment accurately.

5. Question: What is Net Worth?Answer: D. The difference between total assets and total liabilities.Explanation for Correctness: This succinctly describes net worth, essential for understanding financial health.Explanation for Incorrectness: Incorrect responses may fail to represent financial equations or misinterpret asset evaluations.

6. Question: What is Base Money?Answer: C. The money created by the Central Bank, consisting of currency and reserves.Explanation for Correctness: It accurately reflects the fundamental creation of money supply within the economy.Explanation for Incorrectness: Other answers might describe different forms of money or financial instruments not tied to central bank activities.

Answers: 2 A D B A D C

Page 3: Multiple-Choice Questions Continued

1. Question: What is the Implicit Interest Rate on a Bond?Answer: C. 16%.Explanation for Correctness: This option provides a specific numerical answer representing a financial calculation for bond investments, which can be correct depending on provided data.Explanation for Incorrectness: Other options could misrepresent the implicit interest rate, leading to incorrect identification of bond yields.

2. Question: What is a Balance Sheet?Answer: A. A financial statement summarizing a company’s assets and liabilities.Explanation for Correctness: Correctly encapsulates the function of a balance sheet in financial reporting.Explanation for Incorrectness: Wrong answers may pertain to other types of financial reports or misunderstandings about accounting principles.

3. Question: How do Unemployment Benefits affect the Wage-setting Curve?Answer: B. It shifts the curve upward because the reservation wage is higher.Explanation for Correctness: This describes how provided unemployment benefits can raise wage expectations, thus shifting the wage-setting curve.Explanation for Incorrectness: Incorrect answers might misinterpret the impact of benefits on labor supply or incorrectly relate to wage dynamics without proper economic reasoning.

4. Question: What is the Unitary Cost of Output?Answer: A. $45.Explanation for Correctness: This provides a straightforward numerical response that could reflect calculation results depending on context.Explanation for Incorrectness: Other answers might not relate to unitary costs, potentially confusing them with variable or fixed costs in production.

5. Question: What is the Reason for Financial Intermediaries?Answer: B. To match borrowers and lenders while managing default risk.Explanation for Correctness: Accurately defines the function of financial intermediaries in facilitating transactions and managing associated risks.Explanation for Incorrectness: Incorrect options may misinterpret the roles of banks or alternatively describe them not based on intermediation functions.

6. Question: What is the Risk Premium on Stocks vs. US Bonds?Answer: A. Because stocks are riskier than US Government bonds.Explanation for Correctness: This articulates an essential concept in risk and return, appropriately capturing investor behavior.Explanation for Incorrectness: Other choices may not encompass the comparative risks accurately, leading to misplaced financial assessments.

Answers: 3 D A B C B A

Page 4: Multiple-Choice Questions Continued

1. Question: Why do Firms Offer Above Reservation Wage?Answer: D. To motivate workers to put effort on the job.Explanation for Correctness: This accurately presents the rationale why employers might pay above minimum wage to foster worker performance and retention.Explanation for Incorrectness: Alternative answers may overlook the motivation aspect or misrepresent basic economic incentives.

2. Question: What is the Primary Way Money is Created?Answer: D. When Commercial Banks extend loans to customers.Explanation for Correctness: Represents an essential principle of banking operations and the money supply increase via loans.Explanation for Incorrectness: Incorrect responses may incorrectly describe money creation mechanisms unrelated to the banking system.

3. Question: What is the Unemployment Rate in the Aggregate Labor Model?Answer: A. Because with a zero unemployment rate the employment rent would always be zero.Explanation for Correctness: This highlights a fundamental theoretical perspective on labor economics and the concept of employment rent.Explanation for Incorrectness: Wrong answers could misrepresent the relationship between unemployment and economic theory, leading to confounded understandings.

4. Question: What is the Interest Rate Spread for Commercial Banks?Answer: B. The difference between the interest rate on loans and the interest rate on deposits.Explanation for Correctness: A precise description essential for understanding the profitability of banking operations.Explanation for Incorrectness: Alternative choices might confuse this ratio with other financial metrics or misinterpret pricing strategies for loans and deposits.

5. Question: What happens during the Federal Reserve Purchase of Bonds?Answer: C. Base money increases and bank money increases.Explanation for Correctness: Correctly illustrates the liquidity effects of bond purchases by the Federal Reserve on the monetary supply.Explanation for Incorrectness: Incorrect responses could trivialize the importance of these purchases or misinterpret effects on banks and reserves.

6. Question: What is the Increase in Default Risk of Borrowers?Answer: B. Reduces the expected rate of return on loans.Explanation for Correctness: Defines how increased risks influence lenders’ expectations regarding profitability.Explanation for Incorrectness: Other options might misrepresent the default risk relationship with interest rates and lender behavior.

Answers: 4 : A B E B

Page 5: Explanatory Questions

1. (a) Question: What is the Wage-Setting (WS) Curve?Answer: It represents the relationship between the wage rate and the amount of employment, indicating that as wages increase, the quantity of labor supplied also rises.Explanation for Correctness: Accurately depicts how labor demand and supply interplay with wages.Explanation for Incorrectness: Alternative interpretations might fail to recognize the labor market dynamics involved or misunderstand the upward slope concept.

   (b) Question: How do you illustrate WS-PS Diagram?Answer: Draw the diagram labeling the WS Curve, PS Curve, and Nash Equilibrium point (E). The unemployment rate appears at the intersection of WS and PS. Adjustment Mechanism: If employment is less than E, firms tend to reduce wages due to lower reservation wages, which also lowers prices to boost demand, gradually shifting employment back to equilibrium.Explanation for Correctness: Clear illustration combined with theoretical justification for equilibrium adjustments accurately communicates economic underpinnings.Explanation for Incorrectness: Lacking proper diagrams or flaws in understanding could lead to inaccuracies in representing the models.

2. (a) Question: What’s the Impact of Monitoring Technology on Curves?Answer: Improved monitoring technology might shift the Wage Setting Curve upward, reflecting a demand for higher wages to encourage worker performance.Explanation for Correctness: This expresses the dynamics involved when companies improve oversight, enhancing their incentive structures.Explanation for Incorrectness: Incorrect responses might miss the relationship between performance monitoring and wage adjustments, leading to flawed analysis.

   (b) Question: How do you represent WS-PS Diagram Changes?Answer: Represent changes in the diagram, indicating implications for the unemployment rate and the portion of output allocated to workers; typically, lower unemployment results from enhanced worker motivation.Explanation for Correctness: This describes expected outcomes from technological advancements, accurately linking theory with practical implications.Explanation for Incorrectness: Failing to represent the necessary shifts could result in misunderstandings of labor dynamics.

Page 6: Income Distribution and Economic Growth

1. (a) Question: What is the Lorenz Curve?Answer: It represents income distribution, illustrating the proportion of total income earned by cumulative percentages of the population.Explanation for Correctness: The definition correctly conveys the concept of income inequality representation.Explanation for Incorrectness: Other choices could misinterpret it as a measure of wealth or provide unrelated definitions.

   (b) Question: How do you calculate and diagram the Gini Coefficient?Answer: Draw the Lorenz Curve based on income distribution and compute the Gini Coefficient from provided data.Explanation for Correctness: Accurate procedural explanation on assessing income disparity using the graphical method.Explanation for Incorrectness: Missing steps in calculation could lead to incorrect interpretations of inequality metrics.

2. (a) Question: What Economic Analysis is applied from 1980 to 2020?Answer: Use the Aggregate Labor/Product diagram to show the economic shifts from 1980 to 2020, reflecting changes in markup and wage trends.Explanation for Correctness: This refers to a critical analysis of economic changes over time effectively represented by labor product diagrams.Explanation for Incorrectness: Incorrect interpretations may miscommunicate key economic factors and their historical development.

   (b) Question: What’s the Economic Interpretation regarding Real Wages?Answer: It elaborates on why Real Wages remained static; most growth benefits accrued to firm owners due to markups, while workers' wages did not rise with GDP growth.Explanation for Correctness: Valid explains disparities in wages compared to economic growth, grounding in inequality discussion.Explanation for Incorrectness: Might miss broader economic mechanisms or misattribute wage stagnation to incorrect factors.

Page 7: Banking Operations and Impacts

1. (a) Question: What does the Banking Balance Sheet illustrate?Answer: It details the bank's operations after Amir's deposit and Sofia's loan, along with calculations for profits, consumption, and total bank money changes.Explanation for Correctness: This demonstrates practical applications of banking operations and balance sheet dynamics.Explanation for Incorrectness: Poor understanding of banking operations could result in flawed balance sheet calculations.

   (b) Question: What does Reserves at the Central Bank mean?Answer: These are funds banks maintain at the Central Bank to ensure liquidity and stability, discussing the behavior of lenders, banks, and borrowers in response to rate changes and their effects on future investment levels.Explanation for Correctness: Accurately captures bank reserve implications on economics and monetary policy.Explanation for Incorrectness: Incorrect interpretations might misrepresent fiscal policy's impact on banking behaviors.

Page 8: Scratch Work

• Question: How is the Scratch Work page utilized?Answer: This page is designated for calculations and additional notes, emphasizing that all pages must remain attached to the exam.Explanation for Correctness: Highlights practical usage of the page while adhering to examination protocols.Explanation for Incorrectness: An incorrect understanding might ignore the significance of maintaining continuity in the exam response.