ECON202 – Mock Mid-Term

You have 70 minutes to finish all exercises. You always need to justify your answers. Every correct
exercise will award you with the points indicated

Q1. (35 points)

The government and the opposition in the country want to raise Consumption by giving a transfer
immediately of 100 to one (and only one) specific category of people.

The government wants to help university students: since they have no income today, they will
spend immediately a large part of them. The opposition instead prefer to help poor retired
workers, since they claim students are already spending today. Use the two-periods model seen
in class to decide which party is right.

a. Without any transfer payment, show the budget constraints of (A) a student whose income
is 0 in period 1 and 1000 in period 2 and (B) a poor retired worker that has income of 100 in
period 1 and 2, but also starts with 200 of wealth. The real interest rate is 5%.
b. Suppose both agents have the following utility function:
U(c1, c2) = log(c1)+1/1.05 log(c2)
Find the optimal allocations for A and B, without any transfer payments.
c. Now, show to the two parties that which of the two agents (A, B) will consume immediately
the largest share of that additional 100 that they would like to transfer in period 1. Is there
any difference?

Q2. (35 points)

A firm has the following production function:

Y=AK0.5N0.5

a. After explaining what A represents, find the labour demand of this firm if A=2 and K=25.
b. Suppose that the government decides to put a tax on revenues equal 10%. Find the new
labour demand. What will be the effect of this tax on the equilibrium wage, assuming all
firms have this production function? Use a graph to illustrate your answer.
c. Suppose that a new technology allows the firm to use half of the worker and capital to
produce the same quantity (that is A is now 4!). The government is concerned that now
firms will fire a massive amount of their workforce and it decides to ban the new technology.
Was it a correct fear? Show what would have happened.
d. What would have been the impact of the new technology on the capital desired and
investment of the firm? Explain.

Q3. (30 points) True or False.

In this exercise you need to indicate if you think that the following statements are true or false,
carefully explain why you made those decisions. Every answer without a proper explanation will
receive zero point.

a. A firm should always borrow at lowest nominal interest rate available on the international
market in order to save on the interests.
b. A working-age person is either employed or unemployed. For this reason, the employment
rate and the unemployment rate are telling us the same thing.
c. In a close economy, the identity S=I is exactly equivalent to Y=C+I+G.
d. While the GDP is primarily a measure of production, it can be measured in three different
ways. Moreover, if we take GDP per capita, we have a rough but good proxy of well-being in
the country.
e. If we assume that the net transfers of income and the net unilateral transfers are 0, then the
current account measures the trade balance of a country. A positive current account means
that exports are larger than imports.
f. Inflation is a problem because consumers will be able to buy always less goods and services
year by year.