Model B, Page 1 F2023, Econ 3302, Midterm 1

Exercise 1: Calculating and Comparing GDP (30 points)

Consider an economy that produces and consumes two goods: T (for T ender bacon strips)
and G (for Greatest tonic). The following table contains data for this economy for three
consecutive years:

Year Quantity of A Price of A ($) Quantity of B Price of B ($)

1 1200 12 2400 6.0
2 1500 14 2600 6.5
3 1800 15 2800 7.0

Answer the numerical questions below.

1. (2.5 points) Calculate the nominal GDP for Year 2. Call it N ominal GDP2 .

, Solution to Exercise 1, question 1

N ominal GDP2 = 1500 ∗ 14 + 2600 ∗ 6.5 = 37900

2. (2.5 points) Calculate the nominal GDP for Year 3. Call it N ominal GDP3 .

, Solution to Exercise 1, question 2

N ominal GDP3 = 1800 ∗ 15 + 2800 ∗ 7 = 46600

3. (5 points) Using Year 2 as base year, calculate the real GDP in Year 2 (call it
Real GDP2Laspeyres ) and real GDP in Year 3 (call it Real GDP3Laspeyres ).

, Solution to Exercise 1, question 3

Real GDP2Laspeyres = 1500 ∗ 14 + 2600 ∗ 14 = 37900

Real GDP3Laspeyres = 1800 ∗ 14 + 2800 ∗ 14 = 43400

4. (5 points) Using Year 3 as base year, calculate the real GDP in Year 2 (call it
Real GDP2P aasche ) and real GDP in Year 2 (call it Real GDP3P aasche ).

, Solution to Exercise 1, question 4

Real GDP2P aasche = 1500 ∗ 15 + 2600 ∗ 15 = 40700

Real GDP3P aasche = 1800 ∗ 15 + 2800 ∗ 15 = 46600
Model B, Page 2 F2023, Econ 3302, Midterm 1

5. (5 points) Using Year 2 as base year, calculate the growth rate of real GDP between
years 2 and 3. Write in percentages.

, Solution to Exercise 1, question 5

100 43400−37900
37900 14.51%

6. (5 points) Using Year 3 as base year, calculate the growth rate of real GDP between
years 2 and 3.Write in percentages.

, Solution to Exercise 1, question 6

100 46600−40700
40700 = 14.5%

7. (2.5 points) Get the average of the two growth rates you obtained in the last two ques-
tions: the average of the growth rate between Years 2 and 3 in real GDP when Year 2 is
the base and when Year 3 is the base. Write in percentages.

, Solution to Exercise 1, question 7

(14.51 + 14.5)/2 = 14.5%

8. (2.5 points) Rewrite your answer to the previous question in simple units (not percent-
ages) by dividing your answer to the previous question over 100. Call that g chain .

, Solution to Exercise 1, question 8

14.5/100 = 0.145

BONUS. (optional, extra 5 points if correct) Use that growth rate from your last question to
get the value of chain-weighted real GDP in Year 2 that would result in that exact growth rate
if real GDP in Year 3 equals nominal GDP in Year 3. In other words, solve for Real GDP2Chain
in the following equation:

Real GDP2Chain (1 + g chain ) = N ominal GDP3

, Solution to Bonus

40697.23
Model B, Page 3 F2023, Econ 3302, Midterm 1

Exercise 2: Solow Model (30 points)

Barbieland is described by the textbook Solow model with a Cobb-Douglas production func-
tion: Yt = ĀKt0.5 L̄0.5 . The productivity parameter is equal to Ā = 1. The economy has an
investment rate of 10 percent or s̄ = 0.1 and a depreciation rate of 5 percent or d¯ = 0.05.
Barbieland has 1000 working women, which represent the total population and labor force L̄.
There is no population growth. Answer the numerical questions below.

1. (5 points) Label the following graph (see boxed space in the next page) with the cor-
responding variables in the Solow model that summarizes the development process of
Barbieland. In particular,

• label the x-axis below the text “LABEL X-AXIS HERE”, in the right bottom corner;
• label each of the lines next to the closest arrow. You can use text or a formula, as long
as it is clear;
• label along the x-axis where exactly is the steady-state level of capital.

, Solution to Exercise 2, question 1

2. (5 points) Calculate the level of capital K ∗ in steady state.

Model B, Page 4 F2023, Econ 3302, Midterm 1

, Solution to Exercise 2, question 2

  1
K∗ = s̄Ā
d¯
1−α
∗ L̄
¯ t and would have obtained
You can also start from the definition s̄Ā (K ∗ )0.5 L̄0.5 = dK
the same.
  1
K∗ = 0.1∗1
0.05
1−0.5
∗ 1000 = 4000

3. (5 points) Calculate the level of output Y ∗ in steady state.

, Solution to Exercise 2, question 3

Just plug in the value you con above for K ∗ into the production function. The book
provides a formula, but it is effectively the same, as long as you use the right α.
Y ∗ = Ā (K ∗ )0.5 L̄0.5
Y ∗ = 1 ∗ 40000.5 10000.5 = 2000

4. (5 points) Assume Barbieland is not at its steady state. In particular, this economy is
producing 1000 units of output. Write the capital accumulation equation (net invest-
ment) and indicate whether we expect change in capital to be positive or negative.

, Solution to Exercise 2, question 4

Barbieland starts at 1000, which is below its steady state 2000, so net investment

¯ t = s̄Ā (K ∗ )0.5 L̄0.5 − dK

It − dK ¯ t>0

as the transitional dynamics are approaching the steady state from below.

5. (5 points) Now assume Barbieland reaches its steady steady state K ∗ . Discuss whether
we expect output to increase or decrease from there.

, Solution to Exercise 2, question 5

Once in steady state, the country does not move. So we expect output to stay the same.
This is the definition of steady state and the main conclusion of the Solow model we have
seen.

6. (5 points) Assume that there is a permanent decrease in the rate of depreciation to 3%.
Add the new depreciation line to the graph in part 1. Clearly label the new line and
call it “new depreciation line.” Discuss whether we expect output to increase or decrease
from the old steady state towards the new steady state. No need to calculate the new
Model B, Page 5 F2023, Econ 3302, Midterm 1

steady state, just discuss what do you expect will happen based on capital accumulation
towards the new steady state.

, Solution to Exercise 2, question 6

A decrease in depreciation makes the depreciation line flatter (moves down and to the
right, but still starting at 0), so the crossing point with the investment line is at a higher
steady state. Starting from an old steady state to a higher one, capital will accummulate
again and output will grow until it reaches the new higher steady state.