MIDTERM ASSESSMENT/EXAMINATION 2021 ECON 223 Macroeconomics I

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Assume δ > 1. Then, a production function F(K,L) exhibits increasing returns to scale if
a) δ F(K,L) = F(δ K, δ L).
b) δ F(K,L) = F(K/δ, L/δ).
c) δ F(K,L) < F(K+δ, L+δ).
d) δ F(K,L) > F(δ K, δ L).
e) none of the others.
Solution: By definition a production function F(K,L) exhibits increasing returns to scale if
δ F(K,L) < F(δ K, δ L).
2) Assume the government increases lump-sum taxes on income (i.e. T) by £50, and the
closed economy adjusts so that output does not change (i.e. Y is given). If the marginal
propensity to consume is 0.4, then investment
a) falls by £40.
b) rises by £30.
c) falls by £20.
d) rises by £20.
e) none of the others.
Solution: The increase in T reduces disposable income and thus consumption by
CT=0.4£50=£20. Savings increases by the same amount. Hence, investment has to
increase by the same amount in equilibrium.
3) Assume the money supply is £4.5 million, the currency-deposit ratio 20% and the
reserve-deposit ratio 60%. Then, the monetary base in the economy is:
a) £4.5 million.
b) £6.75 million.
c) £3 million.
d) £2.25 million.
e) none of the others.
Solution: In this example the money multiplier is m=(1+0.2)/(0.2+0.6)=1.5. Then the
monetary base, B, is equal to M/m=£4.5/1.5=£3million.
4) The Law of One Price does not hold for the market for
a) Gold.
b) SP500.
c) Diamonds.
d) Hair cuts.
e) None of the others.