Linear regression

. Mandatory Multiple Choice Question (20 Points - 5 points each).
1.A Consider the Ricardian Equivalence Proposition learned in class. Suppose that a government increases its
decit B. In doing so, it can either lower taxes τ1 while keeping government expenditures {G1, G2} xed over
time, or it can x τ1 while increasing G1. According to the Ricardian Equivalence Proposition, which of the
following answers are FALSE (mark all of them):
a) The increase in the government decit by more spending will lead the government to raise more taxes in
the future.
b) The increase in the government decit by lowering taxes will lead to an increase in private consumption
today because it stimulates the economy.
c) The increase in the government decit by lowering taxes will lead to an identical increase in private savings
that exactly osets the reduction in taxes, thereby having no eect on private consumption.
d) The increase in the decit by spending more will lead to a reduction in private expenditures.
e) The increase in the decit will have an eect on output, regardless of the format.
1.B Recently, Pop Economist Noah Smith recently criticized the New York Times saying: Jesus Christ, New
York Times. What kind of economic journalism is this? IMPORTS DO NOT SUBTRACT FROM GDP!
Imports subtract from exports but they add to consumption!! They're simply neutral for GDP!
See the tweet here…
The tweet provoked a lot of discussion. Mark the following correct statements:
a) Indeed, if an import is consumed at cost: GDP does not increase.
b) Indeed, we cannot claim that GDP has fallen because M increased.
c) If imports are stored at cost as inventory: GDP does not increase and I increases.
d) If imports are combined with local labor to produce more output: imports will increase GDP increasing
labor.
1
1.C Fatih lives and works in the US, and is planning to go on a trip to Australia for 1 month. Fatih believes that
the GDP per capita in Australia is US$ 45,000, the exact same amount as in the US. Fatih had planned to take
US$ 5000 dollars for his trip, but he reads an article in The Economist magazine and realizes (to his surprise)
that GDP per capita in Australia is only US$ 20,000 once you translate nominal GDP into purchasing power
parity (PPP)  a number that is much lower than what Fatih initially thought. Fatih also learned that capital
per worker in Australia is the same as in the US. Which of the following reactions ARE CONSISTENT with
what Fatih learned in class:
a) Australia is much more expensive than I thought. I should try to take a bit more of money or stay a
shorter period because my money will be worth much less over there. I will only be able to buy half the stu
I was planning to.
b) I earn much more than I thought in the US, relative to what Australians earn. I should go and spend
more because Australia is cheaper.
c) The amount of physical goods produced in Australia is probably much lower than what is produced in the
US.
d) Wow, productivity in Australia must be much higher than in the US. I should expect to nd a much better
educated population.
e) GDP per capita in PPP terms provides no additional information. The fact that both economies have the
same capital per worker and GDP per capita in nominal terms implies that, for the purpose of my trip, both
economies are identical.
1.D The capital share in Peru is α = 2/3. Relative to last year, capital increased by 30%, labor hours increased by
10%, and total output increased by 10%. Which is the closest approximate number for the growth in Total
Factor Productivity, A? For this question, use the growth accounting formula given in class to deduce the
change in A.
a) 12% b) 6% c) 0% d) -6% e) -12%
2

2. Numerical Question on the Solow Model (40 Points, easy). Let's consider the Solow model with
   population and technology growth. The steady state for capital per eective labor ˜kss is given by
   ˜kss =
   
   s
   δ + n + ˜x + nx˜
    1
   1−α
   ,
   Answer the following questions.
   a. How will the steady state value ˜kss change in response to a 50% decrease in the saving rate? To answer this
   question, let the old and new steady state values be denoted by ˜k
   o
   ss and ˜k
   n
   ss, respectively. Then, express ˜k
   n
   ss in
   terms of ˜k
   o
   ss and you should be able to obtain a concrete expression for their ratio. (10 points)
   b. Let's assume α = 0.5, s = 0.05, δ = 0.15, n = 0.05 and x˜ = 0.01 . Find an exact value for capital in steady
   state. (10 points)
   c. If the savings rate is increased to s = 0.1, what is capital in the new steady state? Is it higher or lower than
   in the original steady state? Provide the economic intuition behind your result. (20 points