Economics 102

Spring 2003

Quiz 3 (25 points)

L. Stone

1. The graphs below show the economy in long-run equilibrium. SHOW the effect of an increase in the capital stock (being sure to carefully label everything). Then indicate the effect on each of the variables listed below. (10 points)

Shift in demand = 2

Shift in production function = 2

Everything labeled = 2

Output: INCREASES

Per capita output: INCREASES

Real wages: INCREASE

Employment: INCREASES

1 point each

2. One supply side program suggests cutting INCOME taxes.

a. Explain the possible impact on government tax revenues (and thus on the government budget deficit), using the Laffer curve. (Note: your answer must include a carefully-labeled graph and some words!) (5 points)

If the current tax rate is to the right of the midpoint on the curve, cutting taxes will increase tax revenues. If it’s to the left of the midpoint, cutting taxes will lower revenues. (2)

Correct graph = 3

b. Explain how (according to supply-side economists) this program is expected to increase output. (Note: your answer must include at least one carefully-labeled graph and some words!) (10 points)

Supply of labor increases.

This increases employment, and thus output increases.

Totally correct graph, everything labeled, (5)

Correct graph but shifts demand, -2 (Explanation should be same… employment increases and thus output increases.