Economics 311 Final

Prof. Bryan Caplan

Fall, 1999




        You have 2 hours, 45 minutes to complete this exam.

        You may use any books, notes, or other materials that you wish, but avoid spending too much time on any one question.

        Partial credit may be awarded on all questions.

        The maximum possible number of points is 200.

        You should have 7 pages, counting this one.


Part 1: True, False, and Explain

(10 points each - 3 for the right answer, and 7 for the explanation)

State whether each of the following six propositions is true or false. In 2-3 sentences (and clearly-labeled diagrams, when helpful), explain why.


1. Suppose the minimum wage in 1999 is $5.25. The inflation rate is 4% per year.


T, F, and Explain: If the minimum wage law is unchanged, the real minimum wage in 2004 will be $4.41.









2. The government imposes a price ceiling in the market for goods (economy-wide price maxima).


T, F, and Explain: This is equivalent to imposing a price ceiling in the market for money.











3. Someone figures out a way to make dishwashers more cheaply.


T, F, and Explain: Labor demand increases because more workers can now enter the workforce. This in turn increases Aggregate Supply.









4. T, F, and Explain: Since real wages in the Third World are extremely low, businesses that invest there make exceptionally high profits.











Questions 5 and 6 refer to the following diagram.











5. T, F, and Explain: The move from AD to AD' could reflect an increase in the money supply.












6. T, F, and Explain: The move from SRAS to SRAS' could reflect the public's expectation that rapid monetary growth will continue.


7. T, F, and Explain: With perfectly flexible prices, a higher rate of monetary growth would immediately raise nominal interest rates, but have no effect on real interest rates.












8. Suppose the head of the central bank violently opposes deficit spending; thus, whenever the legislature borrows more money, the central bank responds by contracting the money supply.


T, F, and Explain: Deficit spending will now appear to reduce AD but have no effect on interest rates.












9. Suppose the central bank targets a 6% unemployment rate, which it believes to be the natural rate of unemployment. In fact, however, the natural rate is only 4%.


T, F, and Explain: Unless the central bank realizes its mistake, this will lead to an inflationary race between government policy and the public's expectations. Inflation will thus spiral out of control.









10. Russia sets a price floor on the value of the ruble.


T, F, and Explain: This will produce a shortage of dollars and a surplus of rubles.








11. Suppose England and Germany each have 10 units of labor, and the following productive abilities. Initially each country allocates 5 units of labor to each task. Afterwards, each country allocates 7 units to the product in which it has a comparative advantage, and the rest to the other product.












T, F, and Explain: The following table shows that given these numbers, there is no way for England and Germany to beneficially trade.



Isolation (Ships, Steel)

Trade (Ships, Steel)



(9, 7)



(7, 6)



(16, 13)










12. T, F, and Explain: In "Industrial Life" (The Russians) Hedrick Smith shows that the main problem with socialist economies is their refusal to use any kind of material incentives.









Part 2: Short Answer

(20 points each)

In 4-6 sentences, answer all of the following questions.



1. Using both an AD-AS diagram AND a supply-and-demand for loanable funds diagram, carefully explain Bastiat's argument about "Thrift and Luxury" in his essay "What Is Seen and What Is Not Seen."


















2. Suppose that unemployment in Russia begins at its natural rate of 7%, with inflation at 100%. Use an expectations-augmented Phillips curve diagram to show: (a) The short-run effect of the Russian central bank's decision to reduce the growth rate of the money supply; (b) How the short-run Phillips curve shifts once Russians become convinced that the change is genuine.

3. What is the "AD Puzzle" of the Great Depression? Show the effects of the monetary shocks from 1929-33 using an AD-AS diagram. Then, briefly explain and diagram how the economy would have adjusted to these AD shocks if the federal government pursued a policy of strict laissez-faire after 1933.



















4. Drawing on Bastiat's conclusion to the First Part of Economic Sophisms, discuss how poor public understanding of economics impeded post-war economic growth in the ONE of the following countries: China, France, or the U.S. How would your chosen country's economic performance change if all of its citizens read and understood Bastiat's writings?