1 Name: Economics 320L, Fall 2015 Midterm 1 Please put all papers away. No calculators, no cell phones, no computers: nothing electronic is allowed. The exam is scheduled for 80 minutes. There are 90 points total on the exam, plus 3 extra credit points. Part 1: Definitions (3 points each) 1)Extensive Margin of Labor Supply: 2)Natural level of output: 3)Reservation wage: 4)Random walk hypothesis: 5)Crowding out:

2 Part 2: Short but important Questions (5 points each) 1) What is the Permanent Income Hypothesis? Describe three pieces of evidence that Milton Friedman argued were consistent with the PIH but inconsistent with traditional Keynesian consumption functions. 2) Explain why an individual’s labor supply curve might be backward-bending. 3) Illustrate graphically how the optimal capital stock of a firm will change when the interest rate rises. What does this imply for investment?

3 Part 3: Longer Questions (20 points each) I-IS-LM Analysis a) Draw the IS-LM diagram and illustrate the effects of an increase in taxes (T) on the interest rate and output. Be sure to label each axis and curve, as well as equilibrium values. (5 points) b) Using your answer to part a), demonstrate how an increase in taxes will affect consumption, investment, and savings. Show all of your work.(5 points)

4 c)