ECO282 Macroeconomic Theory - I

1.  Consider an economy that produces and consumes bread and automobiles.  In the table below are data for two different years.

a. Using the year 2000 as the base year, compute the following statistics for each year:

· Nominal GDP

· Real GDP

· The implicit price deflator for GDP

· The CPI

b. How much have prices risen between year 2000 and year 2010?

2.Do the following functions have constant, increasing or decreasing returns to scale?

a. Y = AK ^0.2L^0.8

b. q = 3LK²

3.   The government raises taxes by $100 billion.  If the marginal propensity to consume is 0.6, what happens to the following?  Do they rise or fall and by how much?

a. Public savings

b. Private savings

c. National saving

d. Investment

4.  Consider an economy described by the following equations:

Y = C + I + G

Y = 5,000

G = 1,000

T = 1,000

C = 250 +0.75(Y – T)

I = 1,000 – 50r

a. In this economy, compute private saving, public saving, and national saving.

b. Find the equilibrium interest rate (measured in percentage points)

c. Now suppose that G rises to 1,250. Compare private saving, public saving and national saving.

5.  When the government subsidizes investment such as with an investment tax credit, the subsidy often apples to only some types of investment.  This question asks you to consider the effects of investment in the economy: business investment and residential investment.  And suppose that the government institutes an investment tax credit only for business investment.

a. How does this policy affect the demand curve for residential investment and the demand curve for business investment?

b. Draw the economy’s supply and demand for loanable funds.  How does this policy affect the supply and demand for loans?  What happens to the equilibrium interest rate?

6. In the country of Road Town, the velocity of money is constant.  Real GDP grows by 5 percent per year, the money stock grows by 14 percent per year, and the nominal interest rate is 11 percent.  What is the real interest rate?

7. Suppose that consumption depends on the level of real money balances (on the grounds that real money balances are part of wealth).  Show that if real money balances depend on the nominal interest rate, than an increase in the rate of money growth affects consumption, investment, and the real interest rate.  Does the nominal interest rate adjust more than one-to-one or less than one-to-one to expected inflation?

8.  If the consumption function is given by C = 500 + 0.5(Y – T), and Y is 6,000 and T is given by T = 200 + 0.2Y, then what is the value of C?

9.  If the consumption function is given by the equation C = 500 + 0.5Y, the production function is Y = 50K^0.5L^0.5, where K = 100 and L = 100, then what is the value of C?

10. Assume that the consumption function is given by C = 200 + 0.7(Y – T), the tax function is given by T = 100 + 0.2Y, and Y = 50K^0.5L^0.5, where K = 100. If L increases from 100 to 144, then consumption increases by how much?

11.  Assume that GDP (Y) is 6,000. Consumption (C) is given by the equation C = 600 + 0.6(Y – T). Investment (I) is given by the equation I = 2,000 – 100r, where r is the real rate of interest in percent. Taxes (T) are 500 and government spending (G) is also 500.

a. What are the equilibrium values of C, I, and r?

b. What are the values of private saving, public saving, and national saving?

c. If government spending rises to 1,000, what a