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Economics 304L SAMPLE MIDTERM EXAM 2

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Question;Economics 304L SAMPLE MIDTERM EXAM #2Instructions: Answer the problems in the space provided. Show your work to receive credit! You may use acalculator and a one-page formula sheet. This sample exam has more questions than your exam will have.Multiple choice (2 points each)1. Consider the effect of a rise in the real interest rate on the quantity of private saving. The sub stitutioneffect of a rise in the real interest rate _____ private saving and _____ consumption.a. increases, increases c. decreases, increasesb. increases, decreases d. decreases, decreases1.' Consider the effect of a rise in the real interest rate on the quantity of private saving. The incomeeffect _____ the private saving of ?lending? households, and _____ the private saving of ?borrowing?households.a. increases, increases c. decreases, increasesb. increases, decreases d. decreases, decreases2. If disposable income falls temporarily, consumption _____ and private saving _____.a. falls, falls c. rises, fallsb. fall, rises d. rises, rises2'. If disposable income increases temporarily, consumption increases _____ t han if the increase indisposable income were permanent, and private saving increases _____.a. more, less c. less, moreb. more, more d. less, lessIn the next four questions, assume Ricardian Equivalence holds. Also assume the economy is closed.3. The government cuts current taxes (without changing government spending now, or governmentspending planned for the future). As a result, national saving _____ and the real interest rate _____.a. increases, falls c. does not change, does not changeb. decreases, rises d. decreases, falls4. Government purchases increases temporarily, due to a war. To avoid increasing the governmentbudget deficit, taxes are increased by enough to cover the increase in government purchases. As aresult, national saving _____ and the real interest rate _____.a. increases, falls c. does not change, does not changeb. decreases, rises d. decreases, falls4.' Government purchases increases temporarily, due to a war. The increase in government spending isbond-financed (the government borrows in financial markets by selling government bonds). As aresult, national saving _____ and the real interest rate _____.a. increases, falls c. does not change, does not changeb. decreases, rises d. decreases, falls24.'' Government purchases increases temporarily, due to a war. The increase in government spending isbond-financed (the government borrows in financial markets by selling government bonds). As aresult, private saving _____ and national saving _____.a. increases, decreases c. does not change, does not changeb. decreases, increases d. decreases, decreases5. Now assume Ricardian Equivalence does not hold (households do not fully take changes in future taxesinto account when they decide on their consumption and private saving). Assume the economy isclosed. The government cuts current taxes (without changing government spending now, orgovernment spending planned for the future). As a result, national saving _____ and the real interestrate _____.a. increases, falls c. does not change, does not changeb. decreases, rises d. decreases, falls6. ?Crowding out? is defined asa. the reduction in investment due to a rise in the real interest rateb. the reduction in investment due to an increase in government purchases or in the governmentbudget deficit.c. the reduction in real tax revenue due to inflation.d. the increase in real tax revenue due to inflation.7. Your research on investment demand suggests that(i) a drop of.01 in the real interest rate causes investment to rise by 20(ii) ?maximum? investment (investment at a zero real interest rate) is 5000Which of the following investment demand functions represents these facts?a. I = 50 ? 20r c. I = 5000 ? 2000rb. I = 5000 + 2000r d. I = 10,000 + 20r8. The marginal propensity to consume (MPC) is defined asa.YDC??b.YDCc.YC??d.YC9. The average propensity to consume (APC) is defined to bea.YDC??b.YDCc.YC??d.YC10. Moving from left to right along the consumption function, the average propensity to consume _____and the marginal propensity to consume _____.a. remains constant, increases c. remains constant, decreasesb. increases, remains constant d. decreases, remains constant11. The substitution effect of an increase in the real interest rate _____ the fraction of disposable incomesaved by borrowers (households with negative net assets), and _____ the fraction of disposableincome saved by lenders (households with positive net assets).a. increases, decreases c. decreases, decreasesb. increases, increases d. decreases, increases312. Suppose disposable income increases permanently (i.e., this year?s disposable income rises by acertain amount, and, compared to what households had been expecting, future disposable incomerises each year by this same amount). Then consumption _____ and saving _____.a. increases, approximately stays the same c. increases, increasesb. approximately stays the same, increases d. increases, decreases13. Consider a temporary increase in disposable income. Which of the following is true? The APC _____,and the MPC _____.a. falls, does not change c. does not change, fallsb. rises, does not change d. does not change, rises14. Which of the following is false?a. 0 < MPC < 1 c. APC + APS = 1b. 0 < APC < 1 d. MPC + MPS = 115. Which of the following is true? A temporary increase in disposable income _____, and a permanentincrease in disposable income _____.a. shifts the consumption function up, moves the economy to the right along the consumptionfunctionb. moves the economy to the right along the consumption function, shifts the consumptionfunction upc. moves the economy to the right along the consumption function, both moves the economy tothe right along the consumption function, and shifts the consumption function upd. both moves the economy to the right along the consumption function, and shifts theconsumption function up, moves the economy to the right along the consumption function16. A recession causes real GDP to fall by 100 billion. During this recession, aggregate consumption falls by56 billion. The proportional tax rate is.3. What is the marginal propensity to consume out ofdisposable income?a..85 c..56b..80 d..7017. Actual expenditure may differ from planned expenditure because _____ may differ from its plannedlevel.a. consumption c. government purchasesb. investment d. net exports18. In general, the slope of the aggregate expenditure curve isa. b(1 ? t) b. b ? m c. b(1 ? t) ? m d. b19. Which of the following is a component of autonomous expenditure?a. IM b. C c. I d. all of the above20. An increase in the marginal propensity to consume (b) _____ the expenditure multiplier, and anincrease in the marginal propensity to import (m) _____ it.a. increases, increases c. decreases, decreasesb. increases, decreases d. decreases, increases421. Which of the following would increase the size of the expenditure multiplier? An increase ina. government purchasesb. the sensitivity of investment to a change in the real interest ratec. the marginal propensity to consumed. all of the above22. Which of the following would shift the aggregate expenditure curve up?a. an increase in government purchasesb. an increase in the purchasing power of assetsc. a cut in interest ratesd. all of the above23. Which of the following would decrease equilibrium expenditure?a. stock prices fallb. households become pessimistic about future incomec. real interest rate risesd. all of the above24. Which of the following would increase equilibrium expenditure and aggregate expenditure the most?a. Lump-sum taxes are cut by $100 million.b. Government purchases are increased by $100 million.c. Lump-sum taxes are cut by $100 million and government purchases are increased by $100million.d. All of above have the same effect on equilibrium expenditure and aggregate demand.25. Which of the following economies (that are otherwise identical) would experience the largest declinein income if investment expenditure decreases? A(n) _____ economy in which taxes are _____a. closed, lump-sum c. open, lump-sumb. closed, proportional d. open, proportional26. Consider a closed economy with lump sum taxes, and a marginal propensity to consume of.8. Ifincome increased by $40 billion due to an increase in government purchases, then governmentpurchases must have increased bya. $.8 billion. c. $8 billion.b. $50 billion. d. $32 billion.27. Suppose that real GDP increases by $50 billion during a business cycle expansion. During thisexpansion, aggregate consumption increases by $36 billion. The proportional tax rate is.2. What isthe value of the marginal propensity to consume out of disposable income?a..54 b..72 c..8 d..928. Which of the following economies would experience the largest decline in equilibrium expenditure andaggregate demand if investment expenditure falls?a. C = 20 +.8YD, T = 100 +.1Y, IM =.1Yb. C = 20 +.9YD, T = 100 +.1Y, IM =.1Yc. C = 20 +.9YD, T = 100 +.1Y, IM = EX = 0d. C = 20 +.9YD, T = 100, IM = EX = 0529. Consider a closed economy with lump-sum taxes (and no proportional taxes). Aggregate expenditureincreases by 100 in response to an increase in government purchases of 10. From this, we can inferthat the marginal propensity to consume equalsa..6 c..8b..7 d..930. The marginal propensity to consume is.9. The proportional tax rate is.2. The marginal propensity toimport is.12. If US exports increase by 10 due to growth in real GDP?s of our trading partners, we canexpect equilibrium expenditure and aggregate demand to increase bya. 16.7 c. 100b. 25 d. 142.931. Which of the following would increase aggregate expenditure?a. expansionary monetary policyb. an increase in real GDP?s of the US?s trading partnersc. an increase in government purchasesd. all of the above32. Suppose the expenditure multiplier is 3. If investment increases by 10, then equilibrium expenditure(income) increases bya. 10 b. 2 c. 30 d. 3 1/333. Start with a model that has no proportional tax and no imports (in other words, a closed economy withlump sum taxes). If both a proportional tax and imports are added to the model, the value of theexpenditure multiplier ____ compared to its original value.a. falls c. is unchangedb. rises d. may rise or fall34. Which of the following reduces the equilibrium value of the trade surplus? An increase ina. investment c. consumer optimism about future incomeb. government purchases d. all of the above35. Suppose that exports increase. As the economy moves to the new level of equilibrium expenditure,aggregate expenditure _____, while income _____.a. decreases, increases. c. remains constant, increases.b. increases, increases faster. d. decreases, remains constant.36. Which of the following economies would experience the largest decline in income if exports drop?a. C = 20 +.8YD, T = 100 +.1Y, IM =.1Yb. C = 20 +.9YD, T = 100 +.1Y, IM =.1Yc. C = 20 +.9YD, T = 100 +.1Y, IM = EX = 0d. C = 20 +.9YD, T = 100, IM = EX = 036'. Which of the following economies would experience the largest decline in income if exports drop?a. C = 20 +.9YD, T = 100 +.1Y, IM =.1Yb. C = 20 +.8YD, T = 100 +.1Y, IM =.1Yc. C = 20 +.8YD, T = 100 +.2Y, IM =.1Yd. C = 20 +.8YD, T = 100 +.2Y, IM =.25Y637. What is the value of the multiplier for an increase in lump-sum taxes? (Assume that investment is afixed amount not depending on the real interest rate.)a.] m) t 1 (b [ 1b????b.] m) t 1 (b [ 1b 1????c.] m) t 1 (b [ 11???d.b 1b??37'. Consider a closed economy with only lump-sum taxes. The multiplier for a balanced-budget increase ingovernment purchases isa.b 11?b.b 1b?c. 1 d.b 1b??37''. Give the value of the multiplier for a balanced-budget increase in government purchases (governmentpurchases and the lump-sum-component of taxes rise by the same amount).a.] m) t 1 (b [ 1b???b.] m) t 1 (b [ 11???c.] m) t 1 (b [ 1b 1????d. 138. The monetary base consists ofa. currency in the hands of the public.b. banks? deposits with the Federal Reserve.c. all currency (currency in the hands of the public plus currency in vaults of banks).d. currency in the hands of the public plus bank reserves.39. Which of the following is part of the money supply?a. credit card balancesb. deposits at banks made by households and businessesc. deposits at banks made by the federal governmentd. bank reserves40. Which of the following is the least liquid type of asset on banks? balance sheets?a. reservesb. long-term bondsc. short-term government bondsd. loans41. Which of the following would change the size of the monetary base?a. Ann writes a check on her Bank of America account, made out to Bob, who deposits it in hisWells Fargo checking account.b. The Fed buys a government bond from Bank of America, and pays by crediting Bank ofAmerica?s account with the Fed.c. Ann withdraws cash from her checking account to have with her when she goes on vacationover the winter break.d. Bank of America makes a withdrawal from its account with the Fed, in order to have more vaultcash going into the holiday season.42. Assuming that the currency-to-deposit ratio and the reserve-to-deposit ratio are stable, the value ofthe money multiplier may be computed asa.C/D R/DC/D 1??b.R/D 1C/D 1??c.R/D1d.D / RD / C743. Which of the following would increase the size of the money multiplier?a. The public holds a larger fraction of the money supply as deposits and less as currency.b. Banks increase their holdings of excess reserves.c. The Fed buys government bonds in the open market.d. All of the above.44. Currency is 1/4 of the money supply, and reserves are 1/10 of bank assets. This means that thecurrency-to-deposit ratio is _____, and the reserve-to-deposit ratio is _____.a. 1/4, 1/10 b. 1/3, 1/10 c. 1/4, 1/11 d. 1/5, 1/1144'. (continued) The value of the money multiplier isa. 3.57 b. 4.14 c. 3 d. 3.0844''. The currency-to-deposit ratio is 1/2, and the reserve-to-deposit ratio is 1/5. This means thathouseholds hold _____ of the money supply in the form of currency, and banks hold _____ of assets asreserves.a..5, 1/6 b. 1/3, 1/6 c. 1/3,.2 d..5,.244'''. (continued) The value of the money multiplier isa. 2.5 b. 7.5 c. 3 *d. 2.1445. Assume that households and firms hold all of their money as bank deposits (no currency drain), andbanks hold no excess reserves. The reserve requirement is.1. The money supply increases by $20million. The monetary base must have increased by $_____ million.a. 200 b. 10 c. 2 d. 2046. Assume that households and firms hold all of their money as bank deposits (no currency drain), andbanks hold no excess reserves. The reserve requirement is.1. The money supply increases by $20million. Then the Fed must have _____ government bonds worth $_____ in the open market forbonds.a. purchased, 2 c. sold, 2b. purchased, 20 d. sold, 2047. Suppose the required reserve ratio is 20%, and excess reserves equal to 5% of deposits are held bybanks. There is no currency drain, so the currency-to-deposit ratio is zero. An increase in the moneysupply of $10 million means that the Fed increased the monetary base by $_____ million.a. 40 c. 2.5b. 50 d. 248. (continued) Suppose instead that the currency-to-deposit ratio is.5. Then the Fed increased themonetary base by $_____ million.a. 20 c. 4.67b. 5 d. 16.67849. Taking into account deposit expansion/contraction, which of the following would change the moneysupply?a. John decides to keep more cash on hand at his business.b. Bank of America sells a government bond to the Fed, which credits Bank of America?s accountwith the Fed.c. Bank of America gives John a business loan.d. all of the above50. Which of the following would increase the quantity of real money (M/P) demanded?a. the real interest rate falls c. the inflation rate fallsb. real GDP rises d. all of the above51. A rise in the price level _____ the quantity of real money demanded, and a rise in the inflation rate_____ the quantity of real money demanded.a. increases, decreases c. has no effect on, decreasesb. decreases, increases d. decreases, has no effect on51'. A rise in the price level _____ the quantity of nominal money demanded, and a rise in the inflation rate_____ the quantity of nominal money demanded.a. increases, decreases c. increases, increasesb. decreases, increases d. decreases, decreases51''. A rise in the inflation rate _____ the quantity of real money demanded, and _____ the quantity ofnominal money demanded.a. increases, decreases c. decreases, has no effect onb. decreases, decreases d. increases, has no effect on52. Consider the effect of the following on the quantity of money demanded:(i) the real interest rate rises(ii) the price level rises(iii) the inflation rate rises(iv) real GDP risesWhich would increase the quantity of nominal money (M) demanded?a. (iv) c. (ii), (iii), and (iv)b. (ii) and (iv) d. all52'. (continued) Which would increase the quantity of real money (M/P) demanded?a. (iv) c. (ii), (iii), and (iv)b. (ii) and (iv) d. all52''. An increase in which of the following would increase the quantity of nominal money demanded?(i.) real GDP (iii.) price level(ii.) real interest rate (iv.) inflation ratea. (i.) c. (i.), (iii.), and (iv.)b. (i.) and (iii.) d. all952'''. If the price level increases, the quantity of real money demanded _____ and the quantity of nominalmoney demanded _____.a. does not change, decreases c. does not change, increasesb. decreases, does not change d. increases, does not change53. Which of the following shifts the money demand curve to the right?a. The real interest rate declines.b. Real GDP increases.c. The inflation rate increases.d. The money supply increases.54. When the Fed undertakes a contractionary open market operation, bond prices _____, and interestrates _____.a. rise, rise b. fall, fall c. rise, fall d. fall, rise54'. When the Fed undertakes an expansionary open market operation, bond prices _____, and interestrates _____.a. rise, rise b. fall, fall c. rise, fall d. fall, rise54''. If the Fed sells government bonds to the public, then as a result, the money supply _____ and short-term interest rates _____.a. increases, rise c. decreases, riseb. increases, fall d. decreases, fall55. As a result of expansionary monetary policy, interest rates _____ and aggregate expenditure _____.a. rise, decreases c. fall, decreasesb. fall, increases d. rise, increases56. You are considering purchasing a bond. It is a perpetuity that pays $50 annually. Your best alternativeinterest rate is.10. What is the most you are willing to pay for this bond?a. $550 b. $500 c. $50 d. $4556'. You are considering buying a Treasury bill that will pay $1000 in one year. If your best alternativeinterest rate is.20, what is the most you should be willing to pay for this bond?a. $1200 b. $5000 c. $800 d. $833.3357. ?Open market operations? refer toa. sales of government bonds to/purchases of government bonds from the public by the US Treasury.b. sales of government bonds to/purchases of government bonds from the public by the Fed.c. changes in reserve requirements.d. changes in the interest rate that the Fed charges when it lends reserves to member banks.58. Which of the following policy tools of the Fed is utilized most frequently? Changes ina. the monetary baseb. the interest rate charged on loans to member banksc. reserve requirements applicable to deposits at member banksd. capital requirements imposed on member banks1059. Assume that banks hold excess reserves because the reserve requirement is small. Reducing thereserve requirement further will cause _____ in bank lending and _____ in the money supply.a. an increase, an increase c. no change, an increaseb. an increase, no change d. no change, no change60. If the Fed buys U.S. Treasury bonds from the publica. bond prices will fall. c. the monetary base will increase.b. interest rates will rise. d. the money supply will decrease61. If households and firms attempt to sell bonds, then bond price s will _____, and interest rates will_____.a. rise, rise c. fall, fallb. rise, fall d. fall, rise62. Suppose that in the next year or so, the inflation rate begins to rise, while real GDP grows at a healthyrate. The Fed would respond to this by _____ the growth rate of the money supply and _____ interestrates.a. reducing, raising c. increasing, raisingb. reducing, lowering d. increasing, lowering62'. Suppose real GDP stops rising and begins to fall, and the inflation rate also declines. The Fed wouldrespond to this by _____ the growth rate of the money supply and _____ interest rates.a. reducing, raising c. increasing, raisingb. reducing, lowering d. increasing, lowering63. Which of the following would increase equilibrium expenditure and income the most?a. Lump-sum taxes are cut by $100 million.b. Government purchases are increased by $100 million.c. A balanced-budget increase in government purchases of $100 million.d. Lump-sum taxes are cut by $100 million and government purchases are increased by $100million.63'. (continued) Which would increase equilibrium expenditure and income the least?64. Taxes collected by the government are _____, and transfer payments made by the government tohouseholds are _____.a. procyclical, procyclical c. countercyclical, procyclicalb. procyclical, countercyclical d. countercyclical, countercyclical65. Which of the following economies (that are otherwise identical) would experience the largest declinein income if investment decreases? A(n) _____ economy in which taxes are _____a. closed, lump-sum c. open, lump-sumb. closed, proportional d. open, proportional66. Suppose federal government spending has just increased due to a large military operation abroad.Simultaneously, the Fed reduces the money supply. As a result, income ____ and interest rates ____.a. may rise or fall, fall c. rises, may rise or fallb. may rise or fall, rise d. falls, may rise or fall1167. How can the government (the federal government and the Fed) reduce equilibrium expenditure andincome without pushing interest rates either up or down? It should utilize _____ monetary policytogether with _____ fiscal policy.a. expansionary, expansionary c. expansionary, contractionaryb. contractionary, contractionary d. contractionary, expansionary67'. How can the government (the federal government and the Fed) lower interest rates without changingequilibrium expenditure and income? It should utilize _____ monetary policy together with _____fiscal policy.a. expansionary, expansionary c. expansionary, contractionaryb. contractionary, contractionary d. contractionary, expansionary68. In the last decade (2000-10), the Japanese government cut taxes and increased government purchases.What effect will this have on interest rates in Japan?a. Interest rates will rise.b. Interest rates will fall.c. There should be very little effect on interest rates.d. The effect on interest rates cannot be predicted.69. Crowding out occurs whena. an increase in investment increases income and the trade deficit.b. investor pessimism causes investment to fall.c. an increase in investment increases income, which increases money demand.d. an increase in government spending or the budget deficit causes interest rates to rise andinvestment to fall.70. Taxes and transfer payments are referred to as automatic stabilizers becausea. when real GDP falls below potential, net taxes automatically fall, which helps stimulate arecovery of real GDP.b. taxes and transfer payments automatically adjust to balance the government budget.c. when taxes and transfers fall, income increases, which reduces the balance of trad e.d. all of the above.Problems(30 points)1. Below are the up-front costs and future revenues of the three possible projects in which a firm couldinvest.RevenuesUp-front cost One year Two years Three yearsProject #1 450 100 200 300Project #2 500 300 200 100Project #3 475 600a. Which of these projects (if any) are profitable at r =.07? What about at r =.12?b. What is the value of investment at r =.07? At r =.12?c. Suppose there are three identical firms in the economy (the firm in this problem plus two more thathave exactly the same set of three possible projects). Graph the two points on the economy?sinvestment demand curve corresponding to r =.07 and r =.12.12(40 points)2. Using a graph of the market for ?loanable funds? (the demand for investment and the supply of nationalsaving), analyze the effect (if any) of each of the following on (i) investment demand, (ii) national saving,(iii) the real interest rate, and (iv) the quantities of investment and national saving. Be sure to state anyassumptions you make that are part of your answer. (On an exam, this question would have only twoparts, not four.)a. US government purchase increase temporarily due to the war in Iraq (assume this is a ?balanced-budget? increase in government purchases).b. The US government cuts this year?s taxes, without changing government purchases either this year orin future years. (This implies future taxes will have to increase.)c. US real GDP is temporarily high due to favorable weather conditions.d. A burst of technological progress increases the profitability of investment (in other words, it increasesthe future revenues deriving from investment projects).(40 points)3. Suppose the world consists of two economies. Call them North and South. North has been industrializedfor decades. South is less developed and its real GDP per person is much less than in North. To begin,both North and South have a current account balance of zero (neither is lending to or borrowing from theother).Starting from this initial situation, North develops a large government budget deficit that is expected totake many years to reduce. This is due to mandated social insurance benefits for an aging population.At the same time, South starts growing rapidly. Its population expected rising living standards (higherreal GDP per person) into the future.a. Represent the initial situation graphically, using graphs of the markets for loanable funds in North andSouth.b. Suppose the only ?shock? were North?s government budget deficit. Assume less than completeRicardian Equivalence. Show the effects on the world real interest rate, and on the current accountbalances of North and South.c. On new graphs, re-draw the initial situation. Suppose instead that the only ?shock? were South?s rapideconomic growth. Show the effects on the world real interest rate, and on the current accountbalances of North and South.d. Now consider the effects of both ?shocks? simultaneously. Do we know the impact on the currentaccount balances of North and South? Explain. Do we know the impact on the world real interestrate? Explain.13(50 points)4. Consider the following economy:Goods market Market for moneyC = 250 +.75 YD MD = 12,000 +.25Y ? 10,000(r +?)YD = Y ? T M = 15,000T = 1000 +.1 Y P = 1I = 5000 ? 5000r? = 0G = 3000EX = 1500IM =.075 YThe reserve requirement is.1. Banks hold no excess reserves. Households and firms hold all of theirmoney in the form of bank deposits (?no currency drain?).a. Suppose the value of the real interest rate (r) is.2. What is the value of equilibriumexpenditure/income (Y)?b. Is the ?market for money? in equilibrium when the real interest rate (r) is.2, and income (Y) is at thislevel (from part a)? Show how you know whether it is, or is not.Parts c ? f are cumulative.c. Start from the values of Y and r in part a (however, note that you can answer parts c ? f correctly evenif part a is incorrect). The Fed wants to increase equilibrium expenditure (Y) by 1000 using monetarypolicy. How much does investment expenditure (I) need to increase?d. How much does the real interest rate (r) need to fall?e. How much will the increase in income of 1000 together with the decline in the real interest rate (frompart d) increase the quantity of real money demanded (MD = M/P demanded)? By how much must thenominal money supply (M) increase?f. What value of government bonds should the Fed buy/sell?Parts g ? j are cumulative.g. Go back to the levels of Y and r in part a (but you can answer parts c ? f correctly even if part a isincorrect). The government wants to increase aggregate expenditure by 1000 using fiscal policy.Specifically, the government intends to increase G. Assuming the policy is successful (Y increases by1000), what change in r will result?h. Give the change in I caused by the change in r (from part g).i. Give the increase in autonomous expenditure that is necessary for Y to increase by 1000. Taking thechange in I into account (from part h), by how much should the government increase G?j. Suppose the government decides to increase Y by 1000 using a cut to lump-sum taxes (T0), instead ofan increase in G.k. (extra credit) Go back to the levels of Y and r in part a (but you can answer this question correctly evenif part a is incorrect). The economy has been hit by negative shocks to exports and investment.Exports decline by 100. In addition, investor pessimism decreases investment demand from I = 5000 ? 5000r to I = 4900 ? 5000r. The government decides to cut lump-sum taxes (T0) to stabilizeincome (Y) at the level in part a (i.e., so income does not change from part a). How much should thegovernment cut lump-sum taxes?14(20 points)5. The following table gives consumption and private saving at various levels of income and net taxes.Consumption (C) Saving (Spr) Income (Y) Net Taxes (T)3,000 ? 2,500 0 ? 5009,800 ? 800 10,000 1,00016,600 900 20,000 2,50023,400 2,600 30,000 4,00030,200 4,300 40,000 5,500a. Calculate the marginal propensity to consume out of disposable income (MPC).b. Derive the equation for the consumption function for this household.c. Calculate the average propensity to consume (APC) at each level of disposable income. Does the APCof this household increase or decrease as disposable income increases?d. Derive the tax function (equation giving net taxes as a function of income).(15 points)6. You decide to purchase a government bond that pays $5000 in one year. This bond makes no interestpayments.a. Suppose you pay $4587.16 for this bond. What is the annual yield (rate of return) you will receive onthis bond?b. Suppose the best annual interest rate you can obtain on another investment that has similar risk is 8%.What is the maximum price you should be willing to pay for the bond in part a?c. A friend buys a perpetuity that pays $100 each year forever. His alternative best investment is thesame as yours. What is the maximum price he should be willing to pay for this bond?In your calculations, give dollar values in cents, and round yields to ?thousandths? (for example,.073 or7.3%).

 

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