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Exam 1 ndash Econ 304 ndash Chuderewicz ndash Fall 2014
Name ______________________________ Last 4 (PSU ID) __________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
Approximately one minute for every two points
To help with time management if spreading time evenly
Question 1 = 60 points 30 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 50 points 25 minutes
1
Please answer all questions You must show all work or points will be taken off
1 (60 points total) This question was motivated by the comic below from October 4 2014
We have two consumers Dagwood and Dagwoods barber who we will refer to from this point on as The Barber Dagwood and The Barber both prefer to perfectly smooth consumption consistent with the lifetime theory of consumption The initial conditions are the same for both consumers and are as follows
Y (current income) = 300K a (current wealth) = 0 Yf (expected future income) = 150Kaf ( expected future wealth) = 100Kr (the current real rate of interest) = -05 (negative 5)
a) (5 points) Calculate Dagwood and The Barbers optimal consumption bundle showing all work Since conditions are exactly the same for both consumers you only need to do this calculation once
2
(20 points total) Now draw two completely labeled diagrams (the two period consumption model) depicting these initial optimal consumption bundles as points CA Please put the diagrams next to each other with the left diagram representing Dagwood and the right diagram representing The Barber Note that CA is exactly the same for both consumers
10 points for each correct and completely labeled diagram
As you can tell from the comic above The Barber is very optimistic about his 401K plan which is his retirement money - representing expected wealth = af As such The Barbers expected wealth has gone up to 200K (from 100K) Dagwood on the other hand is not so excited about the future since his retirement money is in bonds not stocks so his expectation of future wealth does not change
b) (5 points) Calculate The Barbers new optimal consumption bundle showing all work and label as point CB on the diagram representing The Barber
3
Given the most recent payroll report (below) and the long and variable effectiveness lag in monetary policy Janet Yellen and the Fed decide to raise real rates of interest to 10 (10) This is the new real rate of interest faced by both consumers
c) (5 points) Calculate Dagwoodrsquos new optimal consumption bundle depicting his new optimal consumption bundle as point CB
d) (5 points) Calculate The Barbers new optimal consumption bundle depicting his new optimal consumption bundle as point CC
4
e) (10 points) Compare the reaction of Dagwood and The Barber in terms of the change in their current period consumption given the rise in the real interest rate all else constant (this is after The Barber changes his af) Be sure to refer to the substitution and income effects and how they are similardifferent for each consumer
In the space below draw the savings functions for both consumers side by side as you did for the two period consumption model (Dagwood on left The Barber on right)
10 points total (5 points each) for correct and completely labeled diagrams
5
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Please answer all questions You must show all work or points will be taken off
1 (60 points total) This question was motivated by the comic below from October 4 2014
We have two consumers Dagwood and Dagwoods barber who we will refer to from this point on as The Barber Dagwood and The Barber both prefer to perfectly smooth consumption consistent with the lifetime theory of consumption The initial conditions are the same for both consumers and are as follows
Y (current income) = 300K a (current wealth) = 0 Yf (expected future income) = 150Kaf ( expected future wealth) = 100Kr (the current real rate of interest) = -05 (negative 5)
a) (5 points) Calculate Dagwood and The Barbers optimal consumption bundle showing all work Since conditions are exactly the same for both consumers you only need to do this calculation once
2
(20 points total) Now draw two completely labeled diagrams (the two period consumption model) depicting these initial optimal consumption bundles as points CA Please put the diagrams next to each other with the left diagram representing Dagwood and the right diagram representing The Barber Note that CA is exactly the same for both consumers
10 points for each correct and completely labeled diagram
As you can tell from the comic above The Barber is very optimistic about his 401K plan which is his retirement money - representing expected wealth = af As such The Barbers expected wealth has gone up to 200K (from 100K) Dagwood on the other hand is not so excited about the future since his retirement money is in bonds not stocks so his expectation of future wealth does not change
b) (5 points) Calculate The Barbers new optimal consumption bundle showing all work and label as point CB on the diagram representing The Barber
3
Given the most recent payroll report (below) and the long and variable effectiveness lag in monetary policy Janet Yellen and the Fed decide to raise real rates of interest to 10 (10) This is the new real rate of interest faced by both consumers
c) (5 points) Calculate Dagwoodrsquos new optimal consumption bundle depicting his new optimal consumption bundle as point CB
d) (5 points) Calculate The Barbers new optimal consumption bundle depicting his new optimal consumption bundle as point CC
4
e) (10 points) Compare the reaction of Dagwood and The Barber in terms of the change in their current period consumption given the rise in the real interest rate all else constant (this is after The Barber changes his af) Be sure to refer to the substitution and income effects and how they are similardifferent for each consumer
In the space below draw the savings functions for both consumers side by side as you did for the two period consumption model (Dagwood on left The Barber on right)
10 points total (5 points each) for correct and completely labeled diagrams
5
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
(20 points total) Now draw two completely labeled diagrams (the two period consumption model) depicting these initial optimal consumption bundles as points CA Please put the diagrams next to each other with the left diagram representing Dagwood and the right diagram representing The Barber Note that CA is exactly the same for both consumers
10 points for each correct and completely labeled diagram
As you can tell from the comic above The Barber is very optimistic about his 401K plan which is his retirement money - representing expected wealth = af As such The Barbers expected wealth has gone up to 200K (from 100K) Dagwood on the other hand is not so excited about the future since his retirement money is in bonds not stocks so his expectation of future wealth does not change
b) (5 points) Calculate The Barbers new optimal consumption bundle showing all work and label as point CB on the diagram representing The Barber
3
Given the most recent payroll report (below) and the long and variable effectiveness lag in monetary policy Janet Yellen and the Fed decide to raise real rates of interest to 10 (10) This is the new real rate of interest faced by both consumers
c) (5 points) Calculate Dagwoodrsquos new optimal consumption bundle depicting his new optimal consumption bundle as point CB
d) (5 points) Calculate The Barbers new optimal consumption bundle depicting his new optimal consumption bundle as point CC
4
e) (10 points) Compare the reaction of Dagwood and The Barber in terms of the change in their current period consumption given the rise in the real interest rate all else constant (this is after The Barber changes his af) Be sure to refer to the substitution and income effects and how they are similardifferent for each consumer
In the space below draw the savings functions for both consumers side by side as you did for the two period consumption model (Dagwood on left The Barber on right)
10 points total (5 points each) for correct and completely labeled diagrams
5
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Given the most recent payroll report (below) and the long and variable effectiveness lag in monetary policy Janet Yellen and the Fed decide to raise real rates of interest to 10 (10) This is the new real rate of interest faced by both consumers
c) (5 points) Calculate Dagwoodrsquos new optimal consumption bundle depicting his new optimal consumption bundle as point CB
d) (5 points) Calculate The Barbers new optimal consumption bundle depicting his new optimal consumption bundle as point CC
4
e) (10 points) Compare the reaction of Dagwood and The Barber in terms of the change in their current period consumption given the rise in the real interest rate all else constant (this is after The Barber changes his af) Be sure to refer to the substitution and income effects and how they are similardifferent for each consumer
In the space below draw the savings functions for both consumers side by side as you did for the two period consumption model (Dagwood on left The Barber on right)
10 points total (5 points each) for correct and completely labeled diagrams
5
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
e) (10 points) Compare the reaction of Dagwood and The Barber in terms of the change in their current period consumption given the rise in the real interest rate all else constant (this is after The Barber changes his af) Be sure to refer to the substitution and income effects and how they are similardifferent for each consumer
In the space below draw the savings functions for both consumers side by side as you did for the two period consumption model (Dagwood on left The Barber on right)
10 points total (5 points each) for correct and completely labeled diagrams
5
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole costs 800 fishing hours (this is your output) and the rate of depreciation is 8 (008)
The real interest rate is 2 (02)
The expected marginal product of capital is given by
MPKf = 200 ndash 2K
Initially there is no tax on capital so tao (τ) = 0 but this will change
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
6
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
c) Now conditions change The following two shocks occur simultaneously
i) the government imposes a 20 tax on capital so tao (τ) goes from zero to 20 (20)
ii) the expected marginal product of capital changes and is now MPKf = 230 ndash 2K
Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
7
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in tao (τ) and MPKf Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
8
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 6 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
9
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 28 + 9w K goes down from 10 to 8
b) (5 points) What could cause such a change in labor supply Please give two specific and well supported reasons
10
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
c) (10 points) Given the change in NS and K repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 100 + 50(Y-T) ndash 500rId = 796 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
11
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 455 ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give two specific and well supported reasons
12
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
f) (10 points) Given these changes (ie changes in K Y and Id note the new Id = 455 ndash 500r) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
g) (10 points) Considering this entire problem are your results consistent with the Great Recession - why or why not Please be as specific as possible with regard to the changes in your savings function investment function and the change in labor supply Be sure to connect what happened to these 3 functions in this problem to the real world
13
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
4 (50 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 280 + 04(Y-T) ndash 200rw
Id = 150 ndash 200rw
Y = 1000T = 200G =325
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 225 ndash 300rw
YF = 1500TF = 300GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
14
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain (10 points)
15
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams (there are four point Arsquos two on each diagram) Be sure to label diagram completely
10 points for correct and completely labeled diagrams
Now the US experiences a positive productivity shock As a result output in the US goes up to 1050
d) (10 points) Resolve for the world real interest rate that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B (there are four of them) (10 points)
16
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
e) (5 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific
17
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Exam 1 ndash Econ 304 ndash Chuderewicz ndash Spring 2015
Name ______________________________ Last 4 (PSU ID) __________
Section Please Check
Sparks ______________
Keller ______________
PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET ndash ONLY NON-PROGRAMMABLE CALCULATORS ALLOWED THANKS AND GOOD LUCK
Total Points for exam = 240
Test time = 120 minutes
One minute for every two points
To help with time management if spreading time evenly
Question 1 = 55 points 28 minutes
Question 2 = 50 points 25 minutes
Question 31 = 35 points 17 minutes
Question 32 = 45 points 22 minutes
Question 4 = 55 points 27 minutes
18
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Please answer all questions You must show all work or points will be taken off
1 (50 points total) Suppose we have Dagwood who has a current income of $600K and expected future income of $300K He has zero in current wealth and zero in expected wealth
Dagwoodrsquos behavior is consistent with the life-cycle theory of consumption For one he perfectly smoothes consumption and two since he is in his peak earning years he is saving now so that he can maintain his current level of consumption in the future Given that Dagwood faces a real interest rate of negative 5 (- 0 05) Please answer the following questions
a) (5 points) Calculate Dagwoodrsquos optimal consumption bundle showing all work Then draw a completely labeled graph (the two period consumption model) depicting this initial optimal consumption bundle as point CA
(10 points for a completely labeled graph ndash be sure to label the no lending no borrowing point(s) = NLNB and the slope of the budget constraint(s))
19
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
b) (5 points) Janet Yellen and the Fed are finally happy with the way the economy is headed and to be honest is now fearful of overheating As such the Fed tightens and the real rate of interest rises to 5 (005) Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CB
c) (10 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here Be sure to define what the income and substitution effects are and how they play a role in Dagwoodrsquos decision to alter his previously optimal bundle (we are comparing part a) to part b)) Also comment on whether these income and substitution effects work in the same or opposite direction (ie is it a tug of war or do they work in the same direction) in this particular case
20
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
d) (5 points) Now Dagwood goes to the doctor and finds out that he is not as healthy as he thought (too many eating binges) The doctor tells him that he is fine now but next period he is likely to be ill and that if you had anything in life that you really wanted to do (as in leisure) you should do it now As a result Dagwoods preferences change so that he prefers to consume like our friend Homer that is Dagwood prefers to consume twice as much today relative to next period Resolve for Dagwoods optimal consumption bundle given these new preferences and label as point CC (this is of course after the Fed raised rates to 5)
e) ( 5 points) Janet Yellen and the Fed are again really happy with incoming economic data and are very much worried about overheating and raise real rates again to equal 10 (10) Given his change in preferences as above in part d) recalculate the optimal bundle for Dagwood and add this point to your graph and label as point CD
21
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
f) (5 points) Did the Fed policy of raising interest rates work in term of lowering current consumption consistent with preventing overheating Explain being sure to discuss exactly how the substitution and income effects play a role here
g) (5 points) In the space below derive and draw Dagwoods savings function (this is after Dagwood went to the doctor ie use the information from parts d) and e) only
h) (5 points) Given your results from part d) and e) above what are the implications as to the power of monetary policy with regard to influencing consumption Assume that there are many consumers in the economy just like Dagwood after he went to the doctor Please explain
22
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
2 (50 points total) You own a fleet of offshore fishing boats and you need to determine how many fishing poles you need to buy to maximize profits Please answer the following questions given the information below Please be sure to SHOW all work
A brand new fishing pole cost 2000 fishing hours (this is your output) and the rate of depreciation is 5 (005)
The real interest rate is 5 (05)
And the expected marginal product of capital is given by MPKf = 400 ndash 10K
There is a tax on capital so tao (τ) = 20 (20)
a) What is the (tax adjusted) user cost of capital and what is this user cost expressed in (Show work) (5 points)
b) How many fishing poles should you buy to maximize profits Show work (5 points)
Draw a ucK graph depicting the state of affairs and label this initial profit maximizing condition as point A
A correctly drawn and completely labeled diagram is worth 10 points
23
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Now conditions change The following two shocks occur simultaneously
i) the US $ depreciates and since you buy your poles from abroad the poles become more expensive and now cost 2400 fishing hours
ii) the expected marginal product of capital changes and is now MPKf = 420 ndash 5K
c) Resolve for K and show as point B on your ucK diagram ( 5 points)
d) Given the two shocks as above explain the intuition underlying the change in the profit maximizing level of fishing poles (ie why does the firm change its behavior) making sure you refer to the firmrsquos profit maximizing condition (write it out) Be specific and write this like you were a professional economist Be sure to compare the actual user cost to the actual MPKf after the shocks holding K constant at its level from part b) (10 points)
24
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
e) ) Suppose that the Federal Reserve had a goal to get the capital stock (the number of fishing poles purchased) back to its initial level as in part b Given the two shocks as above what would they have to do to the real rate of interest to achieve their objective Please show all work and I am looking for a specific number (ie r = ) Please add this development to your diagram as point C (5 points)
f) Finally draw a desired investment diagram (completely labeled with the relevant shift variables (with the appropriate values as in τ = 20 etc) noted next to the function in parentheses) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A) Label the initial level of desired investment as Id
A Note importantly that we do not have numbers for desired investment but thatrsquos ok we are focusing on the change in desired investment Then show as point B the level of desired investment after the change in the price of capital and the change in the expected MPK Finally show how the Fed policy maps to your investment diagram and label as point C with the corresponding level of investment labeled as Id
C
A completely labeled and correct diagram is worth 10 points (make sure you include the relevant shift variables in parentheses or points will be taken off)
25
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
3 PART 1 (35 points total for this part) This problem is broken into two parts that are totally connected to each other In this first part of the question you apply Chapter 3 (labor mkt etc) material and in PART 2 you get to use Chapter 4 (goods market equilibrium) material Please take all calculations to two decimal places where appropriate except with real interest rate calculations (PART 2) where you need to take the calculation to three decimal places if appropriate PLEASE SHOW ALL WORK AND COMPLETELY LABEL ALL DIAGRAMS
The following equations characterize a countryrsquos closed economy
P roduction function Y = AKN ndash N22Marginal product of labor MPN = AK ndash N
where the initial values of A = 8 and K = 10
The initial labor supply curve is given as NS = 20 + 9w
a) (10 points) Find the equilibrium levels of the real wage employment and output (show work)
26
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
In the space below draw two diagrams vertically with the labor market on the bottom graph and the production function on the top graph Be sure to label everything including these initial equilibrium points as point A
(10 points for completely labeled and correct diagrams)
27
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
We now have numerous changes to our economic conditions (all is not constant) Think of all these changes happening together that is we go from one state of economic affairs to a different state of economic affairs Below are the changes
The labor supply changes and is now NS = 30 + 9w A goes up from 8 to 9
b) (5 points) Given the change in NS and A repeat part a) (ie find the equilibrium levels of the real wage employment and output) Add these results to your labor market and production function diagrams respectively and label as point(s) B Be sure to label the diagram completely with the relevant shift variables in parentheses next to the function
c) (10 points) Why exactly did the firm change their behavior To answer calculate the MPN and w at the same N and compare Then explain what the firm does and why and what the worker does and why This questions is worth 10 points so please be specific and complete
28
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
3 PART 2 (NEW GRADER ndash 45 points total for PART 2)
Before we start this problem put the initial Y as computed in part a) here ____________
And the new Y (after the change in conditions) here ___________
Initial conditions in the goods market
Cd = 1001 + 50(Y-T) ndash 500rId = 590 ndash 500rG = 100T= 100
d) (10 points) Given the initial conditions solve for the equilibrium real rate of interest (that clears the goods market) and the associated levels of desired savings and desired investment
Draw a Sd = Id diagram in the space below locating this initial equilibrium as point A
10 points for correct and completely labeled diagram (be sure to put relevant shift variables in parentheses next to each function)
29
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
NOW WE TAKE INTO ACCOUNT THE CHANGES FROM PART 1 ALONG WITH A CHANGE IN DESIRED INVESTMENT
The desired investment function changes and is now Id = 715 ndash 500r The consumption function is now Cd = 1301 + 50(Y-T) ndash 500r
e) (5 points) What could cause such a change in the desired investment function Please give three specific reasons
f) (10 points) Given these changes (ie changes in A Y Id and C) calculate the new equilibrium levels of the real interest rate desired savings and investment Please add this new equilibrium point to your diagram and label as point B
30
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
g) (10 points) - (5 points for discussion and 5 points for correct and completely labeled diagram) Now it is time to apply your knowledge of the 2 period consumption model to this problem In the space below draw and use the two period consumption model and depict the movement from point A to point B Assume that the consumer is a borrower and a perfect smoother so the no-lending no-borrowing point is to the left (west) of the consumption points Be sure to calculate the actual level of consumption before (point A) and after (point B) all the changes and add these actual numbers to your graph Explain why your graph changed the way it did Make sure you label your graph completely Now the discussion Are the results with regard to the change in income change in consumption and the change in investment consistent with the economy heading into a recession or consistent with the economy in the midst of a recovery Please explain and be as specific as possible
31
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
4 (55 points total) We assume that the world consists of two large open economies USA and China
USA Initial Conditions
Cd = 400 + 04(Y-T) ndash 200rw
Id = 420 ndash 200rw
Y = 2000T = 200G =500
China Initial Conditions
CdF = 480 + 4(YF ndash TF) ndash 300rw
IdF = 370 ndash 300rw
YF = 1600TF = 400GF = 300
a) What is the equilibrium interest rate that clears the international goods market Show all work (10 points)
32
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
b) Now calculate the levels of desired savings and investment for each country at this equilibrium world real interest rate (5 points)
c) Which country is lsquospending beyond its meansrsquo and which country is the saver What exactly do we mean by the phrase lsquospending beyond its meansrsquo in this context Be sure to define and use the word absorption in your answer and compare the level of absorption (specific with each component of absorption) in each country to its income Explain (5 points)
33
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams Be sure to label diagram completely with only the relevant shift variables in parentheses
15 points for correct and completely labeled diagrams
Now China experiences a shock to their desired investment function so that the new desired investment function in China is given by
IdF = 400 ndash 300rw
d) (10 points) Resolve for the world real interest rate that clears the international goods markets along with the lsquonewrsquo Sd and Id for each country and add these results to your diagram labeling this new equilibrium as point B on both of your diagrams (10 points)
34
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35
e) (10 points) Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria (the guest) suggested that we (the US) needed to go to alcoholics anonymous (AA) Are your results consistent with the US going to AA Why or why not Explain and please be specific as to what happened to absorption in the US and why
35