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MarcoEcon - ECON 3123 : Quiz 3
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Terms in this set (16)
Why might people with different credit limits respond differently to a tax rebate?
People with high credit limits are less likely to face binding borrowing constraints, and so are less likely to spend their tax rebate.
The trade-off between a person's current consumption and future consumption depends on the
The substitution effect of a higher real interest rate on consumption causes
The income effect of a higher real interest rate on consumption causes a
real interest rate.
consumers to substitute away from current consumption.
saver to increase current consumption.
The desire to have a relatively even pattern of consumption over time is known as the
If a person's income declines, the consumption-smoothing motive suggests that the person will
consumption-smoothing motive.
reduce consumption in both the current and future periods.
The equation for the expected real after-tax interest rate is
Suppose the expected real after-tax interest rate is ra−t = −0.02, the tax rate on interest income is t = 0.11, and the expected inflation rate is πe = 0.04.
The nominal interest rate equals 0.02. (Round your answer to two decimal places; keep your answer in decimals and do not convert it to percentage points.)
(1-t)i-π^e
0.02
How are desired consumption and desired saving affected by increases in current income, expected future income, and wealth?
When current income rises, desired consumption increases left parenthesis up arrow right parenthesis increases (↑) and desired saving increases left parenthesis up arrow right parenthesis increases (↑).
When expected future income rises, desired consumption increases left parenthesis up arrow right parenthesisincreases (↑) and desired saving decreases left parenthesis down arrow right parenthesis decreases (↓).
When wealth rises, desired consumption increases left parenthesis up arrow right parenthesisincreases (↑) and desired saving decreases left parenthesis down arrow right parenthesisdecreases (↓).
increases increases
increases decreases
increases decreases
Use the concepts of income effect and substitution effect to explain why the effect on desired saving of an increase in the expected real interest rate is potentially ambiguous. (Complete the table below).
Real Interest Rate Substitution Effect Income Effect Total (Net) Effect
Desired Saving (lender) Sd ________ ________ ________
Real Interest Rate Substitution Effect Income Effect Total (Net) Effect
Desired Saving (borrower) Sd ________ ________ ________
increases decrease ambiguous
increases increases increases
The price of a unit of capital is 1,000. The rate of depreciation is: 10% per year and the annual real rate of interest is: 5%
The equation for the expected future marginal product of capital is given as:
MPK = 1000 − 10K
1.) Using the line drawing tool, plot the user cost of capital line. Label this line 'uc'.
2.) Using the point drawing tool, locate the desired (equilibrium) capital stock. Label this point 'A'.
Carefully follow the instructions above, and only draw the required objects. The optimal quantity of capital is: 85 units (enter your response as an integer).
85
The equation for the marginal productivity of capital is given by:
MPKf
= 1000−10K.
Suppose the price of a unit of capital is $2000, the depreciation rate is 5% per year, and the real interest rate is 5% per year.
The user cost of capital (uc) = $200 (Round your answer to the nearest whole number.)
The desired capital stock (K*) = 8080. (Round your answer to the nearest whole number.)
If the existing level of capital Kt is equal to 60 units, the level of gross investment (It ) = 23.023.0 units. (Round your answer to one decimal place.)
200.
80
23.0
What are the two components of the user cost of capital?
The real interest rate and the rate of depreciation.
What is the desired capital stock?
The desired capital stock is the amount of capital that allows the firm to earn the largest possible profit.
Give two equivalent ways of describing equilibrium in the goods market.
Y = C^d +I^d + G and S^d = I^d
Explain why the saving curve slopes upward in the saving-investment diagram.
Explain why the investment curve slopes downward in the saving-investment diagram.
Higher interest rates provide higher returns for savers and also a higher opportunity cost of current consumption.
Higher interest rates increase the user cost of capital thus reducing the desired capital stock.
Why does desired investment fall as the real interest rate rises?
The user cost of capital increases, resulting in a smaller desired capital stock.
An economy has full-employment output of 6,000. Government purchases, G, are 1,000. Desired consumption and desired investment are
Cd
= 3,800−2,000r + 0.20Y, and
Id
= 1,200−3,000r,
where Y is output and r is the real interest rate.
a. Find an equation relating desired national saving, Sd, to r and Y.
Sd = −4800 + 2000 r + 0.8Y
b. Using the goods market equilibrium condition, find the real interest rate that clears the goods market. Assume that output equals full-employment output.
r = 24.0% (enter your response in percent rounded to one decimal place).
c.
Government purchases rise to 1,200. What is the new equilibrium real interest rate?
r'
= 28.0% (enter your response in percent rounded to one decimal
−4800 + 2000 r + 0.8Y
24%
28.0%
Analyze the effects of a temporary increase in the price of oil (a temporary adverse supply shock). Because the supply shock is temporary, you should assume that the expected future MPK and households' expected future incomes are unchanged. Assume throughout that output and employment remain at full-employment levels (which may change).
The effect on: current output decrease left parenthesis down arrow right parenthesisdecrease (↓), employment decrease left parenthesis down arrow right parenthesisdecrease (↓), and the real wage decrease left parenthesis down arrow right parenthesisdecrease (↓).
In the diagram to the right, show the effect of this shock.
Using the line drawing tool, show the effect of this shock. Properly label this line.
Carefully follow the instruction above, and only draw the required object. The real interest rate will increase left parenthesis up arrow right parenthesisincrease (↑).
Decrease Decrease Decrease
increase
Use the two-period model from the Appendix to answer this question.
Your current income is 40,000. Your next period (future) income is known to be 36,000.
If your current consumption expenditure is 32,000, your (current) level of savings S = 8000. (Enter your answer as a whole number.)
If the real interest rate is 15%, how much will you spend on consumption next period (assuming that your current consumption is 32,000)?
Your future consumption Cf = 45,200. (Enter your answer as a whole number.)
S = 8000
Cf = 45200
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