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Agricultural Economics 430 Macroeconomics of Agriculture Fall 2008 Penson First Hour Examination September 18, 2008 NAME:_______ANSWER KEY___________________________ This examination consists of five questions. Please read each question carefully. The term “describe fully” asks that you answer all aspects of the question. Avoid giving extraneous information (i.e., “filler”). Use graphs/formulas whenever possible to help tell your story. Make sure you fully label all graphs. Use the back of the page if necessary. Question 1 _____ of 20 points Question 2 _____ of 25 points Question 3 _____ of 20 points Question 4 _____ of 20 points Question 5 _____ of 15 points TOTAL _____ of 100 points 1 1. Given the following model for planned consumption expenditures, please answer the questions below: Ct = 140 + 0.95(Yt - Tt) where: Ct Total planned consumption expenditures in year t Yt Personal income in year t Tt Total personal taxes due in year t Gt Total government spending in year t and where: Yt = 1,200 Tt = 50 + 0.25(Yt-1) Gt = 250 (Show all work for full credit) a. If personal income last year was $800, what is the level of total consumption expenditures in the current year (year t)? (10 points) Tt = 50 + 0.25(800) = 50 + 200 = 250 Ct = 140 + 0.95(1,200 – 250) = 140 + 0.95(950) = 1,042.5 St = Yt – Tt –Ct = 1,200 – 250 – 1,042.5 = - 92.5 b. How much would consumption expenditures and savings in the economy change if the income tax rate was 30 percent instead of 25 percent? (8 points) Tt = 50 + 0.30(800) = 50 + 240 = 290 Ct = 140 + 0.95(1,200 – 290) = 140 + 0.95(910) = 1,004.5 Therefore consumption fell from 1,042.5 to 1,004.5 St = Yt – Tt –Ct = 1,200 – 290 – 1,004.5 = - 94.5 Therefore saving fell from -92.5 to -94.5 c. What is the marginal propensity to save in year t? (2 points) The marginal propensity to save is .05 or 5 cents per dollar. 2 2. Given the following demand and supply equation for a market, please answer the questions below: QD = 100 –2(P) + 2.5(Y – T) QS = 20 +4(P) where P represents price of the product, Y represents personal income and T represents personal taxes. Assume disposable personal income in 2007 in this economy was $700 and is projected to be 10 percent higher in 2008. (Show all work for full credit) a. What equilibrium price and quantity would you expect in this market in 2008? (10 points) 100 - 2(P) + 2.5(Y-T) = 20 + 4(P) 100 + 2.5(1.10 x 700) – 20 = 6(P) 100 + 2.5(770) – 20 = 6(P) 6(P) = 2,005 Q = 20 + 4(334.17) P = 334.17 Q = 1,357. b. If Congress enacts a tax increase in 2007 that cuts disposable personal income by 10 percent, what price would you expect in 2008? How much would the quantity demanded by consumers in this market change as a result of this tax hike? (10 points) 100 + 2.5(.90 x 770) – 20 = 6(P) 100 + 2.5(693) – 20 = 6(P) 6(P) = 1,812.5 Q = 20 + 4(302.08) P = 302.08 Q = 1,228 therefore ∆Q = - 122.9 c. What is the income elasticity over this range of the demand curve for this market? (5 points) %∆Q = (1,228 – 1,357)/1,357 = -122.9/1,357 = -.09056 %∆Y = -10.0% EY = %∆Q/%∆Y = -.09056/-.10 = 0.9056. 3 3. Please define or graphically illustrate each of the following terms. Make sure you correctly label all graphs used in your answers: (4 points each) % of original capacit y Capacity depreciation One Hoss Shay Straight line Geometric Decay 0 Service life Life cycle hypothesis of consumption This reflects the observation that young consumers tend to have a much higher level of consumption that older consumers. Their number of remaining earning years is greater. Recessionary GDP gap Recessionary gap = YE < YFE You could also have drawn the aggregate demand and supply curves to illustrate this relationship Price Autonomous consumption S2 S1 1 Bottleneck in supply Draw graph to right or explain or state that actual output is less than economic capacity D P2 Bottleneck P1 Actual output Economic capacity Engineering capacity Intercept of the consumption curve or level of consumption if disposable income was equal to zero. 4 4. Given the following equation for total investment expenditures, please answer the questions below: It = 500 – 20(it) where: It Total investment expenditures in year t Kt-1 Capital stock at the start of year t Dt Depreciation in year t it Interest rate in year t and where: Dt = 100 Kt-1 = 1,000 (Show all work for full credit) a. What is the level of net investment expenditures if interest rate is 5 percent? (HINT: use 5.0 rather than 0.05) (8 points) It = 500 – (20(5) = 500 – 100 = 400 NIt = 400 – 100- = 300 b. What is the level of the capital stock at the end of year t? (6 points) Kt = Kt-1 + NIt = 1,000 +300 = 1,300 c. Describe the factors that influence the desired capital stock at the end of the year. What is the relationship between the desired capital stock and the level of investment expenditures in the current year? (6 points) K*t = β[E(Pt) x E(Ot)]/E(Ct) or expected revenue and the expected cost of capital (which includes the cost of debt and equity capital, tax and capacity depreciation, the purchase price of the asset and the income tax rate). K*t = Kt-1 +It - Dt 5 5. We discussed the macro-to-market-to-micro linkage in the economy. Assume conditions of perfect competition. Please illustrate the effects that a tax cut passed by Congress and sighed by the President would have upon the price of price of corn received by a corn farmer. Make sure you correctly label all graphs. (15 points) To answer this question, I would a. Draw the consumption graph showing a increase in consumption expenditures by consumers. b. Draw the market demand and supply curves for the corn market showing the demand curve shifting to the right as disposable income increases and price of corn rising. c. Draw the MR and MC curves for a perfectly competitive corn producer showing the increase in production in respond to the higher price taken from the corn market I will illustrate this in class.