Download Exam I from Spring 2006 with answers

EXAM I
ECON 3900
SPRING 2006
NAME (PRINT): ____________________________
Part I – 30%
1)
Simply Fill out the tables below
a) (10%)
Employment
Unemployed
LFPR
Unemployment Rate
Labor Force
Adult Population
24000000
3000000
75%
11.1%
27,000,000
36,000,000
b) (20%) Please keep the level of precision to 1/1000
Year
1
2
3
4
5
Px
Py
Price Index
w* = 0.70
w=0.30
use year 5 as
base year
10
11
12
13
15
20
17
20
25
20
0.787879
Inflation
N/A
0.775758
-0.01538
0.872727
0.125
1.006061
0.152778
1
-0.00602
Part II (30% - 6% for each part)
1)
Economy in the Long-Run
Assume the following information:
Factor Endowments: L = 250,000, K=10,000
Production technology is described by the following function: Y(L,K)= (L^0.5) * (K^0.5)
Consumption Function is: C = 10000 + 0.70 * ( Y – T )
Investment Function is: I = 7000 – 500 * r
Government Spending is G = 5000
Taxes are T = 10000
a) What is the level of output (Recall the economy is in the long-run):
50,000
b) What is the interest rate?
10%
c) What if T is reduced to 5000? What will the output and interest rate levels be
then?
Y = 50,000
r = 7%
d) What if both, T and G are set to zero, what will the interest rate be then?
4%
e) What is the MPS in this economy?
0.3
Part III
1)
True/False (explain) (30% - 10% each part)
a)
If Autonomous consumption is made a function of the interest rate (for instance, if
the consumption function in part II were to change to C = 11000 – 100*r + 0.7 * ( Y – T )
then the marginal propensity to save will increase.
FALSE, autonomous component of the consumption function is independent of the
current income. MPS measures the fraction of the change in income that will be directed
into saving, and thus is unaffected. Mathematically, the introduction of the interest rate
does not impact the induced component of consumption, and the MPC stays unchanged.
Unless you could change the MPC, MPS remains unchanged.
b)
Some argue that the US savings rate is dropping into negative range. If the
savings rate turns negative the MPS must become negative also.
FALSE. The savings rate can turn negative because the income drops or autonomous
consumption increases, and hence MPS need not be affected at all. Furthermore, in order
for our model to produce an outcome, we must have MPS>0.
c)
Even when capital purchases are financed with cash, interest rate should be
considered as an important cost of capital, while another important cost components is
the economic depreciation.
TRUE. Interest rate acts as the opportunity cost of invested funds and in the case of cash
financing, it is the implicit cost component. In addition to the interest rate, another cost
component is the change in the market value, i.e. economic depreciation.
2) Short answer – Please provide a brief (2-5 sentence answer) (10% )
a)
In 2002 the growth in the Gross Domestic Investment spending returned to
positive levels in the US, yet employment growth remained negative throughout 2002
and all the way into the late Summer of 2003. Does that imply that the Gross Domestic
Investment Spending is not impacting job growth, or can there be another explanation
behind this paradox, perhaps in the data itself?
This is primarily due to the fact that the Gross Domestic Investment includes residential
housing investment. During the course of 2001-03 the sharp drop in the interest rates
stimulated growth in the housing investment, but housing investment does not provide
favorable ground for long term employment growth. In the short-run, it does support
employment growth in construction employment, but long-term possibilities are limited.
It is the investment into the productive capital by businesses that leads to employment
growth, and during this time period the growth in this type of investment was persistently
negative. One main component of that is the investment into non-residential structures
which did not return to positive growth until the end of the summer of 2003. In fact,
shortly after the return to positive growth in this investment spending, positive
employment growth returned.
Extra Credit (2% if you get it right, -1% if you attempt and get it wrong): In the context
of the Classical theory the government spending/taxation has no impact on the long-run
outcome. Yet, there is clearly a place for the government in the economy even in the
context of the Classical theory. Could you please state two examples of when government
spending will impact the long-run equilibrium?
Education
Infrastructure
You could have also mentioned various public goods, provision of institutional support in
the economy, correction for externalities….