178.200 06-2

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178.200 Intermediate MacroeconomicsTutorial (2)

Basic Classical Model

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Short Answer Questions

1. In the national income accounting identity, show the equality between national saving and investment. What are the representations of private saving and public saving?

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Answer:

Starting with Y = C+I+G, subtract C and G from both sides, obtaining Y-C-G = I. The left hand side represents national saving, the total income of the economy that remains after paying for consumption and government purchases. Hence, substituting S for Y-C-G and obtain S = I.

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(continued)

To separate private and public saving, add and subtract T in S = Y-C-G, obtaining S = (Y-T-C) + (T-G). Here, (Y-T-G) represents private saving, the part of disposable income (Y-T) left after subtracting consumption, and (T-G), the government budget surplus represents public saving.

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2. Using a graph representing the market for loanable funds, show and explain what happens to interest rates and investment if the NZ government succeeds in balancing its budget.

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Answer:

If the NZ government succeeds in balancing its budget, there will be more public saving in the economy at each interest rate.

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Short Answer Questions(continued) The supply of loanable

funds curve will shifts from S0 to S1. The new equilibrium is at E1 with a lower interest rate r1 and a higher level of saving and investment q1. Hence, if the NZ government succeeds in balancing its budget, interest rates will fall and investment will increase.

Real Interest

Rate

r0

r1E1

E0

S0

S1

D

q0 q1 Quantityof Loanable

Funds

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True or False Questions

1.The real wage means that the return to labor is measured in units of dollars.

Answer: F

Hint: The real wage (W/P) is the return to labor measured in units of output rather than in dollars.

MPL = W/P

(See P48-50)

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2. Incremental labor units have a raising marginal productivity, ceteris paribus.

Answer: FHint: The marginal

product of labor decrease as the amount of labor increase. (See P50)

Output

L

MPLW/P

QL

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3. In the real world, the concept “economic profit” always contains both accounting profit and the return to capital.

Answer: F

Hint: Accounting Profit = Economic Profit + (MPK K)

(See PP51-52)

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4. If the MPC is 0.6, then households save 60 cents of each additional dollar of disposable income on goods and services and only spend 40 cents.

Answer: F

Hint: (See P54)

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5. The phenomenon “crowding out” to investment happened when the government increases the tax revenues.

Answer: FHint: An expansionary fiscal

policy adopted by government could induce crowding out investment.

(See P64)

r S2 S1

r2

r1 I(r)

I, S

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Multiple-Choice Questions

1. The variable that is held constant for a given production function is the:

a. amount of labor input. b. amount of output. c. amount of capital input. d. production technology.Answer: d.Hint: (See P45).

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Multiple-Choice Questions2. A competitive firm takes: a. the prices of its outputs as given, but not the

prices of its inputs. b. the prices of its inputs as given, but not the

prices of its outputs. c. the prices of both its inputs and its outputs as

given. d. neither the prices of its inputs nor the prices of

its outputs as given.Answer: c.Hint: (See P47).

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3. Constant returns to scale occurs when: a. output doubles when the amounts of all factor

inputs double. b. output remains constant over time. c. the marginal productivity of labor equals the

marginal productivity of capital. d. the marginal products of capital and labor do

not change.Answer: a.Hint: (See P45)

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4. The mathematical expression that gives a measure of productivity using a constant returns to scale production function is

a. xY = AF (L, K, H, N).b. Y/L = AF(1, K/L, H/L, N/L).c. Y/L = AF(xL, xK, xH, xN).d. L = AF(Y, K3, H, N).Answer: bHint: (See P45)

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Multiple-Choice Questions5. A profit-maximizing firm will hire labor up to

the point where: a. the marginal product of labor equals the marginal

product of capital. b. the marginal product of labor equals the real

wage. c. marginal revenue equals zero. d. the real wage equals the real rental price of

capital.Answer: b.Hint: (See P50).

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6. Which of the following transactions is viewed as investment in the national accounts?

a. you buy 100 shares of stock in IBM. b. you buy a computer to help your children do

their homework. c. IBM builds a new factory to manufacture

computers. d. you eat a Big Mac.Answer: c.Hint: (See P25).

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7. The interest rate on a loan depends on:

a. the term of the loan.

b. the riskiness of the loan.

c. the tax treatment of the loan.

d. all of the above.

Answer: d.

Hint: (See P57).

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8. With total output fixed and national saving unrelated to the interest rate, an increase in taxes will:

a. shift the vertical saving schedule to the left. b. decrease investment. c. increase consumption. d. decrease the equilibrium interest rate and

increase investment.Answer: d.Hint: (See P63).

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9. If national saving is positively related to the interest rate, a technological advance that increases investment demand will:

a. have no effect on the amount of national saving. b. shift the investment demand curve to the left. c. increase both investment and the equilibrium

interest rate. d. have no effect on consumption.Answer: c.Hint: (See P65)

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10. If the nominal interest rate is 8% and prices are rising at 5% per year, the real interest rate is:

a. 8%. b. 3%. c. 13%. d. –13%.Answer: b.Hint: (See P55)

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11. If consumption C = 100 + 0.8(Y –T), disposable income equals 1,000, and Y = 2,000, then the marginal propensity to consume is:

a. 0.5. b. 900. c. 0.8. d. 0.9.Answer: c.Hint: (See P54)

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Multiple-Choice Questions12. Diminishing marginal product is the notion thata. As the stock of capital ages, the extra output produced

decreases.b. As the amount of labour increases, the extra output

produced from an additional unit of capital falls.c. As resources are used to produce capital goods, fewer

additional capital goods can be produced.d. As the amount of labour increases, the extra output

produced from an additional unit of labour falls.

Answer: dHint: (See P48)

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13. Assume a consumption function is . By definition, the marginal

propensity to consumea. equals ΔC / Δ(Y-T).b. is the behavioral coefficient c in the equation.c. is the slope of the consumption function.d. all of the above.Answer: dHint: (See P54)

)( TYcCC

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Multiple-Choice Questions(2005 Exam Question)

14. A farmer grows a bushel of wheat and sells it to a miller for $1.00. The miller turns the wheat into flour and then sells the flour to a baker for $3.00. The baker uses the flour to make bread and sells the bread to an engineer for $6.00. The engineer eats the bread. What is the GDP?

a. $10.00b. $4.00c. $2.00d. $6.00Answer: dHint: (See P25)

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15. Which of the following transactions should be placed in one of the four components of expenditure as investment in the US?

a. Boeing sells an airplane to the Air Force.b. Boeing sells an airplane to American Airline.c. Boeing sells an airplane to Air France.d. Boeing sells an airplane to a retired US President.Answer: bHint: (See P25)

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16. In the classical model with fixed income, a reduction in the government budget deficit will lead to a

a. higher real interest rate.b. higher level of output.c. lower level of output.d. lower real interest rate.Answer: dHint: (See P61)

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17. A profit-maximizing firm will hire labour up to the point where

a. the marginal product of labour equals the marginal product of capital.

b. the marginal product of labour equals the real wage.

c. marginal revenue equals zero.d. the real wage equals the real rental price of capital.Answer: bHint: P MPL = W ⇒ MPL = W/P (See P50)

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18. With total output fixed and national saving unrelated to the interest rate, an increase in taxes will

a. shift the vertical saving schedule to the left.b. decrease investment.c. increase consumption.d. decrease the equilibrium interest rate and increase

investment.Answer: dHint: (See P61)

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19. If disposable income is 4,000, consumption is 3,500, government spending is 1,000, and tax revenues are 800, national saving is equal to

a. 300

b. 500

c. 700

d. 1,000

Answer: a

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20. If the consumption function is C = 100 + 0.8 (Y-T) and both taxes and government purchases increase by $1, the equilibrium level of income will

a. remain constant.b. increase by $3.c. increase by $1.d. decrease by $4.Answer: c

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Numerical Questions from TextbookQuestion 6 on page 70

Consider an economy described by the following equations

Y = C+I+G, Y = 5,000, G = 1,000, T = 1,000 C = 250+0.75(Y-T), I = 1,000-50r.a. In this economy, compute private saving, public

saving, and national saving.b. Find the equilibrium interest rate.c. Now suppose that G rises to 1,250. Compute

private saving, public saving, and national saving.d. Find the new equilibrium interest rate.

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Numerical Questions from TextbookQuestion 6 on page 70

Answer:

a. Private Saving = Y-T-C = 5000-1000-250-0.75(5000-1000) = 750

Public Saving = T-G = 1000-1000 = 0

National Saving = S = Private Saving + Public Saving = 750

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Numerical Questions (continued)

b. S = I 750 = 1000-50r r = 5%c. Private Saving is unchanged. Public Saving = 1000-1250 = -250 National Saving = 750-250 = 500d. 500 = 1000-50r r = 10%

178.200 06-2

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