Deck 3: Consciousness and Learning

Question 1

Franco the economist uses data for Canada to estimate a Keynesian consumption function:
C^d = 0.46 + 0.92Y
In this equation, what is the marginal propensity to consume?

A) 0.46
B) 0.50
C) 0.92
D) 1.38

Answer 1

0.92

Question 2

A firm has current and future marginal productivity of capital given by MPK = 10,000 - 2K + N, and marginal productivity of labour given by MPN = 50 - 2N + K. The price of capital is $5,000, the real interest rate is 10%, and capital depreciates at a 15% rate. The real wage is $15.

Answer 2

a. uc = (r + d)pK = .25 × $5000 = $1250.
b. Setting w = MPN gives 15 = 50 - 2N + K, or 2N = 35 + K. Setting uc = MPK gives 1250 = 10,000 - 2K + N, or N =-8750 - 2K or 2N = -17,500 + 4K. Setting = 17,500 - 4K = 35 - K gives 3K = 17,535 which yields K = 5845. Then N =2940.

Question 3

Perpetual plastic plant makers cost $200 each. The number of plants that your firm expects to produce each year for each level of capital stock is as follows:
?
The plants sell for $1 each and your firm faces no other costs. The real interest rate is 10% and the depreciation rate of capital is 15%. There is a 20% tax on your firm's revenues from selling these plants.
a. What is the firm's tax-adjusted user cost of capital?
b. What is the marginal product of capital for each number of machines (1, 2, 3, 4, and 5)?
c. How many machines should the firm buy? What is their production, pretax revenue, and profit after deducting taxes, interest, and depreciation?

Answer 3

a. Tax-adjusted user cost = (r + d)pK/1 - T) = (.10 + .15) × $200/(1 - 0.20) = $62.50
b. MPKs: one machine produces 250 plants × $1 each = $250; two produce 150 more plants × $1 each = $150; three:
100 × $1 = $100; four: 65 × $1 = $65; five: 35 × $1 = $35.
c. Four machines (MPK > uc); production = 565 plants, pretax revenue = $565, profit = $565 - $113 (taxes = $565 ×.20) - $80 (interest = $800 × .10) - $120 (depreciation = $800 × .15) = 252

Question 4

Consider a Keynesian consumption function with desired consumption equal to 0.9 Y, where Y is income. Government purchases are $1000, net exports are zero, and desired investment varies with real interest rate according to the following schedule:
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Assume the interest rate adjusts so that the economy gets to equilibrium. Equilibrium output at full employment is $50,000. Find the values of consumption, investment, and the real interest rate at full-employment equilibrium.

Question 5

Suppose the current account shows debits of $4.7 billion and credits of $5.3 billion. The current account balance is ________, and the capital account balance is ________.

A) -$0.6 billion; +$0.6 billion
B) +$0.6 billion; +$0.6 billion
C) -$0.6 billion; -$0.6 billion
D) +$0.6 billion; -$0.6 billion

Question 6

Suppose a country has the following balance of payments data:

a. Calculate the current account balance.
b. Calculate the capital account balance.
c. Calculate the trade balance.
d. Calculate net factor payments.

Question 7

Consider a small open economy with desired national saving of S^d = 20 + 200 r^w and desired investment of I^d = 30 - 200 r^w. Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is
a. r^w = 0.025
b. r^w = 0.05
c. r^w = 0.0
d. Now suppose something causes desired national saving to increase by 10, so that it is now _Sd _{= 30 + 200 r}w. Repeat parts a, b, and c.
e. Suppose, with desired national saving at its original level of S^d = 20 + 200 r^w, something causes desired investment to rise by 10, I^d = 40 - 200 r^w. Repeat parts a, b, and c.

Question 8

A large open economy has desired national saving of S^d = 20 + 200 r^w and desired national investment of I^d = 30 - 200 r^w. The foreign economy has desired national saving of S^d = 40 + 100 r^w and desired national investment of I^d_For = 75 - 400 r^w.
a. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For, and I_For.
b. Suppose S^d rises by 45, so that now S^d = 65 + 200 r^w. Calculate the equilibrium values of r^w CA, CA_For, S, I, S_For, and I_For.v
c. Suppose with S^d back to S^d = 20 + 200 r^w as in part a, that I^d rises by 45, to I^d = 75 - 200 r^w. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For and I_For.

Question 9

Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?