Question

1. Consider an economy that produces and consumes bread and automobiles. In the table below are data for two different years:

	Year 2010	Year 2025
Price of an automobile	$50,000	$60,000
Price of a loaf of bread	$10	$20
Number of automobiles produced	100	120
Number of loaves of bread produced	500,000	400,000

Using the year 2010 as the base year, compute the following: nominal GDP, implicit price deflator and the CPI.

2.

Assume that GDP (Y) is 5,000. Consumption (C) is given by the equation:

C = 1,200 + 0.3(Y –T) – 50 r, where r is the real interest rate.

Investment (I) is given by the equation I = 1,500 – 50r.

Taxes (T) are 1,000 and government spending (G) is 1,500.

A)   What are the equilibrium values of C, I, and r?

B)    What are the values of private saving, public saving, and national saving?

C)    Now assume there is a technological innovation that makes business want to invest more. It raises the investment equation to:

I = 2,000 – 50r.

What are the new equilibrium values of C, I, and r?

D) What are the new values of private saving, public saving, and national saving?

3.

Suppose an economy is described by the following relationships:

C = a + b(Y-T).

Consumption, C, is a function of disposable (i.e., after-tax) income, (Y -T). The terms a and b are parameters.

I = c – dR where I is the investment and R is the rate of interest. The terms c and d are parameters.

NX = m - ne where I is the net exports and e is the real exchange rate. The terms m and n are parameters.

We assume that Y and R are fixed. Use the national income identity, Y = C + I + G + NX to show:

A) What happens when taxes (T) fall and when government expenditure (G) rises.

B)    What happens to National Saving and Consumption? Draw a diagram to show your work.

4.

Suppose a country has a money demand function (M/P)^d = kY, where k is a constant parameter. The money supply grows by 12 percent per year, and the real income grows by 4 percent per year.

A)   What is the average inflation rate?

B)    How would inflation be different if real income growth were higher? Explain.

C)    How do you interpret parameter k? What is its relationship to velocity of money?

D) Suppose instead of a constant money demand function, the velocity of money in this economy was growing steadily because of financial innovation. How would that affect the inflation rate? Explain.

**show work please

Answer 1

Answer to question 1.