Principles of Economics (12th Edition)
12th Edition
ISBN: 9780134078779
Author: Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher: PEARSON
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Chapter 23, Problem 4.4P
To determine
Wealth accumulation and the equilibrium level of
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Question 13
0/1.5 points
Consider the two-period model. Consumer's have preferences over current and future consumption (c and
c). Households only receive income in the second period, y! That is, income in the first period is equal to
zero, y=0. Households can save, s, for the second period and receive interest rate r. The slope of the budget
constraint is
-(1+r). As such, an increase in r would increase the slope in (c,c') space (the standard graph).
The government implements a proportional income tax, O
Problem Set 4: Saving and Investment
Economists in Fantasialand, a closed economy, have collected the following information about the economy for a particular year: Y = 9000; C = 6000; T = 1500; G = 1700. The economists also estimate that the investment function is: I = 3300 - 100r, where r is the country’s real interest rate, expressed as a percentage (i.e. r = 1 means interest rate is one percent). Calculate private saving, public saving, national saving, investment, and the equilibrium real interest rate.
5. The market for loanable funds and government policy
The following graph shows the loanable funds market. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete
the questions that follow. Consider each scenario separately by returning the graph to its starting position when moving from one scenario to the next.
(Note: You will not be graded on any changes you make to the graph.)
INTEREST RATE (Percent)
Supply
Demand
LOANABLE FUNDS (Billions of dollars)
Demand
Supply
?
Chapter 23 Solutions
Principles of Economics (12th Edition)
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- In the language of macroeconomics, a person or firm purchases new capital. occurs when a person's income exceeds his consumption, while Which of the following situations represent saving? Check all that apply. You use your $200 paycheck to buy stock in AT&T. Your family takes out a mortgage and buys a new house. You borrow $1,000 from a bank to buy a car to use in your pizza delivery business. Your roommate earns $100 and deposits it in his account at a bank. occurs whenarrow_forwardLet's use the Euler equation two ways. First, to find out the optimal consumption path, taking the interest rate as a given and then to find out the equilibrium interest rate that will eliminate demand for saving and investment, taking the consumption path as a given. Both times, the utility function will be the same. U = In(c) + 0.9 ln(c₁+₁) t+1 So the future counts 90% as much as the present. In Part 1, income each period is 100, and the interest rate is 20%. In Part 2, consumption in each period is 100 -- in other words, income each period is 100, but income isn't storable (it's “manna”), so you have to consume it or lose it. Answer the following questions: Part A: What is optimal consumption each period? In period t of this two-period world, will this person be borrowing or saving or neither? Part B: What is the equilibrium interest rate between these two periods? If the equilibrium interest rate were lower than that level, would that create a surplus or a shortage, in Econ 101…arrow_forwardConsider the following information on aggregate income, consumption expenditure, and planned investment for a country:arrow_forward
- 7. Consider the model where an individual has wealth k which they can either save or consume. If they save it, they receive a fixed and exogenous return r. The instantaneous utility function is given by: u(c, k) = c + a(k) where c is consumption, k is wealth, and a(k) is a function that defines the utility that an individual gets from holding wealth. The growth in wealth is given as the returns on wealth rk, plus income from working z(t), minus consumption c(t). a. Write out the differential equation for wealth. b. For an infinite time model, set up the optimal control problem with discounting at a rate 8. c. Write the current-valued Hamiltonian of this problem. d. Derive the steady-state level of consumption.arrow_forwardAssume in a simple economy that the level of saving is –500 when aggregate output equals zero and that the marginal propensity to save is 0.2. Derive the saving function and the consumption function, and draw a graph showing these functions. At what level of aggregate output does the consumption curve cross the 45° line? Explain your answer and show this on the graph.arrow_forwardUse the graphs to illustrate the effect of a decrease in consumer income expectations on the consumption (C) function and the savings (S) function. Real consumption 500 450 400 350 300 250 200 150 100 50 0 0 50 C = DI с 100 150 200 250 300 350 400 450 500 Real disposable income (DI) Real savings 500 450 400 350 300 250 200 150 100 50 0 -50 -100 -150 0 50 100 150 200 250 300 350 Real disposable income (DI) S 400 450 500arrow_forward
- Indicate whether each of the following descriptions represents saving or investment, as defined by a macroeconomist. Saving Investment Description This occurs when a person or firm purchases new capital. This occurs when a person's income exceeds his consumption. Which of the following situations represent investment? Check all that apply. You use your $200 paycheck to buy stock in AT&T. Your family takes out a mortgage and buys a new house. You borrow $1,000 from a bank to buy a car to use in your pizza delivery business. Your roommate earns $100 and deposits it in his account at a bank.arrow_forwardScenario 1: Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is a decrease in the tax rate on interest income, from 20% to 15%. Shift the appropriate curve on the graph to reflect this change. This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to and the level of investment spending toarrow_forwardThe following graph shows the market for loanable funds. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Treat each scenario separately by resetting the graph to its original state before examining the effect of each individual scenario. (graph in image) Scenario 1: Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is an increase in the tax rate on interest income, from 20% to 25%. Shift the appropriate curve on the graph to reflect this change. This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to (a. fall, b. rise) and the level of investment spending to (a. increase, b. decrease). Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases…arrow_forward
- Consider a two-period consumption saving model and let ci and c2 denote the first and second period consumption, respectively. Assume that the interest rate at which the consumer may lend or borrow is 10%. Suppose that a consumer's utility function is u (C1, c2) = c1 + 20 c2. The consumer first period income is I1 = $100 and the present value of her income stream is $330. (a) What is the optimal consumption stream (consumption bundle) of this consumer? (b) Is this consumer borrower or lender? How much does she borrow or lend? (c) What is the effect of a reduction of the interest rate to 5% on the consumer's optimal first-period saving? (Make sure to take into account the effect of the decline in the interest rate on the present value of the consumer's income stream.)arrow_forwardSuppose an economy has reached its steady state. If agents decide to save and invest a larger fraction of their income then GDP: starts shrinking starts growing is unaffectedarrow_forwardClassify each of the following scenarios listed in the table below using the macroeconomic definitions of saving and investment. Saving Investment Manuel buys a government bond. Poornima borrows money to build an addition to a lab owned by her engineering firm. Valerie purchases shares of stock in Warm Breeze, a cloud computing company. Shen takes out a loan and uses it to build a new cabin in Idaho.arrow_forward
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