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Assignment 2 Answer Key F17

The document contains sample questions and answers for an economics exam. It includes: 1) A multi-part question about a neoclassical growth model, asking about the production function, consumption, capital stock, and steady state. 2) A question using the IS-LM model to analyze the effects of changes like immigration laws and tax policy. 3) A question comparing the effects of a tax cut/increase on saving, investment and current accounts under the assumptions of Ricardian equivalence versus no Ricardian equivalence.

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196 views

Assignment 2 Answer Key F17

The document contains sample questions and answers for an economics exam. It includes: 1) A multi-part question about a neoclassical growth model, asking about the production function, consumption, capital stock, and steady state. 2) A question using the IS-LM model to analyze the effects of changes like immigration laws and tax policy. 3) A question comparing the effects of a tax cut/increase on saving, investment and current accounts under the assumptions of Ricardian equivalence versus no Ricardian equivalence.

Uploaded by

James
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Assignment 2 Answer Key

Q.1 The neoclassical growth model assumes that population is growing, at any point in time a
share of the population of working age is fixed, both the population and the workforce grow at a
rate n, the economy is fixed and there is no role for government.

The production function for the representative firm is given by


(a) Write down the equation that determines consumption for the representative consumer and
explain the trade off that the representative consumer faces in its labour-leisure choice.
(2 marks)
(b) Graph the production function of the representative firm and both graphically and in words
show that there is diminishing marginal productivity of capital. (2 marks)
(c) Write down the law of motion for the capital stock and for investment. (1 mark)
(d) Convert aggregate variables (output, capital, consumption, investment) into per capita terms.
(2 marks)
(e) Solve for the steady state of this model. Find the equilibrium steady state equations that
determine (y*, c*, i*, k*). (6 marks)
(f) What are the determinants of long run living standards according to this model? (3 marks)

Q. 2 Use the IS-LM model to determine the effects of each of the following on the general
equilibrium values of the real wage, employment, output, the real interest rate, consumption,
investment, and the price level.

a. Tougher immigration laws reduce the working-age population. (4 marks)


b. There's increased volatility in the prices of stocks and bonds. (4 marks)
c. The government tries to achieve tax equity by an increase in the corporate tax rate. (4 marks)
d. Increased computerization reduces stock market brokerage costs. (4 marks)

Answer:
a. The decline in labour supply increases the real wage and reduces employment and
output, shifting the FE line to the left. The LM curve shifts up as the price level rises to
restore equilibrium. As a result, the real interest rate rises, reducing consumption and
investment.
b. Real money demand rises, which shifts the LM curve up. To restore equilibrium, the
price level must decline, shifting the LM curve down. There's no effect on any other
variable.
c. The higher tax rate reduces investment, shifting the IS curve down. To restore
equilibrium, the LM curve shifts down as the price level falls. As a result, the real interest
rate declines, so consumption increases. There's no change in the real wage, employment,
or output.
d. Increased liquidity on nonmoney assets reduces money demand, shifting the LM curve
down. The price level rises to restore equilibrium by shifting the LM curve back up.
There's no effect on the other variables.

Q.3 The government of a small open economy announces a tax cut of $100 this year, combined
with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this
change on the world real interest rate, national saving, investment, and the current account
balance in equilibrium when:

a. Ricardian equivalence holds? (2 marks)


b. Ricardian equivalence does not hold? (2 marks)

Answer
a. No effect on any of the variables.
b. Real world interest rate unchanged, national saving declines (private saving rises, but
not as much as government saving declines), investment is unchanged, and the current
account balance declines.

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