# PS3S - Problem Set 3 Answer Key(1(a The expected after-tax...

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Problem Set 3 Answer Key (1) (a) The expected after-tax real interest rate is r = i (1 – t ) – π e = 0.10 (1 – 0.30) – 0.05 = 0.07 – 0.05 = 0.02. (b) The cost of maintaining the house is depreciation. So the annual user cost of capital is uc = ( r + d ) p K = (0.02 + 0.06)\$200,000 = \$16,000. (c) You should be indifferent between buying and renting if the rent is \$16,000 per year. (2) (a) As Figure 4.5 shows, the shift to the right in the saving curve from S 1 to S 2 causes saving and investment to increase and the real interest rate to decrease. Figure 4.5 (b) This is really just a transfer from the general population to veterans. The effect on saving depends on whether the marginal propensity to consume ( MPC ) of veterans differs from that of the general population. If there is no difference in MPC s, there will be no shift of the saving curve; neither investment nor the real interest rate is affected. If the MPC of veterans is higher than the MPC of the general population, then desired national saving declines and the saving curve shifts to the left; the real interest rate rises and investment declines. If the MPC of veterans is lower than that of the general population, the saving curve shifts to the right; the real interest rate declines and investment rises. (c) The investment tax credit encourages investment, shifting the investment curve from I 1 to I 2 in Figure 4.6. Saving and investment increase, as does the real interest rate.

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Figure 4.6 (d) The increase in expected future income decreases current desired saving, as people increase desired consumption immediately. The rise of the future marginal productivity of capital shifts the investment curve to the right. The result, as shown in Figure 4.7, is that the real interest rate rises, with ambiguous effects on saving and investment.
Figure 4.7 (3) (a) To find the equilibrium interest rate ( r w ), we must first calculate the current account for each country as a function of r w . Then we can find the value of r w that clears the goods market, that is, where CA + CA For = 0. Home: C d = 320 + 0.4(1000 – 200) – 200 r w = 320 + 320 – 200 r w = 640 – 200 r w CA = NX = S d I d = Y – ( C d + I d + G ) = 1000 – (640 – 200 r w + 150 – 200 r w + 275) = –65 + 400 r w Foreign: C d For = 480 + 0.4(1500 – 300) – 300 r w = 480 + 480 – 300 r w = 960 – 300 r w CA For = NX For = S d For I d For = Y For – ( C d For + I d For + G For ) = 1500 – (960 – 300 r w + 225 – 300 r w + 300) = 15 + 600 r w At equilibrium, CA + CA For = 0, so: –65 + 400 r w + 15 + 600 r w = 0 –50 + 1000 r w = 0 r w = .05 C = 640 – 200 r w = 630 C For = 960 – 300 r w = 945 S = Y C G = 1000 – 630 – 275 = 95 S For = Y For C For G For = 1500 – 945 – 300 = 255 I = 150 – 200 r w = 140

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## This note was uploaded on 04/15/2008 for the course AST 0035 taught by Professor Barbkucinski during the Fall '08 term at Pittsburgh.

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PS3S - Problem Set 3 Answer Key(1(a The expected after-tax...

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