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Answers to Homework 3 Econ 102 Due March 9,2006 Question 1: Use the following relationships to fill in the table below: GDP = C + I + G + (X – M) KI = M – X I = Private Saving + Government Saving + (M-X) I = NS + KI Government Saving = T – TR – G where GDP = gross domestic product C = Consumer spending I = Investment spending G = government spending X = exports M = imports KI = capital inflow NS = national saving T = taxes TR = transfers Year 1 Year 2 Year3 Year 4 GDP 890 7678 8400 8531 Consumption 720 5272 7686 7689 Investment 98 1765 545 776 Gov Purchase 95 650 240 87 Gov Saving 43 -535 54 -3 Private Saving 32 2291 420 758 National Saving 75 1756 474 755 Transfer 12 885 456 543 Tax 150 1000 750 627 Export 10 76 3 66 Import 33 85 74 87 Capital Inflow 23 9 71 21 Question 2: Suppose that the demand for labor in Fantasyland is given by the equation w = 1000 – 2L while the supply of labor in Fantasyland is given by the equation w = 100 + 2L where w is the wage per year and L is the number of labor units hired per year. a. What is the equilibrium level of employment per year and the equilibrium wage rate in Fantasyland? The equilibrium level of employment per year is 225 and the

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equilibrium wage rate is \$550. To find these answers set demand equal to supply and solve for L. Once you have found L then you can use either the demand or the supply equation to find the value of w. b. According to the Classical view what will happen if the wage rate in Fantasyland is currently at \$500? According to the Classical view all markets clear, including the labor market. Thus, if the wage rate is currently \$500 the labor market is in disequilibrium since at this wage there is an excess demand for labor. The market will return to equilibrium due to wage adjustment: the wage will increase until supply equals demand and this will occur at a wage of \$550. c. If the aggregate production function is: Output = 50 – (2500)/(50 + number of Workers) What is the full employment output for this economy? From part (a) we know the equilibrium level of employment is 225 units (the Classical view assumes this will correspond to the full employment level for the economy). Placing this number in the above equation results in Output = 50 – (2500)/(50 + 225) = (50 - 9.09) units of output = 40.91 units of output.
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