Macro Problem Set_4 Answers

Macro Problem Set_4 Answers - Economics 201: Principles of...

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Economics 201: Principles of Macroeconomics Amjad Toukan Spring 2008 Due at the start of lecture on February 25/26 PROBLEM SET 4 Answers 1 Textbook Exercises (1) Chapter 26, Problems 1 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 Additional Problem: Suppose the economy is characterized by the following behavioral equations: C = 160 +0.6(Y-T) I = 150 G = 150 T = 100 (They are called behavioral equations, to indicate that the equations capture some aspect of behavior – in this case, the behavior of consumers.) Solve for: a. GDP (Y). b. Consumption spending (C). c. Private Saving. d. Public Saving. e. National Saving. f. Is the government running a budget deficit or budget surplus? Explain. g. What is the effect of the government budget deficit or surplus on the equilibrium interest rate and the equilibrium quantity of loanable funds in the market for loanable funds? What is the effect of said policy on the economy’s growth rate? Answers: 1. a. The bond of an eastern European government would pay a higher interest rate than the bond of the U.S. government because there would be a greater risk of default. b. A bond that repays the principal in 2025 would pay a higher interest rate than a bond that repays the principal in 2005 because it has a longer term to maturity, so there is more risk to the principal. c. A bond from a software company you run in your garage would pay a higher interest rate than a bond from Coca-Cola because your software company has more credit risk.
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d. A bond issued by the federal government would pay a higher interest rate than a bond issued by New York State because an investor does not have to pay federal income tax on the bond from New York state. 2. The stock market does have a social purpose. Firms obtain funds for investment by issuing new stock. People are more likely to buy that stock because there are organized stock markets, so people know that they can sell their stock if they want to. 3. When the Russian government defaulted on its debt, investors perceived a higher chance of default (than they had before) on similar bonds sold by other developing countries. Thus, the supply of loanable funds shifted to the left, as shown in the Figure below. The result was an increase in the interest rate.
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4. Companies encourage their employees to hold stock in the company because it gives the employees the incentive to care about the firm’s profits, not just their own salary. Then, if employees see waste or see areas in which the firm can improve, they will take
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Macro Problem Set_4 Answers - Economics 201: Principles of...

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