First Prelim suggested answers - Econ 3140-2 Fall 2009...

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Econ 3140-2 Fall 2009 Suggested answers to the 1 st Prelim macroeconomic terms: (a) (6 pts) How the fall of stock market prices has lead to the shift of the investment locus to the left. at the stock market is not lower than the cost of replacement. So, stock market crash contracted investment. (b) (6 pts) How the fall of stock market prices has lead to the shift of the saving locus to the right. Due to wealth e/ect, a stock market crash reduces consumption in the current period and increase savings. (c) (8 pts) How the lack of intersection between the investment and saving loci at any positive interest rate makes the usual monetary policy ine/ective. Since the interest rate cannot be negative, the excess of savings over investment at zero interest rate is a puzzle for policymakers, so the monetary policy is ine/ective. 2. Barro defends the Classicals±stand that government should leave the private sector like tax-cutting is known to be irrelevant). Explain: (a) (5 pts) Barro±s reasoning. Barro claims that governments balance budget in the long run. Tax cutting now balanced by tax raising later leaves life-cycle resources the same. (b) (5 pts) A counter-example claiming that the equivalence fails for senior citizens. Senior citizens may not care for tax-raising in the future, since they may not live for that. (c) (5 pts) Why the presence or absence of bequeaths matter in this argument. If senior citizens care for the well-being of their descendants, bequeath will be given. Tax-cutting will just mean senior citizens leave a larger bequeath (since they may expect a tax raise in a future period) and they may keep their current consumption the same. 1
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(d) (5 pts) The nature of such di/erence of opinion between Barro and his critics. Not everyone leaves bequeath. Also young people may borrow up their credit limit for them, tax cutting will raise consumption.
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First Prelim suggested answers - Econ 3140-2 Fall 2009...

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