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Unformatted text preview: Economics 202 Name: _______________ Spring 2005 Professor Melick Final Examination 1. Given the information in the table below, calculate the average annual rate of inflation over the thirtyyear period 1974 to 2004 as measured by both the Consumer Price Index from the Bureau of Labor Statistics and the Personal Consumption Expenditures Price Index from the Bureau of Economic Analysis. Year Consumer Price Index (19821984 = 100) Personal Consumption Expenditures Price Index (2000 = 100) 1974 49.3 33.191 2004 188.9 107.824 2. As of May 10, 2005, the interest rate on the 10year Treasury bond was 4.25 percent. Assuming that the average annual rate of inflation from the CPI index calculated above represents your expectation of the average annual rate of inflation over the coming ten years, calculate the ex ante real interest rate for the 10year Treasury bond. 3. Suppose a consumer has income of 100 in period 1 and the consumer knows with certainty that their income in period 2 will amount to 65.625, perhaps due to retirement. In this economy, the real interest rate is 5 percent and the individuals wealth (accumulated assets) amounts to 14 in period 1. The tax rate in period 1 is 20 percent and the individual believes that the tax rate in period 2 will remain at 20 percent. a) In a slight variation of the two period model presented in the textbook, suppose that consumption is a function of aftertax income, as well as the real interest rate and wealth. Suppose further, that this consumer in this simple two period economy wants to equate the present value of consumption in period 2 to 80 percent of the present value of consumption in period 1. If this is the case, solve for the values of desired consumption in periods 1 and 2. Plot these points on a budget constraint for this individual, where the value of consumption in period 1 is plotted on the horizontal axis and the value of consumption in period 2 is plotted on the vertical axis. Make sure to label the intercepts for both axes. b) Suppose it is announced that the tax rate in period 2 will be increased from 20 percent to 40 percent in order to fund an expected government budget deficit brought about by a promise to pay for prescription drugs for the elderly. Assuming no change in the real interest rate, solve for the values of consumption in periods 1 and 2 for the individual. Relative to part a), calculate what happens to the savings of the individual. happens to the savings of the individual....
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 Spring '10
 Jakes
 Inflation

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