First Prelim SUGGESTED ANSWERS - Econ 3140 Spring 2010...

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Econ 3140 Spring 2010 Suggested Answers to the 1 st Prelim 03/01/2010 This exam contains 6 questions; each question is worth 20 points. Answer 5 of the 6 questions. If all six are done, then problem 6 : will not be graded. You have 50 minutes to answer the exam. 1. Answer all the following (a) (3 pts) How would a fall of the real interest rate a/ect the investment decision of A fall of the real interest rate r will increase investment I . (b) (3 pts) How would a fall of the real interest rate a/ect the consumption decision of various consumers? Show graphically your response A fall of the real interest rate r will decrease savings and increase consumption C . When considering intertemporal decisions, the answer and the graph of changes in current and future consumption will be dependant on whether the consumers are lenders or borrowers. (c) (3 pts) In a recession, would the Federal Reserve wish to see a high or low level of real interest rate? Explain your answer The Fed wish to see a low interest rate r in order to increase full employment output Y given higher investment I and consumption C . Recall Y = C + I + G in a period with respect to a base period. (e) (4 pts) How would de±ation a/ect the real interest rate, given a particular nominal interest rate achieved through policy actions of the Federal Reserve System? Use a formula to explain your answer. Using the formula r = i e , then de±ation can be characterized as negative expected in±ation e < 0 , therefore, de±ation will increase the level of the real interest rate r . 1
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at a lower price, and; ii) as concluded in part e: of the real interest rate and so the debt of the ±rm in real terms will also increase. 2. Answer all the following
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First Prelim SUGGESTED ANSWERS - Econ 3140 Spring 2010...

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