HW Chapter 4 - Universidad Iberoamericana UNIBE BBA in...

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Universidad Iberoamericana UNIBE BBA in International Business Applied Macroeconomics Professor Carmen L. Sanchez Group 1 – Section 02 Homework Chapter 3 Beatriz Asilis (10-1013) Xasica Rosario (10-0147) Maria G. Liriano (09-0881) Valerie Bodden K. (10-0014) May 20, 2011
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Santo Domingo, Dominican Republic Review Questions 2) How are desired consumption and desired saving affected by increases in current income, expected future income, and wealth? If there is an increase in current income, both consumption and saving increase. Higher expected future income leads to more consumption today, so saving falls. An increase in wealth raises current consumption, so lowers current saving. 3) Use concepts of income effect and substitution effect to explain why the effect on desired saving of an increase in the expected real interest rate is potentially ambiguous. The effect on desired saving of an increase in the expected real interest rate is potentially ambiguous. An increase in the expected real interest rate has two effects on desired saving. o The substitution effect increases saving, because the amount of future consumption that can be obtained in exchange for giving up a unit of current consumption rises. o The income effect reduces saving for a lender, because a person who saves is better off as a result of having a higher real interest rate, so he or she increases current consumption. For a borrower, both the income and substitution effects work in the same direction and savings definitely increases. For a lender, the income and substitution effect work in opposite directions so the result on desired saving is ambiguous. 5 ) What effect dies a temporary increase in government purchases- for example, to fight a war- have on desired consumption and desired national saving , for a constant level of output? What is the effect on desired national saving of a lump-sum tax increase? Why is the effect of a lump-sum tax increase controversial? When government purchases increase temporarily, consumers see that higher taxes will be required in the future to pay off the deficit. They reduce both current
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consumption and future consumption, but current consumption declines by less than the amount of the government purchases. Since national savings is output minus desired consumption minus government purchases, and government purchases have increased more than current desired consumption has decreased, national savings declines at a given real interest rate. In the case of a lump-sum tax increase, consumers have higher taxes today, but
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HW Chapter 4 - Universidad Iberoamericana UNIBE BBA in...

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