Econ 3900 Macroeconomics
Prof. Grace O
1
Practice Questions Chapter 3
1. Consider a production function for an economy:
Y
= 20(
L
.5
K
.4
N
.1
)
where
L
is labor,
K
is capital, and
N
is land. In this economy the factors of production are in
fixed supply with
L
= 100,
K
= 100, and
N
= 100.
a.
What is the level of output in this country?
b.
Does this production function exhibit constant returns to scale? Demonstrate
by example.
c.
If the economy is competitive so that factors of production are paid the value
of their marginal products, what share of total income will go to land?
2. Assume that GDP (
Y
) is 6,000. Consumption (
C
) is given by the equation
C
= 600 + 0.6(
Y
–
T
). Investment (
I
) is given by the equation
I
= 2,000 – 100
r
, where
r
is the real rate of
interest in percent. Taxes (
T
) are 500 and government spending (
G
) is also 500.
a.
What are the equilibrium values of
C
,
I
, and
r
?
b.
What are the values of private saving, public saving, and national saving?
c.
If government spending rises to 1,000, what are the new equilibrium values of
C
,
I
, and
r
?
d.
What are the new equilibrium values of private saving, public saving, and
national saving?
3. Assume that GDP (
Y
) is 5,000. Consumption (
C
) is given by the equation
C
= 1,200 + 0.3(
Y
–
T
) – 50
r
, where
r
is the real interest rate. Investment (
I
) is given by the equation
I
= 1,500 –
50
r
. Taxes (
T
) are 1,000 and government spending (
G
) is 1,500.
a.
What are the equilibrium values of
C
,
I
, and
r
?
b.
What are the values of private saving, public saving, and national saving?
c.
Now assume there is a technological innovation that makes business want to
invest more. It raises the investment equation to
I
= 2,000 – 50
r
. What are the
new equilibrium values of
C
,
I
, and
r
?
d.
What are the new values of private saving, public saving, and national
saving?
4. Price flexibility plays a key role in the classical model by ensuring that the markets reach
equilibrium.
a.