Macroeconomics

18 mutiple choices, and 3 essay quetions about market for loanable funds and investment crowding out.

Part A: Essay questions (64 points)

1. Suppose that a drop in consumer confidence lowers household���s consumption but stimulates private savings and overall national savings. This increase in the supply of loanable funds (a supply shift) affects investment in capital goods (I) differently depending on the responsiveness of the supply of funds to interest rate. Under which of the following two assumptions would this increase in savings (S) encourage investment (I) the most? Support your answer with the graph below. (20 points)

Assumption 1: The supply of loanable funds is not responsive to interest rates –

Assumption 2: The supply of loanable funds is strongly responsive to interest rates – S2(r)

r

S2(r)

I(r)

Quantity of loanable funds

Explanation

2. A) Under which of the following two assumptions (about the responsiveness of investment to interest rate) would an exogenous decrease in government spending (G) encourage private investment (I) the most? Explain and support your answer with the graph below. (15 points)

Assumption 1: The demand for loanable funds (I1) is strongly responsive to real interest rate (r).

Assumption 2: The demand for loanable funds (I2) is weakly responsive to real interest rate (r).

Graph – Draw the impact of a decrease in G on I under both assumptions. Label I1 and I2 appropriately.

r S(r)

Q of loanable funds

Explanation

B) If the supply of loanable funds were vertical, would your choice of assumption from part (A) be the same? Use the graph below for the market for loanable funds with S vertical and the same two demand of loanable funds I1 and I2 to explain. (15 points)

r S

Q of loanable funds

Explanation

3 3. Explain whether the following italicized statement is true or false. Assume the supply of loanable fund is vertical. Explain (1), (2) and (3) individually. (14 points)

Other things the same, if the government increases transfer payments to households, then (1) investment will increase, (2) the rate of interest will rise, (3) public saving will fall by more than private saving will increase.

Part B: Report your answers to the multiple choice questions in this table (36 points; 2 points each)

The multiple choice questions are on pages 5 to 7.

1. 4. 7. 10. 13. 16.

2. 5. 8. 11. 14. 17.

3. 6. 9. 12. 15. 18.

Part B: Multiple choice questions. Report your answers to the multiple choice questions in the table p. 4.

1. If the consumption function is given by C = 0.75(Y ��� T) and T decreases by $100 billion, then private saving _________, public saving _________, hence national saving______:

A) decreases by $25 billion; increases by $100 billion; increases by $75 billion.

B) decreases by $25 billion; decreases by $100 billion; decreases by $125 billion.

C) increases by $25 billion; decreases by $100 billion; decreases by $75 billion.

D) increases by $25 billion; increases by $100 billion; increases by $125 billion.

2. When economists speak of ���the��� interest rate, they mean:

A) the rate on 90-day Treasury bills.

B) the rate on 30-year government bonds.

C) the ���prime��� rate on loans.

D) no particular interest rate, since it is assumed that various interest rates tend to move up and down together.

3. When the demand for loanable funds is less than the supply of loanable funds, households want to save ______ than firms want to invest and the interest rate ______.

A) more; rises

B) more; falls

C) less; rises

D) less; falls

4. Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C = 500 + 0.6(Y ��� T). Net taxes (T) are equal to 600. Government spending is equal to 1,000. Investment is given by the equation I = 2,160 ��� 100r, where r is the real interest rate in percent. In this case, the equilibrium real interest rate is:

A) 5 percent.

B) 8 percent.

C) 10 percent.

D) 13 percent.

5. When net taxes decrease without a change in government spending (assume C is not function of real interest rates):

A) consumption and investment both increase.

B) consumption and investment both decrease.

C) consumption increases and investment decreases.

D) consumption decreases and investment increases.

6. When government spending increases and net taxes increase by an equal amount (assume C is not function of real interest rates):

A) consumption and investment both increase.

B) consumption and investment both decrease.

C) consumption increases and investment decreases.

D) consumption decreases and investment increases.

7. If there is a decrease in government spending with no change in net taxes, then public saving ______ and private saving ______. Assume consumption (or private saving) is not function of real interest rates.

A) increases; increases.

B) increases; does not change

C) decreases; increases

D) decreases; does not change

8. An increase in the government budget deficit will lead to a:

A) higher real interest rate and lower national debt.

B) lower real interest rate and lower national debt.

C) higher real interest rate and higher national debt.

D) lower interest rate and higher national debt.

9. When government spending decreases and net taxes are decreased by an equal amount (assume C is not function of real interest rates), interest rates:

A) increase.

B) remain the same.

C) decrease.

D) can vary wildly.

10. Assume that consumption does not depend on the interest rate. In this case, when there is a technological advance that leads to an increase in investment demand:

A) investment increases and the interest rate rises.

B) investment is unchanged and the interest rate rises.

C) investment and the interest rate are both unchanged.

D) investment increases and the interest rate falls.

11. Assume that consumption decreases, other things being equal, when the interest rate rises. If there is a technological advance that leads to an increase in investment demand:

A) investment increases and the interest rate rises.

B) investment is unchanged and the interest rate rises.

C) investment and the interest rate are both unchanged.

D) investment decreases and the interest rate rises.

12. An increase in the real interest rate could be the result of a(n):

A) increase in government spending.

B) decrease in taxes.

C) increase in investment.

D) A, B and C are correct.

E) A and C are correct.

13. Investment goods as measured in the GDP are purchased by:

A) business firms alone.

B) households alone.

C) business firms and households.

D) business firms, households, and governments.

14. If there is a tax law change that makes investment projects less profitable and decreases the demand for investment goods, but does not change the amount of taxes collected in the economy, then interest rate

A) falls.

B) increases.

C) is unchanged.

D) may or may not change, it���s impossible to say.

15. Crowding out occurs when an increase in government spending ____ the interest rate and investment _____.

A) increases; increases.

B) increases; decreases.

C) decreases; increases.

D) decreases; decreases.

16. Assume that an increase in consumer confidence raises consumers��� expectations of future income and thus the amount they want to consume today for any given income. This shift will:

A) lower investment and raise the interest rate.

B) raise investment and lower the interest rate.

C) lower both investment and the interest rate.

D) raise both investment and the interest rate.

17. The government spending component of GDP includes all of the following except:

A) federal spending on goods.

B) state and local spending on goods.

C) federal spending on transfer payments.

D) federal spending on services.

18. Suppose that GDP (Y) is 5,000. Consumption (C) is given by the equation C = 500 + 0.5(Y-T). Investment (I) is given by the equation I = 2,000 ��� 100r, where r is the real interest rate in percent. Government spending (G) is 1,000 and net taxes (T) is also 1,000. When a technological innovation changes the investment function to

I = 3,000 ��� 100r:

A) I rises by 1,000 and r rises by 10 percentage points.

B) I rises by 1,000 and r is unchanged.

C) I is unchanged and r rises by 10 percentage points.

D) I is unchanged and r rises by 15 percentage points.

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