W2

Question 1

national level of desired consumption (𝐶𝑑)

Answer 1

the aggregate quantity of goods and services that households want to consume

Question 2

Cd is also linked to ______

Answer 2

Desired national saving (𝑆^𝑑

Question 3

Desired national saving 𝑆^𝑑

Answer 3

the level of national saving that occurs when aggregate consumption is at its desired level

Question 4

desired national saving equation

Answer 4

𝑆^𝑑=𝑌−𝐶^𝑑−𝐺 = Y - national level of desired consumption - G

Question 5

saving is positive/ negative when

Answer 5

• A person can consume less than current income - A person can consume more than current income

Question 6

distinction between saving and savings

Answer 6

• Saving refers to the flow of funds that is not consumed out of income.- Savings is the stock of funds that represents the accumulated amount of net saving over time.

Question 7

Consumption-smoothing

Answer 7

By consuming less today, you accumulate savings, and helps to smooth your consumption

Question 8

A trade-off between current consumption and future consumption depends on the ___________

Answer 8

real interest rate

Question 9

5 Determinants of desired national saving

Answer 9

current incomefuture incomewealththe real interest rate fiscal policy

Question 10

Effect of changes in current income^ in Current Income –>

Answer 10

^ in Current Income >>> C ^ and S ^However, At the aggregate level: when current income (Y) rises, 𝐶^𝑑 rises, but not by as much as Y, so 𝑆^𝑑 rises.

Question 11

MPC

Answer 11

fraction of additional current income consumed in current period

Question 12

if MPC = 0.4 and MPS = 0.6, and you receive a bonus of $6000 ($60,000 current salary), how much is(i) additional current consumption(ii) saved

Answer 12

(i) 0.4 x $6000 = $2400(ii) 6000-2400 = $3600

Question 13

Effect of changes in expected future income (

i) higher expected future income leads to _____
(ii) At the aggregate level

Answer 13

(i) more consumption today, so saving falls. (ii) If people expect that aggregate output and income, Y, will be HIGHER in the future, current desired consumption, 𝐶^𝑑 , should INCREASE and current desired national saving, 𝑆^𝑑, should FALL

Question 14

Effect of changes in wealth

Answer 14

increase in wealth RAISES current consumption, so LOWERS current saving.

Question 15

Effect of changes in real interest ratereal return earned by savers is _____

Answer 15

actually less than the difference between the nominal interest rate and expected inflation.

Question 16

Expected real after-tax interest rate

Answer 16

= nominal after-tax interest rate – expected inflation rate =(1−𝑡)𝑖 − 𝜋^𝑒 * measures the increase in the purchasing power of their saving after payment of taxes.

Question 17

Summary of Determinants of desired national saving

Answer 17

Question 18

Crucial role in investment

Answer 18

determining the long-run productive capacity of the economy. Investment creates new capital goods, a high rate of investment means that the capital stock is growing quickly.

Question 19

desired capital stock

Answer 19

the amount of capital that allows the firm to earn the largest expected profit. -Desired capital stock depends on costs and benefits of additional capital 〖𝑴𝑷𝑲〗^𝒇=𝒖𝒄

Question 20

the benefit of investment

Answer 20

is the future marginal product of capital (〖𝑴𝑷𝑲〗^𝒇).

Question 21

𝑀𝑃𝐾. future marginal product of K

Answer 21

expected increase in output that a firm can obtain by adding a unit of capital (ceteris paribus)

Question 22

User cost of capital

Answer 22

real cost of using a unit of capital for a specified period of time = real interest cost + depreciation. 𝑢𝑐=𝑟𝑝_𝑘+𝑑𝑝_𝑘=(𝑟+𝑑) 𝑝_𝑘

Question 23

Real price of a new oven = $100 per cubic foot. Oven depreciates at rate (produces less cookies) = 10% per year. Can borrow/lend at prevailing exp real interest rate = 8% per year. What is the user cost of capital (oven) per year?

Answer 23

𝑢𝑐=” (0.1 + 0.08)”×$100=$18.

Question 24

MPK>uc MPK

Answer 24

1) profits rise as K is added (marginal benefits > marginal costs). 2) If 〖𝑀𝑃𝐾〗^𝑓 < 𝑢𝑐, profits rise as K is reduced (marginal benefits < marginal costs). 3) Profits are maximized where 〖𝑀𝑃𝐾〗^𝑓=𝑢𝑐.

Question 25

RII ---- the decline in the real interest rate reduces 𝑢𝑐, and increases capital stock (K) of oven capacity from $18 to $16 per cubic foot per year and shifts the user-cost line down.

Answer 25

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Question 26

Factor that increases MPK

Answer 26

tech. advancement

Question 27

tax-adjusted user cost of capital.

Answer 27

〖𝑀𝑃𝐾〗^𝑓=𝑢𝑐/(1−𝜏)=((𝑟+𝑑) 𝑝\_𝑘)/(1−𝜏)

Question 28

An increase in 𝜏 \_\_\_\_\_\_

Answer 28

raises the tax-adjusted user cost and reduces the desired capital stock.

Question 29

capital stock changes from two opposing channels

Answer 29

New capital increases the capital stock; this is gross investment, 𝑰\_𝒕. The capital stock depreciates, which reduces the capital stock.

Question 30

Net Investment

Answer 30

Net investment = gross investment minus depreciation: 𝐾\_(𝑡+1)−𝐾\_𝑡=𝐼\_𝑡−𝑑𝐾\_𝑡 𝐼\_𝑡=𝐾\_(𝑡+1)−𝐾\_𝑡+𝑑𝐾\_𝑡

Question 31

If firms can change their capital stocks in one period, then: 𝐼\_𝑡=𝐾^∗−𝐾\_𝑡+𝑑𝐾\_𝑡 (4.6) Eq. (4.6) shows that firms’ gross investment during a year has two parts:

Answer 31

1) The desired net increase in the capital stock over the year (𝐾^∗−𝐾\_𝑡) 2) The investment needed to replace worn out or depreciated capital, 𝑑𝐾\_𝑡.

Question 32

Lags and Investment on desired capital stock

Answer 32

Some capital can be constructed easily, but other capital may take years to put in place. So investment needed to reach the desired capital stock may be spread out over several years.

Question 33

goods market in equilibrium EQ

Answer 33

AS = AD 𝒀=𝑪^𝒅+𝑰^𝒅+𝑮

Question 34

𝑆^𝑑 = desired national savings =

Answer 34

= (𝑌−𝐶^𝑑−𝐺)

Question 35

goods market equilibrium condition:

Answer 35

𝑺^𝒅=𝑰^𝒅

Question 36

saving-investment diagram

Answer 36

Question 37

(5) Determinants of desired savings:

Answer 37

- Current output - Expected future output - Wealth - Government purchases - Taxes (unless Ricardian equivalence holds, in which case tax changes have no effect)

Question 38

what happens if there is a temporary increase in government purchase? (saving-inv diagram)

Answer 38

An increase in G causes 𝑆^𝑑 to shift to the left. Result of lower savings: higher 𝑟, causing crowding out of 𝐼.

Question 39

Determinants of desired investment (3)

Answer 39

- RRI - The effective tax rate - Expected future marginal productivity of capital

Question 40

what happens if there is a fall in the effective tax rate?

Answer 40

A fall in the effective tax rate increases I and causes 𝐼^𝑑 to shift to the right. Result of increased investment: higher 𝑟, higher 𝑆 and 𝐼

Question 41

Give two equivalent ways of describing equilibrium in the goods market. Use a diagram to show how goods market equilibrium is attained.

Answer 41

Equilibrium in the goods market occurs when the aggregate supply of goods (Y) equals the aggregate demand for goods (Cd + Id + G). Since desired national saving (Sd) is Y – Cd – G, an equivalent condition is Sd = Id. Equilibrium is achieved by the adjustment of the real interest rate to make the desired level of saving equal to the desired level of investment, as shown in Figure 4.7 in the text.

Question 42

Why do desired consumption and desired investment fall as the real interest rate rises?

Answer 42

Desired consumption declines as the real interest rate rises because the higher return to saving encourages higher saving. Desired investment declines as the real interest rate rises because the user cost of capital is higher, reducing the desired capital stock, and thus investment.