1. A production function can exhibit increasing, constant or decreasing returns to scale. Describe the meaning of this statement using a simple production function Y = F (K, L), where K is capital and L is labor.  Why might it exhibit increasing or decreasing returns to scale?

2. Consider an economy described as follows:

Y = C + I + G

Y = 10,000

G = 3,000

T = 2,200

C = 1500 + 0.75(Y - T)

I = 1000 - 75r

a. Compute private saving, public saving and national saving in this economy

b. Fin the interest rate that maintains equilibrium in the economy.

c. Suppose that G is reduced by 500. Compute private saving, public saving and national saving and new equilibrium interest rate

d. Suppose that T is increased to 3,000. Compute private saving, public saving and national saving and the effect on the equilibrium interest rate.