1. Explain how GDP deflator and CPI measures of inflation are calculated and discuss the difference between them.

2. The government lowers taxes by $30. The marginal propensity to consume is 0.60. Using the national income identity Y = C(Y-T) + I(r) + G, determine the impact of the tax cut on the following? Do they rise or fall? By what amount?

a. Consumption

b. Private saving

c. Public saving

d. Investment

e. Interest rate.

3. Define marginal product of factors K and L in the production function Y = F (K, L).
If the factors are paid according to their marginal product, the economic profit is zero when the production function has the property of constant returns to scale. Explain this statement. Does this mean profit does not exist in the economy?

4. In quantity theory of money model, MV = PY, assume that V is constant, M is growing at 6% per year, Y is growing at 3%.

a. If r = 2, what is i?

b. If the Fed reduces the money growth rate by 2% points per year, what would be effect on i, given r = 2?

c. If the growth rate of Y increases to 5% per year, what would be the effect on inflation? Interest rate?

5. The money supply and money demand functions of an economy are as follows:
Money supply: (M/P)s
Money demand: (M/P)d = L (i, Y) = 0.2Y/0.5i

a. What is the velocity of money in this economy?

b. If output is 1000 units, i is 4 percent and money supply M is $1,200, what is the price level P?

c. If money supply increases by 5%, what will be the impact on price level if the output increases by 2% and the interest rate remains constant?

d. If money supply increases by 5%, what will be the impact on price level if the output increases by 2%, interest rate by 1%?