Fall 1999: Homework 3-               

Part I:

Question 1-  The following data gives a complete picture of the household, business, government and foreign sectors for country Zerbia for the year 1998.  (All figures are in billion dollars.)

                Consumption spending                                                  100

                Government transfer payments                                      10

                Government expenditures on goods and services             50

                Imports                                                                        20

                Exports                                                                        10

                Capital Stock (end of 1997)                                           200

                Capital Stock (end of 1998)                                           208

                Depreciation rate                                                          6%

                Interest Rate                                                                10%

                Total Taxes                                                                  20

a. How many units of capital wore out during the course of 1998? 

b. What was the total amount of investment that occurred in 1998 including expenditures on the replacement of worn out capital? 

c. What is the value of GDP for this economy in 1998? 

d. What is the value of savings for this economy? 

e. With a macro model that includes a foreign sector we can think of leakages as being equal to S + T + M and injections as being equal to I + G + X.  Are leakages equal to injections for this economy? 

f. Assume we are using a Classical Model of the economy.  Suppose the government increases its total spending for the year by $5 billion.  What will happen to:

i) The interest rate?

ii) Total private investment?

iii) Total saving?

iv) Real GDP?

Question 2-  For this question assume there is no foreign sector.

Draw a graph depicting the situation in the loanable funds market if the government is operating with a balanced budget.  Clearly label the equilibrium interest rate, the equilibrium level of saving, and the demand and supply of funds. 

Now, suppose the government decides to run a deficit.  Illustrate this on the same graph being sure to label all changes clearly.  Clearly label the new equilibrium interest rate, the equilibrium level of saving, the new level of private investment, and the demand and supply of funds. 

Question 3- Zebra is a country that produces a single type of good called a widget.  Widgets cost 2 dollars a piece and 3 million widgets are currently being produced in Zebra. The country of Zerbia is suffering an economic downturn.  One economist suggests a solution to the President of Zerbia: drop additional currency into the country using a helicopter.  Prior to the dropping of currency by the helicopter there are $900,000 dollars in circulation in Zerbia.

Use the Classical Quantity Theory of Money to answer the following questions.

a. Assume Zebra is in monetary equilibrium (i.e., money demand equals money supply) prior to the helicopter drop.  What is the ratio of desired money holdings to income? 

b. If the helicopter drops $45,000 on the country, what will the new price of a widget be? 

c. What is the impact of the helicopter drop on Zebra's level of real output?  Explain your answer. 

d. Another economist disagrees with the helicopter idea.  She recommends that the President should increase government spending on national defense and pay for the increase by enlarging the nation's deficit.  She claims this will increase the real GDP of the country and therefore the average standard of living will be higher next year.  According to the Classical Model will this policy result in any change in real output?  If there's a change, what kind of change in real output will there be?  Give a reason for your answer. 

Part II:

Read an article from an economic or financial publication that has relevance for what we are learning in this class. The "accepted" list of publications is Wall Street Journal, Financial Times, The Economist, Barron's, and Business Week. Obviously, this list is not intended to be comprehensive. If you find a good and interesting article in any publication, printed or on the Internet, you are invited to read it.

Write a one page (single spaced, font 10) review of the article you just read. Attach a copy of the original article.

Your review will be graded according to its relevance for this class, the ideas you put forward, and your knowledge of written English.