178.

200 Intermediate Macroeconomics

Tutorial (2)

Basic Classical Model

1
 Short Answer Questions

1. In the national income accounting

identity, show the equality between
national saving and investment. What
are the representations of private saving
and public saving?

2
 Short Answer Questions

Answer:
Starting with Y = C+I+G, subtract C and G
from both sides, obtaining Y-C-G = I. The
left hand side represents national saving, the
total income of the economy that remains
after paying for consumption and
government purchases. Hence, substituting
S for Y-C-G and obtain S = I.
3
 Short Answer Questions

(continued)
To separate private and public saving, add
and subtract T in S = Y-C-G, obtaining S =
(Y-T-C) + (T-G). Here, (Y-T-G) represents
private saving, the part of disposable
income (Y-T) left after subtracting
consumption, and (T-G), the government
budget surplus represents public saving.
4
 Short Answer Questions

2. Using a graph representing the market

for loanable funds, show and explain
what happens to interest rates and
investment if the NZ government
succeeds in balancing its budget.

5
 Short Answer Questions

Answer:
If the NZ government succeeds in balancing
its budget, there will be more public saving
in the economy at each interest rate.

6
 Short Answer Questions
(continued)
Real
The supply of loanable Interest
funds curve will shifts Rate
from S0 to S1. The new S0
equilibrium is at E1 with a E0
lower interest rate r1 and a r0 S1
higher level of saving and E1
investment q1. Hence, if r1
the NZ government
succeeds in balancing its D
budget, interest rates will
fall and investment will
increase. q0 q1 Quantity
of Loanable
Funds
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 True or False Questions
1.The real wage means that the return to
labor is measured in units of dollars.
Answer: F
Hint: The real wage (W/P) is the return to
labor measured in units of output rather
than in dollars.
MPL = W/P
(See P48-50)
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 True or False Questions
2. Incremental labor
units have a raising
marginal
productivity, ceteris Output
paribus.
Answer: F
Hint: The marginal
W/P
product of labor MPL
decrease as the
amount of labor
increase. (See P50) QL
L
9
 True or False Questions

3. In the real world, the concept “economic

profit” always contains both accounting
profit and the return to capital.
Answer: F
Hint: Accounting Profit = Economic Profit + (MPK × K)
(See PP51-52)

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 True or False Questions

4. If the MPC is 0.6, then households save

60 cents of each additional dollar of
disposable income on goods and services
and only spend 40 cents.
Answer: F
Hint: (See P54)

11
 True or False Questions
5. The phenomenon
“crowding out” to r S2 S1
investment happened
when the government
increases the tax
revenues.
Answer: F
r2
Hint: An expansionary fiscal
policy adopted by r1 I(r)
government could induce
crowding out investment. I, S
(See P64)
12
 Multiple-Choice Questions
1. The variable that is held constant for a
given production function is the:
a. amount of labor input.
b. amount of output.
c. amount of capital input.
d. production technology.
Answer: d.
Hint: (See P45).
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 Multiple-Choice Questions
2. A competitive firm takes:
a. the prices of its outputs as given, but not the
prices of its inputs.
b. the prices of its inputs as given, but not the
prices of its outputs.
c. the prices of both its inputs and its outputs as
given.
d. neither the prices of its inputs nor the prices of
its outputs as given.
Answer: c.
Hint: (See P47).
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 Multiple-Choice Questions
3. Constant returns to scale occurs when:
a. output doubles when the amounts of all factor
inputs double.
b. output remains constant over time.
c. the marginal productivity of labor equals the
marginal productivity of capital.
d. the marginal products of capital and labor do
not change.
Answer: a.
Hint: (See P45)
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 Multiple-Choice Questions

4. The mathematical expression that gives a

measure of productivity using a constant
returns to scale production function is
• xY = AF (L, K, H, N).
• Y/L = AF(1, K/L, H/L, N/L).
• Y/L = AF(xL, xK, xH, xN).
• L = AF(Y, K3, H, N).
Answer: b
Hint: (See P45)
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 Multiple-Choice Questions
5. A profit-maximizing firm will hire labor up to
the point where:
a. the marginal product of labor equals the
marginal product of capital.
b. the marginal product of labor equals the real
wage.
c. marginal revenue equals zero.
d. the real wage equals the real rental price of
capital.
Answer: b.
Hint: (See P50).
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 Multiple-Choice Questions
6. Which of the following transactions is viewed
as investment in the national accounts?
a. you buy 100 shares of stock in IBM.
b. you buy a computer to help your children do
their homework.
c. IBM builds a new factory to manufacture
computers.
d. you eat a Big Mac.
Answer: c.
Hint: (See P25).
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 Multiple-Choice Questions

7. The interest rate on a loan depends on:

a. the term of the loan.
b. the riskiness of the loan.
c. the tax treatment of the loan.
d. all of the above.
Answer: d.
Hint: (See P57).
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 Multiple-Choice Questions
8. With total output fixed and national saving
unrelated to the interest rate, an increase in
taxes will:
a. shift the vertical saving schedule to the left.
b. decrease investment.
c. increase consumption.
d. decrease the equilibrium interest rate and
increase investment.
Answer: d.
Hint: (See P63).
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 Multiple-Choice Questions
9. If national saving is positively related to the
interest rate, a technological advance that
increases investment demand will:
a. have no effect on the amount of national saving.
b. shift the investment demand curve to the left.
c. increase both investment and the equilibrium
interest rate.
d. have no effect on consumption.
Answer: c.
Hint: (See P65)
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 Multiple-Choice Questions

10. If the nominal interest rate is 8% and prices

are rising at 5% per year, the real interest rate
is:
a. 8%.
b. 3%.
c. 13%.
d. –13%.
Answer: b.
Hint: (See P55)
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 Multiple-Choice Questions

11. If consumption C = 100 + 0.8(Y –T),

disposable income equals 1,000, and Y = 2,000,
then the marginal propensity to consume is:
a. 0.5.
b. 900.
c. 0.8.
d. 0.9.
Answer: c.
Hint: (See P54)
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 Multiple-Choice Questions
12. Diminishing marginal product is the notion that
b. As the stock of capital ages, the extra output produced
decreases.
c. As the amount of labour increases, the extra output
produced from an additional unit of capital falls.
d. As resources are used to produce capital goods, fewer
additional capital goods can be produced.
e. As the amount of labour increases, the extra output
produced from an additional unit of labour falls.
Answer: d
Hint: (See P48)

24
 Multiple-Choice Questions

13. Assume a consumption function is

C = C + c(Y − T ). By definition, the marginal
propensity to consume
• equals ΔC / Δ(Y-T).
• is the behavioral coefficient c in the equation.
• is the slope of the consumption function.
• all of the above.
Answer: d
Hint: (See P54)
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 Multiple-Choice Questions
(2005 Exam Question)
14. A farmer grows a bushel of wheat and sells it to a
miller for $1.00. The miller turns the wheat into flour
and then sells the flour to a baker for $3.00. The
baker uses the flour to make bread and sells the
bread to an engineer for $6.00. The engineer eats the
bread. What is the GDP?
b. $10.00
c. $4.00
d. $2.00
e. $6.00
Answer: d
Hint: (See P25) 26
 Multiple-Choice Questions
(2005 Exam Question)

15. Which of the following transactions should be

placed in one of the four components of
expenditure as investment in the US?
b. Boeing sells an airplane to the Air Force.
c. Boeing sells an airplane to American Airline.
d. Boeing sells an airplane to Air France.
e. Boeing sells an airplane to a retired US
President.
Answer: b
Hint: (See P25) 27
 Multiple-Choice Questions
(2005 Exam Question)

16. In the classical model with fixed income, a

reduction in the government budget deficit
will lead to a
b. higher real interest rate.
c. higher level of output.
d. lower level of output.
e. lower real interest rate.
Answer: d
Hint: (See P61)
28
 Multiple-Choice Questions
(2005 Exam Question)
17. A profit-maximizing firm will hire labour up
to the point where
b. the marginal product of labour equals the
marginal product of capital.
c. the marginal product of labour equals the real
wage.
d. marginal revenue equals zero.
e. the real wage equals the real rental price of
capital.
Answer: b
Hint: P × MPL = W ⇒ MPL = W/P (See P50) 29
 Multiple-Choice Questions
(2005 Exam Question)
18. With total output fixed and national saving
unrelated to the interest rate, an increase in
taxes will
b. shift the vertical saving schedule to the left.
c. decrease investment.
d. increase consumption.
e. decrease the equilibrium interest rate and
increase investment.
Answer: d
Hint: (See P61)
30
 Multiple-Choice Questions
(2005 Exam Question)

19. If disposable income is 4,000, consumption is

3,500, government spending is 1,000, and tax
revenues are 800, national saving is equal to
b. 300
c. 500
d. 700
e. 1,000
Answer: a
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 Multiple-Choice Questions
(2005 Exam Question)

20. If the consumption function is C = 100 + 0.8

(Y-T) and both taxes and government
purchases increase by $1, the equilibrium
level of income will
b. remain constant.
c. increase by $3.
d. increase by $1.
e. decrease by $4.
Answer: c
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 Numerical Questions from Textbook
Question 6 on page 70
Consider an economy described by the
following equations
Y = C+I+G, Y = 5,000, G = 1,000, T = 1,000
C = 250+0.75(Y-T), I = 1,000-50r.
d. In this economy, compute private saving,
public saving, and national saving.
e. Find the equilibrium interest rate.
f. Now suppose that G rises to 1,250. Compute
private saving, public saving, and national
saving.
g. Find the new equilibrium interest rate. 33
 Numerical Questions from Textbook
Question 6 on page 70

Answer:
• Private Saving = Y-T-C = 5000-1000-250-
0.75(5000-1000) = 750
Public Saving = T-G = 1000-1000 = 0
National Saving = S = Private Saving +
Public Saving = 750

34
 Numerical Questions (continued)
b. S = I
750 = 1000-50r
r = 5%
c. Private Saving is unchanged.
Public Saving = 1000-1250 = -250
National Saving = 750-250 = 500
d. 500 = 1000-50r
r = 10%
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