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(ECON514)774faa - EC51409PracticeMidterm02.pdf
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Midterm Exam
Economics 514
Macroeconomic Analysis
November 13, 2008

Each Question 16
Points Each.
1.
Permanent Income Hypothesis Two households born at time 0 lives through time T = . The household begins period zero with zero financial wealth Thus, the present value of lifetime consumption is equal to the present value of lifetime income.





the interest rate is 20% (i.e. r = .2). Each household has initial income Y0.and chooses consumption according to the permanent income hypothesis. In each case, we can write consumption as proportional to initial income C0 = mpcY0.
A.
The first household experiences continuously declining income in all future periods. The level of income in each period is a fraction of the last period. Yt = Yt-1. Solve for mpc when = .9









Please write your answers on this exam paper.

B.
The second household experiences constant growth in output through period N, when the household retires from work. Yt = (1+g)Yt-1 if tN At time N+1 and for all periods after, the household has zero income. Solve for mpc when N = 9 and g = .2.


C.
Explain in words why mpc is an increasing function of in part A. and an increasing function of N in part B





















2.
Implied Capital Rental Rate The inflation rate of output goods price is 6% (i.e. = .06). The nominal interest rate is 9% (i = .09). The relative price of investment goods to output goods is always Itp=.75 and the depreciation rate is 9%. Solve for capital productivity and the capital labor ratio when the marginal productivity of capital equals the capital rental rate and production is given by the Cobb-Douglass function.






Please write your answers on this exam paper.

3.
Excise Taxes on Capital Assume the production function of a firm is given by so that the marginal product of capital was 1.1.




A.
The firm can rent capital at a capital rental rate of. Calculate the optimal level of capital. Calculate output at that level of capital. Calculate the capital bill. Calculate the surplus.




















B.
Now, the government imposes a direct tax, tw, on hiring capital so that the after-tax cost of hiring capital is and profits are given by. Calculate the tax bill when tw = .1 and .8. Explain which regime produces the largest tax bill and why.














4.
Autarky and the Interest Rate Assume a patient household with a discount rate = 1.lives for 2 periods Each maximizes utility





subject to the constraint that the present value of consumption equals the present value of income.


The income in Y0 = 100 and income in period 2 is Y1 = 121.
A.
What is the level of the interest rate such that the household would neither borrow nor save a