The following table shows Bishop’s macroeconomic data for 1999 and 2000:

(a) Calculate the growth rate of total factor productivity between 1999 and 2000.

(b) Suppose productivity remains constant from 2000 to 2001 and the labour force increases from 75 to 80. Calculate how much capital stock is needed to produce output of 2200 in year 2001.

(c) Starting from 1999, suppose in ten years time, both the inputs double in size (K=3400, N=130). What will be the output in ten years time, assuming productivity remains unchanged?

(d) Using the expression for production function, show that doubling the inputs (K and N) will exactly double the output. (No calculations required - work with the expression of production function)

Q2. [20] Using diagrammatic exposition, explain what is meant by MPN (marginal product of labour) and MPK (marginal product of capital).

(a) Suppose the production function exhibits diminishing returns to scale. Explain two properties of MPK functions. Draw diagrams.

(b) Suppose the production function exhibits constant returns to scale. Explain two properties of MPN functions. Draw diagrams.

(Note: by property of function we mean how this function relates to K and N)

Q3. [27] For an economy the MPN is:

where N is aggregate employment. The aggregate quantity of labour supplied is [500 + 10 (1-t) w], where t is the income tax rate and w is the real wage rate.

(a) Find the expressions for before-tax real wage rate, employment and after-tax real wage rate.

(b) What happens to before-tax real wage rate, after-tax real wage rate and employment when tax rate increases?

(c) Suppose that tax rate, t, is 50%. Calculate values of w and N. What will be the impact of instituting a minimum wage that sets the before-tax real wage at 200 on employment? Draw diagram to depict the situation.

(d) Suppose there is a technology shock that changes the MPN. The new function is given by: MPN=400-0.5 N. Explain whether this is due to an adverse or favorable productivity shock. Recalculate part (c) and explain the impact of this change with the help of a diagram.

Q4. [18] Explain how firms determine their desired capital stock. Draw diagram to illustrate. In addition explain how the following will affect firm’s desired capital stock:

(a) a technological improvement

(b) an increase in N due to increased immigration

(c) an increase in expected real interest rate

Q5. [20] A firm has current and future marginal productivity of capital given by

The price of capital is $5000, the real interest rate is 10%, and capital depreciates at a 15% rate. The real wage is $15.

(a) Calculate the user cost of capital

(b) Find the firm’s optimal amount of employment and the size of capital stock.

For Practice Only

Q6. Explain the equilibrium condition in the goods market. Illustrate it with the help of a diagram. Explain how the equilibrium will be affected in the following situations:

(a) an increase in the income tax rate assuming Ricardian equivalence holds true

(b) a temporary decline in government spending

(c)an increase in the tax on firm’s revenue

Draw diagram in each of the cases to depict the before and after change situation.

Q7. An economy has full employment output of 5000. Government purchases are zero. Desired consumption and desired investment are given by: