2. Predict the impact on the real wage of each of the following events:

3. A firm's expected future marginal product of capital is MPK^f=1520-3K. The real interest rate is 4 percent, the depreciation rate is 8 percent, and the tax rate on the firm's revenue is 25 percent. If the firm's desired capital stock is 400,

(a) what is the price of capital?

(b) what is the user cost of capital?

(c) what is the tax-adjusted user cost of capital?

(d) and if the tax rate is raised to 40 percent, at the price of capital you calculated in (a),what will be the change in the desired stock of capital?

4. Suppose that the production function in the Canadian economy is Y = AK^{0.3}N^{0.7}. And you have the following information:

	1980	1990
Real output Y (billions $)	424	565
Capital K (Billions $)	367	479
Labour L (millions workers)	10.7	12.6

1980 1990 Real output Y(billion $) 424 565 Capital K (billion $) 367 479 Labor L (million workers) 10.7 12.6 (a) What was the growth rate in total factor productivity over the 1980-1990 period?

(b) What would have been the real output in 1990 if there had been no growth in total factor productivity during 1980-1990?

5. Imagine a small open economy in which G=10 and NX=-5. Households' desired consumption is C = 10+ 0.6Y-100RW, and firms' desired investment is I=40-200RW. The world real interest rate, RW, is 5 percent.

(a) Solve for Y, C, S, and I.

(b) If the government increases its purchases by 5, and if the increase does not affect the output level, calculate changes in S and NX.

6. Suppose you have the following information on Pecunia's balance of payments accounts. The figures are in millions of dollars

Merchandise exports	250,428
Service exports	34,612
Merchandise imports	222,284
Service imports	42,644
Net income from assets	-34,372
Net transfers	696
Increase in Pecunian-owned assets abroad	-3,489

Calculate the following

7. Suppose you divide your life into two periods -- working age and retirement age. When you work, you earn labour income Y; when retired, you earn no labour income, but must live off your savings and the interest it earns. You save the amount S while working, earning interest rate r, so you have (1+r) to live on when retired. Suppose also that you want to maintain the same level of consumption over the two periods.

(a) Suppose you earn 1 million over your working life, and the real interest rate for retirement saving is 40%. How much will you save and how much will you consume in each part of your life?

(b) Suppose your current income went up to $1.5 million when working. Now what will you save and how much will you consume each period?

(c) Suppose you want to leave $0.3 million to your children at the end of period 2. Now, with Y = $1 million as in part (a), how much will you save and how much will you consume each period?

(d) Suppose the interest rate rises (starting from the situation in part (a)). Will you save more or less?

Solutions to Assignment 2

1. (a) 12.4*(1-0.095)=11.222

(b) 12.4/0.67-12.4=6.107

(c) [12.4*(1-0.095)]/[12.4/0.67]=0.60635 or 60.635%

2. (a) it shifts the labor supply curve to the right and decreases the real wage

(b) it shifts the labor demand curve to the left and decreases the real wage

(c) it shifts the labor demand curve to the right and increases the real wage

3. (a) 2000

(b) 240

(c) 320

(d) the new desired capital stock is 373.3. The change is a decrease of 26.7.

4. (a)

1980

1990>

TFP

13.72

15.05

percentage increase in A over 1980-1990: (15.05-13.72)/13.72 = 9.69%

(b) At A = 13.72 (1980 level), Y = 13.72*(479)^0.3*(12.6)^0.7=514.89

5. (a) Y=100; C=65; S=25; I=30

(b) S=20, decreases by 5; NX=-10, decreases by 5

6. (a) 250,428+34,612-222,284-42,644-34.372+696 = -13,510 mil

(b) 250,428+34,612-222,284-42,644 = 20,112 mil

(c) CA+KA =0, so KA = +13,510 mil

(d) 13,510-3,489 = 10,021 mil

7. (a) (Y-C1)*(1+r)=C2, C1=C2, S=Y-C1

S=0.417 mil; C1=C2=0.583 mil

(b) S=0.625 mil; C1=C2=0.875 mil

(c) (Y-C1)*(1+r)=C2+0.3, C1=C2, S=Y-C1

S=0.542 mil; C1=C2=0.458 mil

(d) since Y=C1+C2/(1+r) and C1=C2=C, we have C[1+1/(1+r)]=Y. An increase in r will lead to a higher C, so you save less.