Reference no: EM131022785

Class Handout 3-

1) Last year, the nation of Bruinville had $500 of private savings.  Government spending was $400, and total tax revenue was $900.  Households spent $2100 on consumption goods and businesses spent $1000 on investment.  Transfer programs cost the government $200.  Under the assumptions of the classical model, what was the value of capital inflows in Bruinville last year?

2) If private savings equals investment in an open economy, then which of the following must also be true?

a. Capital inflows = G - (T - TR)

b. Imports = Exports

Use the information below to answer the following two questions:

When the government has a balanced budget and there are zero capital inflows, the market for loanable funds on Whaler Island is defined by

Supply:                 LF_S = S_p = 600 + 500i

Demand: LF_D = I = 4100 - 200i

where i is the interest rate expressed in percentages (i.e., i = 14 is a 14% interest rate), LFS and LFD are the quantity of loanable funds supplied and demanded in the economy, SP is private savings, and I is investment.

3) The Whaler Island government begins running a deficit and an equilibrium interest rate of 7% results in the loanable funds market.  How large is the deficit?

a. $0

b. $200

c. $700

d. $1400

4) How much private investment spending is crowded out by the government deficit?

a. $0

b. $200

c. $400

d. $1000

5) In the classical model of a closed economy, if G increases by $1000 without any change in taxes or transfer programs, then which of the following best describes the response of other economic aggregate variables?

a. The equilibrium interest rate will fall, while consumption and investment fall by a combined amount of $1000

b. The equilibrium interest rate will rise, while consumption and investment fall by a combined amount of $1000

c. The equilibrium interest rate will rise, while investment will fall by $1000

d. The equilibrium interest rate will fall, while investment will fall by $1000

Use the information below to answer the following two questions using a classical model:

Cubland is a closed economy. The economy in Cubland has

T = taxes = 1000

TR = government transfer payments = 200

G = government spending = 600

I = investment spending = 5000 - 600i

S_p = private saving = 200i

Where i is the interest rate expressed in percentages (i.e., i = 14 is a 14% interest rate) and all numerical values are in dollars (e.g., government spending is equal to $600).

6) What is the equilibrium interest rate?

a. 5%

b. 6%

c. 6.25%

d. 7%

7) What is the total quantity of leakages in Cubland?

a. $2000

b. $2050

c. $2200

d. $2250