ECMC06-Sample Term test 2.pdf

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Economics for Management Studies

DEPARTMENTOF MANAGEMENT University of Toronto Scarborough ECMC06 – TOPICS IN MACROECONOMICS THEORY Sample Test-2 Instructor: A. Mazaheri InstructionsThis is a closed book test. You are allowed a non-programmable calculator. You have 2 Hours. Good Luck! Last Name: First Name: ID FOR MARKERS ONLY: Q1 Q2 Q3 Q4 Q5 Total Marks Earned Maximum Marks 28 17 20 20 15 100 Possible Page 1 of 13 Answer all following questions: Question-1 [28 Points] Answer the following short questions: a) [10 Points] Consider the Fisher model of intertemporal consumption. Suppose the consumer can save at rate r andsborrow at rate r , wherb r < r . Use grbphs to show the impact of this on the consumption for borrowers and lenders (savers) as well as for an individual who is neither a borrower nor a lender. Make the argument that a borrower facing this situation may not smooth out her consumption as in the Keynesian theory even though she is rational & forward-looking. Page 2 of 13 a1) [10 Points)] According to Robert Barro (1974), the debt financed fiscal policy is ineffective even if households do not expect to pay higher taxes later in their life, as long as they care about their children as much as they care about themselves. Complete the following “partial” illustration and explain why that might be the case. Children Parents Page 3 of 13 a2) Since the children are expected to have a higher income, an individual who smoothes consumption across generations might want to borrow on the behalf of the children but cannot. Therefore, a “tax cut will not be passed on to the kids”. This implies that, debt-financed fiscal policy will be effective. Complete the following “partial” illustration and explain why that might be the case. Children Parents Page 4 of 13 c) [8 Points] Explain using formulas or graphs were needed how the permanent income hypothesis resolve the seemingly contradictory pieces of evidence regarding consumption behaviour? Page 5 of 13 Problem-2: [17 Points] Consider the stylized pattern of lifetime income, consumption, saving, dissaving, and wealth shown in the following graph. Assume that consumption is constant over the entire lifetime, income is constant over working lifetime, the real interest rate is zero, and there is no uncertainty about life span. If there is no population growth, the ratio of wealth to income will be constant for the nation. If all individuals live T years and work R years, the amount of wealth accumulated at the time of retirement must be enough for T – R years of consumption (C per year). a) (7 Points) Find the formula for accumulated wealth on the retirement day as a function of consumption. Assuming W stands for the average wealth over the life of this individual, find he ratio of W/C expressed in terms of T and R? Page 6 of 13 b) (5 Points) Briefly explain how this model can explain the Kuznets’ consumption puzzle. c) (5 Points) If you believe in the life cycle hypothesis, what do you think the initial impact of the aging population will be on the consumption, and saving rates?
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