University of Toronto Scarborough
ECMC06 – TOPICS IN MACROECONOMICS THEORY
Instructor: A. Mazaheri
InstructionsThis is a closed book test. You are allowed a non-programmable calculator.
You have 2 Hours.
FOR MARKERS ONLY:
Q1 Q2 Q3 Q4 Q5 Total
Marks 28 17 20 20 15 100
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.
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.
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
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?