# MGEB06H3 Study Guide - Midterm Guide: Nominal Interest Rate, Loanable Funds, Growth Accounting

by OC195132

Department

Economics for Management StudiesCourse Code

MGEB06H3Professor

Jack ParkinsonStudy Guide

MidtermThis

**preview**shows pages 1-3. to view the full**11 pages of the document.**ECM B06 - WINTER 2011 – MIDTERM SOLUTIONS

Q1. (20 marks)

Solution

PART A:

LR Output

•Y = 4(6,400)0.50(3,600)0.50 = 4(80)(60) = 19,200 (2 marks)

Real interest rate

•Y = C + I + G (OR S = I)

•19,200 = 3,500 + 0.60(19,200 – 7,680) – 50r + 2,000 – 80r + 7,680

•130r =892

•r = (892/130) = 6,862 (percent) (2 marks)

Government spending on goods and services (net) = G = .40xY = 7,680

Taxes = T = 7,680 = G

Consumption

•C = 10,068.92 (2 marks)

Investment

•I = 1,451.08 (1 mark)

Private Saving = SPVT = Y – T – C = 1,451.08 (1 mark)

Government saving = SGOVT = T – G = 0 (1 mark)

National saving = SNAT = SPVT + SGOVT = Y – C – G = 1,451.08 (1 mark)

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Q1. Solution (continued)

PART B:

LR Output

•Y = 19,200 (1 mark)

Real interest rate

•Y = C + I + G (OR S = I)

•19,200 = 2,800 + 0.60(19,200 – 7,680) – 50r + 2,000 – 80r + 7,680

•130r =192

•r = (192/130) = 1.477 (percent) (2 marks)

Government spending on goods and services (net) = G = .40xY = 7,680

Taxes = T = 7,680 = G

Consumption

•C = 9,638.15 (1 mark)

Investment

•I = 1,881.85 (1 mark)

Private Saving = SPVT = Y – T – C = 1,881.85 (1 mark)

Government saving = SGOVT = T – G = 0 (1 mark)

National saving = SNAT = SPVT + SGOVT = Y – C – G = 1,881.85 (1 mark)

r SNAT

6.862% AGraph: 2 points

• LESS 1 pt if supply of LF curve in NOT upward slopingvertical

1.477% B • subtract 1 pt if wrong curve shift OR if in incorrect direction

I0(r)

1451.08 1881.85 S, I

2

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Q2. (15 marks) - Quantity Theory of Money

Solution

A) In the LR when V & Y are both constant (fixed) M & P move together one-to-one.

Initially in LR equilibrium we have

YPVM

⋅=⋅

00

, later this becomes

YPVM

⋅=⋅

00

33

If the central bank raises the money supply to 3 times its previous level then, in the LR:

1) the nominal price level (P) will also be raised to 3 times its previous level;

2) nominal GDP (P∙Y) will be raised to 3 times its previous level; and

3) real GDP (Y) will remain the same (i.e. Y & V, which are real variables, are unaffected by

any money supply change in the LR).

(7 marks – 2 marks each for points 1), 2) & 3) AND 1 mark for explanation )

B) If M∙V = P∙Y holds in the very LR then over time it holds in rates of changes:

∆

+

∆

=

∆

+

∆

Y

Y

P

P

V

V

M

M

, so

∆

+=

∆

+

∆

Y

Y

V

V

M

M

π

If this equation holds in the very long-run we expect it to continue to hold, so:

e

e

ee

Y

Y

V

V

M

M

∆

+=

∆

+

∆

π

Also growth accounting explains the growth rate of real output in the very long-

run. The growth accounting expression is:

∆

+

∆

⋅−+

∆

⋅=

∆

A

A

L

L

K

K

Y

Y)1(

αα

We expect this relationship to continue to hold in the very long-run, so:

eeee

A

A

L

L

K

K

Y

Y

∆

+

∆

⋅−+

∆

⋅=

∆

)1(

αα

In the question we are given the following annual growth rates:

%8

=

∆

e

M

M

%2

=

∆

e

V

V

%3

=

∆

e

K

K

%3

=

∆

e

L

L

%5.0

=

∆

e

A

A

& α = 25%

Therefore, we get

( ) ( ) ( )

%50.3%50.0%375.0%325.0

=+⋅+⋅=

∆

e

Y

Y

(2 marks)

3

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