Institute of Business Management

Semester II
Course Instructor: Irfan Lal Total Marks:100
Date:
Assignment No.3

Q# 1 Explain why the saving curve slopes upward and the investment curve slopes downward in the
saving investment diagram. Give two examples of changes that would shift the saving curve to the
right, and two examples of changes that would shift the investment curve to the right.

Q#2 You have just taken a job that requires you to move to a new city. In relocating, you face the
decision of whether to buy or rent a house. A suitable house costs $300,000 and you have saved
enough for the down payment. The (nominal) mortgage interest rate is 10°/o per year, and you can
also earn 10°/o per year on savings.
Mortgage interest payments are tax deductible, interest earnings on savings are taxable, and you are
in a 30°/o tax bracket. Interest is paid or received, and
taxes are paid, on the last day of the year. The expected inflation rate is 5°/o per year.
The cost of maintaining the house (replacing worn out roofing, painting, and so on) is 6°/o of the value
of the house. Assume that these expenses also are paid entirely
on the last day of the year. If the maintenance is done, the house retains its full real value. There are
no other relevant costs or expenses.

a. What is the expected after-tax real interest rate on the home mortgage?
b. What is the user cost of the house?
.

Q#3 Explain Desire Capital stock with the help of diagram?

Q#4 6. An economy has full-employment output of 6000. Government purchases, G, are 1200.
Desired consumption and desired investment are
Cd == 3600 - 2000r + 0.10Y, and
Id == 1200 - 4000r,
where Y is output and r is the real interest rate.

a. Find an equation relating desired national saving, sd, to r and Y.

b. Using both versions of the goods market equilibrium condition, Eqs. ( 4.7) and ( 4.8), find the real
interest rate that clears the goods market. Assume that output equals full-employment output.
c. Government purchases rise to 1440. How does this increase change the equation describing
desired national saving? Show the change graphically. What happens to the market-clearing real
interest rate?

Q# 5 Use the saving-investment diagram to analyze the effects of the following on national saving,
investment, and the real interest rate. Explain your reasoning.

a. Consumers become more future-oriented and thus decide to save more The government
introduces an investment tax credit (offset by other types of taxes, so total tax collections remain
unchanged).
b. A large number of accessible oil deposits are discovered, which increases the expected future
marginal product of oil rigs and pipelines. It also causes an increase in expected future income.
Q#6 Explain Balance of payment and explain relationship between
i) current account and capital account
ii) current account and net export

Q#7 How would each of the following affect national saving, investment, the current account balance,
and the real interest rate in a large open economy?
a. An increase in the domestic willingness to save (which raises desired national saving at any given real
interest rate).
b. An increase in the willingness of foreigners to save.
c. A temporary increase in government purchases.
d. An increase in taxes (consider both the case in which Ricardian equivalence holds and the case in which it
doesn't hold).

Q # 8 What is the q theory of investment? Who developed it? What is q, and what do different values of q
imply? How is q related to the stock market value of a firm and its capital stock?

Q# 9 Solve numerical no. 3 , 4 and 5 from chapter no 5 ?