PS1 Answers:

1)
a) MRP of labor = $5 * $12 = $60
MRP of capital = $25 * $20 = $500
50*$12 + 15*$20 = $900
Since MRP of capital is greater than the cost of capital, the firm should use more capital
and less labor to maximize profit.
The firm is not maximizing profit.
b) The firm should reduce the number of workers and increase the number of
equipment to increase the marginal product of capital and ultimately maximize
profit.
2)
a) C = a + b*(Y-T) = a + 0.4*(Y - (Y+1)) = a - 0.4*1 = a - 0.4
The effect on private consumption is a decrease of $400 million.
b) S = Y - C = Y - (a - 0.4) = Y - a + 0.4
So the effect on private savings is a decrease of $400 million.
c) T = Y + P, so P = T - Y = (Y+1) - Y = 1.
Therefore, the effect on public saving is an increase of $1 billion.
d) N = S + P = (Y - a + 0.4) + 1 = Y - a + 0.4 + 1 = Y - a + 0.6
So the effect on national saving is a decrease of $400 million.
e) N = S + P = (Y - a + 1) + 1 = Y - a + 2
So the effect on national saving is a decrease of $1 billion.
3)
a) Trade surplus mean Net exports > 0 (Exports > Imports).
World real interest rate is higher than the real interest rate.
b) At the prevailing world interest rate, this will result in an increased trade surplus.
4)
a) 0.2 * Y = 0.04 * K
Y = 2ks
0.2 * 2ks = 0.04 * K
0.4ks = 0.04K
k = 0.1
b) Y/L = 2ks/L = 2k
0.2 * Y/L = 0.2 * 2ks/L = 0.4k
2k - 0.4k = 1.6k = 0.16
5)
a) Although the immediate impact of a higher saving rate on the capital-labor ratio is
unclear, over time, as the economy converges to a new steady-state level with
more capital per worker, the capital-labor ratio would rise.
 b) The ideal saving rate will vary depending on your spending, income level, and
long-term financial objectives.
6)
a) Y = A K^ 1/3L^2/3
Solow residual is a measure of total factor productivity. Solow residual is 4%
Y = 4% + (1/3)*3% + (2/3)*3%
Y = 7%
b) Productivity growth = 4%
Total output growth = 7%
(4% / 7%) = 0.5714
=57.14%
7)
a) According to the AD/AS model, the economy is at equilibrium when the AD and
AS curves intersect. The AS curve depicts the whole supply of goods and
services, whereas the AD curve shows the total demand for goods and services.
The economy is producing to its full potential and is in equilibrium when actual
GDP (Y) equals potential GDP (Y). This is shown as a point on the junction of the
AD and AS curves in the AD/AS diagram.
b) The equilibrium in the goods market is represented by the IS curve. It displays
the output levels and interest rate combinations at which total demand equals
total output. At any given interest rate, businesses want to spend less on
investment products as economic future uncertainty increases. Indicating a
decline in investment demand at any given level of interest rates, this would
cause the IS curve to shift to the left. The production and interest rates would be
lower at the new equilibrium point.
c) The AS curve depicts the whole supply of goods and services, whereas the AD
curve shows the total demand for goods and services. The AD curve would move
to the left as economic future uncertainty increased. This is because a decline in
aggregate demand brought on by a decline in investment demand would result in
a shift to the left of the AD curve. As a result, as the economy shifts from point A
to point B, the new equilibrium point, the short-run equilibrium levels of output
and inflation would decline. Point B reflects a lower level of output and inflation
than point A and is situated at the point where the new AD curve and the AS
curve converge. This happens because a decline in investment demand lowers
overall demand levels in the economy, which lowers output and inflation levels.