Problem set.

LCCn1012 rlnclples of Lconomlcs ll

rob|em Set 4 1he I|nanc|a| System
DEPARTMENT OF ECONOMICS
ECON 3006: International Trade
1. For the economy as a whole, which oI the Iollowing would be classiIied as an investment?
a) Building a new Iactory.
b) Buying shares on the stock market.
c) Making a deposit in your savings account Ior retirement.
d) Expanding your existing Iactory by adding a new warehouse.
e) Buying new computer-controlled stitching machines but only to replace old manual ones.
I) Upon retirement, building a beach cottage to spend your days watching the waves.
g) Buy a Iriend`s beach cottage, instead.

2. II the 3423,rate oI interest is 14 and the prevailing rate oI inIlation is 11, how much is the 70,rate
oI interest?
3. II Y C I G (X-M), prove that investment is equal to the sum oI private, domestic savings and
Ioreign savings (the trade deIicit) less the government`s Iiscal deIicit. What does this tell you about the
relationship between Iiscal deIicits and the economy`s level oI investment?
4. Calculate the level oI investment in the economy iI you know that income $200, consumption $100,
imports $60, exports $40, and government expenditure $70.
5. You are provided with the Iollowing inIormation: GDP $12,000; consumption $2,000; imports
$5,000; exports $4,500; taxation $3,500; government expenditure $4,000. Calculate private, domestic
savings, Ioreign savings, and the Iiscal deIicit. How much investment is taking place?
6. You know that the level oI income is $10m, taxes amount to $5m, consumption is equal to $4m, the trade
deIicit is $2m, and the Iiscal deIicit is $1m.
a) Calculate the level oI investment.
b) Suppose the Iiscal deIicit worsens to $2m. What is the new level oI investment?
c) Sketch the movement in 'b on a diagram oI the market Ior loanable Iunds.
d) What happens to the rate oI interest?

7. What would you recommend to the Government oI Jamaica as a way to bring down interest rates?
8. Using a diagram oI the market Ior loanable Iunds, examine the eIIect on the interest rate and the amount oI
investment oI the Iollowing developments. (Remember, identiIy which curve is aIIected and in what
direction it shiIts.)
a) A public education campaign encourages people to save more.
b) A rise in crime diminishes long term investment prospects.
c) A destructive hurricane necessitates the rebuilding oI roads and bridges.
d) A Iall in compliance reduces tax revenue, increasing the size oI the Iiscal deIicit.

9. You expect a contemplated $10m investment project to break even aIter the Iirst year and to earn a return
oI $2m in each oI the subsequent two years. AIter the 4th year, you can sell the operation Ior and expected
$12m.
a) II the rate oI interest is 10, would you make this investment?
b) Suppose the rate oI interest rises to 15, would you make this investment? Why or why not?
c) What do you conclude about the relationship between the rate oI interest and the level oI investment?