3. TRUE/FALSE/MAYBE and EXPLAIN: (4 MARKS). (Maximum length: one page) "A government sells a large amount of new bonds to finance an immediate cut in personal income taxes. According to the Loanable Funds and Money Market models this will lower short- and long-run real interest rates (ceteris paribus)."

1. Multiple Choice Question 1.A Assume that a Peruvian company, DMB LLC, just reported its earnings this year (year 0). The reported revenue was $9 million and the reported cost was $10 million. Its revenue is expected to grow 6% annually, while its cost is expected to grow 2% annually. Mark ALL the CORRECT statements. For this question, profit revenue - cost. First, apply the Gordon Formula to calculate the present value of all future revenues and the present value of all future costs separately. Then, calculate the present value of all future profits, which equals the present value of all future revenues minus the present value of all future costs. a) The first year that the profit of the company becomes positive is year 3. b) If the discount rate is 12%, the present value of all future profits of the company is $50 million. c) If the discount rate is 10%, the present value of all future profits of the company is $111 million. d) If the discount rate is 5%, the present value of all future profits of the company is infinite. e) The present value of all future profits of the company is always positive no matter what the discount rate is. 1.B Suppose the capital share in Canada is a = 2/5. Mark ALL the CORRECT statements. For this question, use the growth accounting formula given in class. a) If capital increases by 10%, labor hours increase by 5%, and total output increases by 10% relative to last year, then TFP should decrease by 1%. b) If capital increases by 15%, labor hours decrease by 5%, and TFP increases by 5% relative to last year, then total output should increase by 5%. c) If capital increases by 10%, TFP increases by 10%, and total output increases by 10% relative to last year, then labor hours should increase by 10%. d) If labor hours increase by 10%, TFP increases by 5%, and total output increases by 15% relative to last year, then capital should increase by 1%. e) None of the above. 1.C Suppose the Federal Reserve sells Treasury Bills and Treasury Bonds in the open market. Compared to a scenario in which no such open market operations took place, which of the following answers are CORRECT? a) Banks short of reserves end up with more loans. b) Banks short of reserves end up with the same amount of deposits. c) Banks short of reserves end up with more equities. d) The federal funds rate is lower. e) The money supply is lower.

3. Analytic Question on Consumption and Labor decisions during the Pandemic In this question we will study how workers change their labor supply. Imagine there is a consumer/worker with preference over consumption C and leisure & given by the equation below: U(C,) = log(C) + log(l) 1. Assume the consumer faces a wage rate of w and consumption price P. She also has one unit of available time to spend working or resting. Solve for the consumer's optimal choice of consumption and hours worked. 2. Now assume a pandemic hits the economy and the consumer receives more utility from leisure. We model this by changing the preferences to: U(C,) -log(C) + 0 log(l) 0 with > 1. Solve for the hours worked and consumption under these new preferences. Compute the elasticity of labor supply and consumption with respect to real wages. Compare your answer with the previous part (when 0-1). Does the consumer wants to work more or less? 3. The government wants to increase hours worked, and so it enacts a law that includes a subsidy on wages. This subsidy is proportional to labor income. Explain why the new budget constraint can be expressed as: PC = (1+7)w(1-0), where is the subsidy (with 7 > 0). Solve for the optimal hours worked and consumption and compare your answer with that of the previous question. What is the effect of this subsidy on hours worked? 4. Now the government wants to try a different fiscal policy. Instead, it creates a new lump-sum tax that the consumer has to pay regardless of income or consumption. Explain why the new budget constraint can be written as: PC w(1)-T, where T is the new lump-sum tax. Assume 0 <T<w and w is sufficient, large to have a positive consumption. Solve for hours worked and consumption. Compare with part 2. - 5. Imagine the government wants to choose the tax amount T such that the worker supplies exactly the same number of hours worked as in part 1. Find this tax amount. Assume < 1+0. Is the consumer better off? Relate your answer to the First Welfare Theorem, assuming the given prices clear markets in a competitive equilibrium.

Consider the Solow model. A firm produces output according to Cobb-Douglas pro- duction structure Y₁ = K (ZN)¹-a, where K, is physical capital stock, and ZtNt is units of effective worker. Labor Nt grows at a rate of 9n and efficiency of labor Zt grows at a rate gz. The household consumes a fixed fraction of its income each period, equal to (1-s).

Consider an economy with a corn producer, some consumers, and a government. In a given year, the corn producer grows 30 million bushels of corn and the market price for corn is $5 per bushel. Of the 30 million bushels produced, 20 million bushels are sold to consumers, 5 million are stored in inventory, and 5 million are sold to the government. The corn producer pays $60 million in wages to consumers and $20 million in taxes to the government. Consumers pay $10 million in taxes to the government, receive $10 million in interest on the government debt, and receive $5 million in Social Security payments from the government. The profits of the corn producer are distributed to consumers. (a) Calculate GDP using (i) the product approach, (ii) the expenditure approach, and (iii) the income approach. (b) Calculate private disposable income, private sector saving, government saving, national saving, and the government deficit. Is the government budget in deficit or surplus?

In year 1 and year 2, two products are produced in a given economy, computers and bread. Suppose that there are no intermediate goods. In year 1, 30 computers are produced and sold at $1,000 each, and in year 2, 45 computers are sold at $1,200 each. In year 1, $10,000 loaves of bread are sold for $1.00 each, and in year 2, 12,000 loaves of bread are sold for $1.40 each. (a) Calculate nominal GDP in each year. (b) Calculate real GDP in each year, and the percentage increase in real GDP from year 1 to year 2 using year 1 as the base year. Next, do the same calculations using the chain-weighting method. (c) Calculate the implicit GDP price deflator and the percentage inflation rate from year 1 to year 2 using year 1 as the base year. Next, do the same calculations using the chain-weighting method. (d) Using year 1 as the base year, calculate the CPI in years 1 and 2, and calculate the CPI rate of inflation.

When unexpected inflation is zero, the corresponding unemployment rate is: O the maximum unemployment rate. O the equilibrium unemployment rate. O zero. O the minimum unemployment rate.

Unemployment will rise when: O the output gap is positive. O there is excess demand. O inflation falls below the level of expected inflation. O the output gap is equal to zero.

Which of the following changes (or "shocks") could create a more positive output gap in an economy? - Government spending increases. - There is a reduction in taxes. - The risk premium increases. - The default rates on loans falls.

In the IS-MP framework, the impact of an increase in the risk premium in the economy is that the