Question 1. Suppose that an earthquake destroys part of the capital stock. Predict what will happen to (1) total production, (2) the real return to capital, and (3) the real wage. For simplicity, assume that the size of the population is unaffected.
Question 2. Assume that GDP (Y) is 5000. Consumption is C = 1000 + .3(Y-T). Investment is I = 1500 - 50r, where r is the real interest rate. Taxes T are 1000, and government expenditures (G) are 1500.
a. Calculate the equilibrium values of C, I and r.
b. Calculate the equilibrium values of private saving, government saving and total saving.
c. Now suppose that there is a technological innovation that makes businesses want to invest more, so that the new investment function is I = 2000 - 50r. Calculate the new equilibrium values of C, I and r.
d. Calculate the new equilibrium values of private saving, government saving and total saving.
Question 3. Suppose that the government finances an increase in expenditures by raising taxes, so that the budget remains balanced (in other words, ΔG = ΔT). What happens to the interest rate and investment? For simplicity, assume that the MPC out of the tax cut is positive and less than one.