MPC=0.7 Saved= $0.30 Consumed=$0.70 C=$233 When MPC decreases, Consumption decreases. Graphically, the slope of the line is less when MPC decreases.

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1 1. Suppose a person works full time for a company. He earns Y dollars after taxes are taken out. Now suppose his consumption is measured by: Yd. I. Find the Marginal Propensity to Consumer. MPC=0.7 Based on the answer found above, explain what the MPC means in terms of how much is saved and how much is consumed given an $1 increase to disposable income. Saved= $0.30 Consumed=$0.70 Suppose that the man gets a raise for working so hard. He earns $200 in gross pay. The rate of taxes is 5%. Find the worker s consumption (C)? C=$233 What happens to consumption when the MPC decreases? Feel free to display this graphically. When MPC decreases, Consumption decreases. Graphically, the slope of the line is less when MPC decreases. V. Would a rich person (i.e. Bill Gates) have a higher or lower MPC than the typical American worker? Explain Rich people tend to have a lower MPC than the typical American worker since the marginal utility is less for rich people. For instance, rich people already spend money and would rather save. Poor people tend to spend more to receive a higher utility/happiness rather than saving today. VI. Suppose this worker is young but is expect to move up the corporate ladder, ultimately becoming CEO who earns millions of dollars. How should this worker handle his finances? Save or consume? Explain. People who tend to earn more tomorrow should spend today since the dollar is worth less today than tomorrow. For example, spend and consume today to help get you to the high point in life, because the money in the future can pay for the expenses today.

2 2. Suppose the economy is described by: Y=3000, G=1000, T=500, C= (Y-T), and I(r)=500-40r. I. Find the equilibrium interest rate and the equilibrium investment. r= 3.75% (*Note: The actual answer is but you can t have a negative r) I(r)= $350 (Note: Actual answer is 650 when accounting for -3.75) Find the national savings. $650 What happens to Y if r increases? Explain. Increase in r causes a decrease in Y What happens to Y if G increases? Explain. Increase in G causes a increase in Y V. What happens to Y if T decreases? Explain. Decrease in T causes a increase in Y VI. Describe the relationship between G and r when a country is at war. G and r are closely related. During wars, r increase and G increases.

3 3. Suppose an economy is described by: C(Y-T)=50+0.2(Y-5), I(r)=70-40(r), G=35, and r=0.7. I. Find the equilibrium Y. Y=$157.5 Find private savings. Private Savings= $72 Describe what M means in terms of consumption. M is a variable often used to represent MPC. The MPC measures how much of an additional unit of disposable income will be consumed. A higher M will cause a higher consumption. Explain what is occurring when the economy s potential GDP is less than Y*. When actual is less than potential, the economy has under produced or has not met its goal of production. V. Explain how changing M effects Y? An increase in M (a.k.a MPC) increases consumption which increases Y.

4 4. Suppose that you need to borrow some money to help pay for student loans. You take out a loan for $1000. The current interest rate is 8%. I. How much do you owe in one year? $ 1080 How much do you owe if the interest rate falls to 5%? $1050 If you know that you need to pay back exactly $1000 tomorrow, how much are you borrowing today? (Interest rate is at 8%) Approximately $ When should a person save instead of borrowing based on interest rates? Explain. Borrow when the interest rate is low. Save when the interest rate is high. As a borrow, you prefer a low interest rate since you have less to pay back in the future from borrowing today. V. State and describe r? State r as if you were a borrower and then as a lender. r is the unit cost of using borrowed funds. It is also the rate of interest paid on borrowed funds. It is the return from lending funds to investors. VI. Explain how a bond works. A bond is a promise that a bank, government, or company will pay back the principle plus the principle*r. Bonds are often sold to help collect money when the government, bank, or company needs additional funds.

5 5. Show how aggregate supply equals aggregate demand. (Use the production function and expenditure formula) I. Show the work here: F(K,L)=C+I+G If Y> C+I+G holds true, what happens to the interest rate r? R will decrease If Y<C+I+G holds true, what happens to the interest rate r? R will increase Describe the government budget when G > T? The government is running a deficit. V. Describe the government budget when G = T? The government is running a balanced budget. 6. Show how supply of loanable funds equals the demand of loanable funds. I. Show the work here: I(r)=Y-C-G Explain what the Supply of Loanable Funds mean? Supply of Loanable Funds is the amount of savings that households lend to investors through financial markets (Direct Lending) or deposit in a bank (Indirect Lending). Explain what the Demand of Loanable Funds mean? Demand of Loanable Funds is the amount of savings that investors borrow from the public by selling stocks or bonds.

6 7. Why do Americans work more than Europeans? I. Based on the data from 1970 to 1974, which country or countries had hours worked per person greater than the US? United Kingdom, Japan, Germany, & France Based on the data from 1993 to 1996, which country or countries had greater output per hour worked than the US? France Explain why Americans tend to work more than Europeans. Europeans tend to pay higher taxes than Americans. Thus, Americans are more willing to work more to earn more in disposable income, thus receiving a higher utility. Explain why Americans consume more on average than other countries? (List at least 3 reasons) Standard of living, attitude, availability of resources, culture, type of government, geography, availability of financial lending, amount of advertising, country s history, etc.