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Homework - 4 AK

The document provides a suggested solution to a macroeconomics problem set. It includes explanations and calculations for problems related to consumption and saving determinants, present value of debt payments, and goods market equilibrium. The solutions demonstrate understanding of macroeconomic concepts like consumption, investment, interest rates, and how these impact savings.

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18 views3 pages

Homework - 4 AK

The document provides a suggested solution to a macroeconomics problem set. It includes explanations and calculations for problems related to consumption and saving determinants, present value of debt payments, and goods market equilibrium. The solutions demonstrate understanding of macroeconomic concepts like consumption, investment, interest rates, and how these impact savings.

Uploaded by

María
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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U6301 Macroeconomics for International and Public Affairs Martsella Davitaya

Columbia University | SIPA


Problem Set #4
Suggested Solutions
_____________________________________________________________________________
Deadline. 11:59 pm Feb 20, 2024
Instructions. The electronic version (either scanned or typed up) of solutions must be uploaded to
CourseWorks by the indicated deadline. Solutions submitted after the deadline will receive 0 points.
Solutions submitted via email will receive 0 points. Solutions can be submitted individually or by a
group of up to 4 students. You can work in a group with students from sections 1, 2, 3, and 4 only. If
you work in a group, please indicate all names and UNI-s on top of the first page.

Problem 1. Consumption, Saving, and their determinants.


Define what component of the consumption function (current income, future income, wealth, interest
rate, marginal propensity to consume, other factors, etc.) would change and in what direction, and
what would happen to the current consumption and saving in each of the cases listed before and put
your answers in the table, following example in a).
Task Changing Current Saving Brief explanation
Component Consumption
Increase in 𝑦 𝑓 increases both current and
future consumption.
a) 𝑦 𝑓  
Since current income does not change, saving
decreases.
Credit Borrower:  Borrower:  Tighter credit constraints will only affect net
b)
constraint Saver: 𝛥𝑐 = 0 Saver: 𝛥𝑠 = 0 borrower, they will borrow less (s).
Marginal propensity to save increases, which is
c) MPC   
the same as MPC decreasing.
Since consumers expects lack of consumer goods
in the future, they will consume more now by
d) expectations  
dis-saving (either by borrowing or by decreasing
savings).
More years of retirement will induce young
e) MPCyoung   
people to save more now.
Increase in wealth increases current
f) a  
consumption.
Stock price fall decreases wealth, hence,
g) a  
consumption.
Consumers make more spending on products for
h) demographics  
children by running down saving.
One can talk about SE and IE of interest rate
i) r   change for borrowers or savers. The net outcome
for savers depends on the relative size of SE and
IE. Since it is unclear, which will dominate,
“ambiguous” is accepted as the correct answer.
We will assume that decrease in interest rates
increases consumption and decreases saving.

a) Consumers consider their job secure and therefore become more confident about the future level of
the disposable income.
b) Credit card issuers implement tighter credit standards and consumers are less able to buy goods
and services on credit.
c) Households decide to be thrifty and now save more from their additional income.
d) The threat of political destabilization strengthens the consumer expectations of the future lack of
durable goods. (Hint: recall what durable goods are. Which component of GDP is that?)
e) New information appears that due to medical advances everyone can count on more years of
retirement than ever before. (Hint: think about life-cycle hypothesis to answer this question)
f) Consumers’ wealth increased by 5%.
g) Stock prices fall tremendously.
h) The rate of population growth begins to increase.
i) Commercial banks decrease the interest rate on consumer loans.

Problem 2. Present Value.


Do this exercise in Excel. You owe 12,000 on your credit card, the annual interest rate on the debt is
24%, and the monthly interest rate is therefore 2%. For both questions give the number of months and
the size of the last payment.
i. Suppose you plan to pay $200 per month. How long will it take you to pay down your balance?

One will never pay down credit card debt because interest 0.02*12,000=$240 is higher than the payment of $200.

ii. If you pay back $500 per month, how long will it take you to pay down your balance?

34 months. The last payment will be $11.

Problem 3. Goods Market Equilibrium.


A private closed economy has full-employment output of 9000. Desired consumption and investment
are as follows
Real interest rate Desired Desired
Consumption investment
2 6100 1500
3 6000 1400
4 5900 1300
5 5800 1200
6 5700 1100
a) Why do desired consumption and desired investment fall as real interest rates rise?
Desired consumption declines as the real interest rate rises because the higher return to saving encourages higher
saving; desired investment declines as the real interest rate rises because the user cost of capital is higher, reducing
the desired capital stock, and thus investment.

b) Find desired national savings for each value of real interest rate. Note that table reflects desired
investment, not actual investment.

S=Y–C–G
r S
2 900
3 1000
4 1100
5 1200
6 1300

c) At what real interest rate is the goods market in equilibrium? That is, find the interest rate at which
Savings equal to Investment. Show equilibrium in investment-savings graph.

At r=5%, S=I, so goods market is in equilibrium.

A
r=5%

I=S=1200 I,S

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