ECON 201-Ch.8 Practice HW

If the government collects more in tax revenue than it spends, and households consume more than they get in after-tax income, then

Private saving is negative, but public saving is positive. - Private saving is the amount of income households have left after paying their taxes and paying for their consumption, or Y-T-C. Public saving is the amount of tax revenue that the government has left after paying for its spending, T-G. When consumption is greater than after-tax income (C>Y-T), private saving is negative; when the government collects more in taxes than it spends (T>G), public saving is positive. See Section: Some Important Identities.

Investment

Refers to the purchase of new capital, such as equipment or buildings.

Assuming that Intel needs to borrow money in the bond market, an increase in interest rates affects Intel's decision about whether to build the factory, because now the cost of borrowing money becomes _________.

Higher - If interest rates increase, the cost of borrowing money to build the factory becomes higher, so the returns from building the new plant may not be sufficient to cover the costs. Thus, higher interest rates make it less likely that Intel will build the new factory.

From 2008 to 2012, the ratio of government debt to GDP in the United States.

Increased markedly. - As the economy was experiencing a financial crisis and deep recession in 2008, the debt-to-GDP ratio in the United States increased markedly.

Private Saving

Is the amount of income that households have left after paying their taxes and paying for their consumption. In the language of macroeconomics.

If the business community becomes more optimistic about the profitability of capital, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________.

demand, up - The more profitable capital becomes, the more firms are rewarded for borrowing money to invest in new capital. Thus if capital is perceived as more profitable, the demand for loanable funds would shift to the right, driving the equilibrium interest rate up.

If a popular TV show on personal finance convinces more Americans about the importance of saving for retirement, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________.

supply, down - The equilibrium interest rate is determined by the intersection of the supply and demand curves in the market for loanable funds. Saving makes up the supply of loanable funds; therefore, an increase in saving shifts the supply curve for loanable funds to the right. This drives the equilibrium interest rate down.

A closed economy has income of $1,000, government spending of $200, taxes of $150, and investment of $250. What is private saving?

$300 - In a closed economy (that is, an economy that does not trade with the rest of the world), saving must be equal to investment, S=I. Saving can be broken down into the income that is left after subtracting consumption and government spending, or Y-C-G. Private saving is equal to income minus consumption and taxes, with public saving equal to taxes minus government spending; therefore, total saving can be rewritten as (Y-C-G) + (T-G). To solve for private saving, set total saving equal to investment, and substitute the value of public saving.

Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public saving is $0.2 trillion. Assuming the economy is closed, complete the following table by calculating consumption, government purchases, national saving, and investment.

(In trillions of dollars) - Consumption: 6 - Government Purchases: 1.3 - National Saving: 0.7 - Investment: 0.7

Economists in Funlandia, which has a closed economy, have collected the following information about the economy for a particular year: Y=10000, C=6000, T=1500, G=1700 The economists also estimate that the investment function is (where r is the country's real interest rate, expressed as a percentage): I=3300-100r Complete the following table by calculating private saving, public saving, national saving, investment, and the equilibrium real interest rate.

- Private Saving: 2500 - Public Saving: -200 - National Saving: 2300 - Investment: 2300 - Equilibrium Real Interest Rate: 10%

There are many different bonds in the world economy, and these bonds differ according to three characteristics.

- Term: Long-term bonds are riskier than short-term bonds because holders of long-term bonds have to wait longer for repayment of principal. To compensate for this risk, long-term bonds usually pay higher interest rates than short-term bonds. - Credit risk: When bond buyers perceive that the probability of default is high, they demand a higher interest rate as compensation for this risk. - Tax treatment: When state and local governments issue bonds, the bond owners are not required to pay federal income tax on the interest income. Because of this tax advantage, bonds issued by state and local governments typically pay a lower interest rate than bonds issued by corporations or the federal government.

Nina wants to buy and operate an ice cream truck but doesn't have the financial resources to start the business. She borrows $5,000 from her friend Max, to whom she promises an interest rate of 7 percent, and gets another $10,000 from her friend David, to whom she promises a third of her profits. What describes this situation?

David is a stockholder, and Max is a bondholder. - Stockholders share in the profits of a corporation, offering both higher risk and potentially higher reward than bonds. Bondholders, on the other hand, receive a fixed interest payment, regardless of the company's profitability.

True or False: If Intel has enough of its own funds to build the new factory without borrowing, an increase in interest rates still affects Intel's decision about whether to build the factory.

True - Even if Intel uses its own funds to build the factory, the rise in interest rates still matters. There is an opportunity cost on the use of the funds. Instead of investing in the factory, Intel could use the money to purchase bonds and earn the higher interest rate available there. Intel will compare its potential returns from building the factory to the potential return from the bond market. If interest rates rise, so that bond market returns rise, Intel is again less likely to invest in the factory.