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Question 2
a) increase; consumption b) decrease
c) investment; saving d) real interest rate; investment (or saving)
e) investment; potential output
Question 4
a) See the completed table below. If g is the annual growth rate, in each case the value in
the cell is given by 100 × (1 g)
where N is the number of years.
Year 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
0 100 100 100 100 100 100
1 101.0 101.5 102.0 102.5 103.0 103.5
3 103.03 104.57 106.12 107.69 109.27 110.87
5 105.10 107.73 110.41 113.14 115.93 118.77
10 110.46 116.05 121.90 128.01 134.39 141.06
20 122.02 134.69 148.59 163.86 180.61 198.98
30 134.78 156.31 181.14 209.76 242.73 280.68
50 164.46 210.52 269.16 343.71 438.39 558.49
b) See the table above.
c) In the 3% growth case, real GDP in year 20 is 180.61. In the 1.5% growth case, it is
134.69. It is 34.1 percent larger in the 3% growth case than in the 1.5% growth case.
d) In the 3% growth case, real GDP in year 50 is 438.39. In the 1.5% growth case, it is
210.52. It is 108.2 percent larger in the 3% growth case than in the 1.5% growth case.
Question 6
a) See the diagram below. The national saving (NS) curve is upward sloping because a
rise in the real interest rate leads households to reduce their current desired consumption.
Since NS = Y* – C – G, a reduction in C is a rise in national saving. The investment
demand (I) curve is downward sloping because a reduction in the real interest rate causes
firms to increase their desired level of investment.
© 2005 Pearson Education Canada Inc.
b) A reduction in government purchases, G, leads to an increase in national saving at any
given level of the interest rate. Thus the NS curve shifts to the right, to NS1. At the initial
interest rate, there is an excess supply of loanable funds that reduces the equilibrium
interest rate to r*1. At the lower interest rate, firms increase their desired investment to I1.
The greater amount of investment means that capital is accumulating faster, thereby
leading to a higher long-run growth rate of potential output.
c) An increase in taxes will probably lead to a reduction in household consumption and
thus to a rise in national saving. If NS shifts to the right, then the same qualitative
analysis applies as for part (b).
Question 8
a) Increases in population and real incomes should increase the demand for oil and, with
a given supply, cause a continual increase in its price.
b) As the price rises, users of the resource are led to substitute away from the resource
toward available substitutes.
c) Part of the process of substitution away from a higher-price resource involves
developing production methods that do not require the resource, or perhaps use less of that
resource. These developments are technological improvements. Thus, part of the reason for
technical change is as an endogenous response to the changing business environment.
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