Problem Set #3 Suppose the federal government gives every U.S. household a $5000
ID: 1127138 • Letter: P
Question
Problem Set #3 Suppose the federal government gives every U.S. household a $5000 one-time federal income tax refund this year Explain the effect, if any, the refund may have on unemployment according to each of the following consumption theories a. 1. Keynesian Consumption Theory b. Permanent-lncome Hypothesis c. Life-Cycle Theory of Consumption Which of the three consumption theories listed above that would predict the most number of jobs created by this tax refund? 2. em Set #4 What are the basic determinants of investment? Explain the relationship between the real interest rate and the level of investment. Why is investment spending unstable? How is it possible for investment spending to increase even in a period in which the real interest rate rises? Problem Set #5: Suppose the Coco-Waku economy has an MPC of 0.9 and real GDP of $400 billion. If investment spending falls by $4 billion, what will be its new level of real GDP? roblem Set #6: This question explores how international trade affects the multiplier Assume initially that a country is isolated from the world and its MPC is 0.8. What is the multiplier? 1. Now assume it opens up its borders and people still spend 80 cents of every new dollar earned on consumption. But 50 cents is spent on domestically produced consumption goods and 30 cents on imported consumption goods. What is the multiplier now? What is the effect of international trade on the multiplier in this case? 2. Problem Set #7: True/False and Explain: a depreciation of U.S. currency would cause a contractionary impact on the U.S. economy. [Grading is based on explanation only.] Problem Set #8: 1. Suppose that aggregate demand and supply for a hypothetical economy are as shown:Explanation / Answer
1) a) Keynesian consumption theory
This theory states that consumption depends on income, autonomous consumtion and marginal propensity to consume. Tax refund increases income. This increase in income increases consumption and this leads to increase in aggregate demand. More output is produced which needs more workers. Thus unemployment reduces.
b) permanent income hypothesis
This hypothesis states consumers respond only to permanent changes. One time tax refund is a temporary increase in their income, so consumers do not respond to this. Unemployment remains the same.
c) life cycle theory of consumption
This theory states that consumers tend to smooth their consumption over lifetime. One time tax refund increases consumption evenly over lifetime by an average amount. Unemployment will reduce.
2) Keynesian consumption theory will predict most jobs created. Keynesian states that consumption depends only on current income, so tax refund will be used at the current period. It creates the maximum jobs.
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