March 28, 2017

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Need help on this question, I tried the ones i know.

a The consumption function is C = 1.5 + 0.75(Y-T). What is the marginal propensity to consume,
MPC? What is the marginal propensity to save, MPS?
ans: MPC=0.75 and MPS=1-MPC=0.25 correct?

b The trade balance is TB = 5(1-[1/E])-0.25(Y-8).What is the marginal propensity to consume foreign goods,MPCF ? What is the marginal propensity to consume home goods, MPCH?

c The investment function is I=2-10i. What is investment when the interest rate i is equal to 0.10=10%?
ans: I=2-10(0.1)=1

d Assume government spending is G. Add up the four components of demand and write down the expression for D.

e Assume forex market equilibrium is given by i = ([1/E]-1)+0.10 where the two foreign return terms on the right are expected depreciation and the foreign interest rate. What is the foreign interest rate?
What is the expected future exchange rate?

  • Econ - ,

    a) correct.
    b) the "imports" part of the equation is .25(Y-8). So the MPCF is .25
    Alone, I don't think there is enough information to determine the MPCH -- Unless you can use the overall consumption function from a). If so, the MPCH=.75-.25 = .50
    d) D=C+I+G+(E-M) = 1.5+.75(Y-T) + (2-10i) + G + (5(1-1/E)-.25(Y-8))
    e) something seems missing here. Is i is the foreign interest rate or the domestic interest rate? is E exports or the expected depreciation rate. I am confused.

  • Econ - ,

    e) i believe i is the domestic interest rate and ([1/E]-1) is the expected depreciation and 0.10 is the foreign interest rate. E i think is the spot exchange rate.

    I don't get why its asking for foreign interest rate again?

  • Econ - ,

    I don't understand why depreciation is in the equation. I think of depreciation as the degradation of a physical asset over time. Depreciation affects interest rates in a round-a-bout way.

    That said, is it possible that 0.10 is the depreciation rate and 1/E-1 is the foreign interest rate, where E is not the nominal spot exchange rate but normalized exchanged rate;

    Anyway, I'm stumped

  • Econ - ,

    For d) the text this question is from uses the formula i(home)=i(foreign)+[E(expected)+E]/E. Assuming the question is just meant to recall knowledge of the formula from earlier in the chapter: i(foreign) = (1/E)-1 and expected depreciation = 0.1.

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