Principles of Macroeconomics Econ 100.

001 spring 2013 Problem Set 2------- Due March 4 Your Name:

1. The accompanying graph shows a nations aggregate production function. a) Does this production function exhibit diminishing returns to physical capital? Explain.

Real GDP per capita

2,500 2,000 1,000 A

C B

100 200 300 Physical capital per worker b) Calculate growth rate or real GDP per capita from point A to B and then calculate the growth rate from point B to C.

2. Assume that an economy is open to capital inflows and that capital inflows are equal to the difference between imports and exports (IM-X). Answer each of the following questions. a) Budget balance = -$20; X = $60; IM = $90; Private saving = $150. Calculate the investment spending.

b) Private saving = $200; Investment = $220; Budget balance =-$30. Calculate (IM-X).

3. Draw the supply and demand for loanable funds market (with appropriate labeling). Answer the following questions: a) If the government budget deficit increases, how equilibrium interest rate and quantity of loanable funds change. b) If the prices of homes rise in the US, what will happen in the loanable funds market as a result of that? c) In recent years countries like China and Saudi Arabia run huge trade surplus, and this resulted in increase in capital inflow from these countries to US, how this will affect the loanable funds market in the US?

4. Table: Investment Projects (please answer questions 13) Project Rate of return on investment F 20% G 18 H 16 I 14 J 12 K 10 L 8 M 6 Cost of Investment 500 300 1,000 200 2,000 1,500 1,200 800

a) If the equilibrium rate of interest is 11%, which projects will not be economically feasible? b) If the market interest rate declines from 15% to 13% then the amount of investment demanded will increase by:

5. Consider each of these forms of investment. Identify whether it is an example of investment spending, an investment in physical asset, or a financial investment. a) You purchase a classic 1965 Ford Mustang. b) You buy 50 shares of stock in the Ford motor Company. c) Ford Motor Company builds a new plant in Tennessee.

6. Financial market has three tasks name those and explain what each three means.

7. a) There are two principal competing views about how asset price expectations are determined. What are these two views, explain.

b) Define efficient markets hypothesis