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ID: A

ECON 2102 Macroeconomics 2 - Tutorial 5:Markets, Prices, Supply and Demand Answer Section
TRUE/FALSE 1. T 2. F MULTIPLE CHOICE 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. B C B B D C D D C C B D

SHORT ANSWER 15. Profit is:

= PY (wL d + RK d )
or

= P A F(K d , L d ) (wL d + RK d )
or in words profit is the difference between the value of output and the costs of producing that output. The value of output being what it can be sold for, PY, and the cost of producing it including the labor costs and the rental costs of capital. 16. The households real budget constraint is:

C + (B / P) + K = + (w / P) L + i ((B / P) + K)
It tells us a household can use its income from profit from its production of goods, wage earnings from working and interest income from bonds and capital to purchase consumption goods, more bonds or more capital. 17. The return on capital equals the return on bonds because, aside from rates of return, households view bond and capital the same, a way to hold assets. If the return on capital were greater than the return on bonds, households would not hold bonds. If the return on bonds were greater than the return on capital, households would hold no capital. Thus the two returns must be equal to get people to hold both assets.

ID: A 18. The period one household real budget constraint is:

C 1 + ((B 1 / P) + K 1 ) ((B 0 / P) + K 0 ) = (w / P) 1 L + i 0 ((B 0 / P) + K 0 )


the period two constraint is:

C 2 + ((B 2 / P) + K 2 ) ((B 1 / P) + K 1 ) = (w / P) 2 L + i 1 ((B 1 / P) + K 1 )


solve either or both equations for ((B 1 / P) + K 1 ) period one:

((B 1 / P) + K 1 ) = (w / P) 1 L + i 0 ((B 0 / P) + K 0 ) ((B 0 / P) + K 0 ) C 1


period two:

((B 1 / P) + K 1 ) = C 2 / (1 + i 1 ) + ((B 2 / P) + K 2 ) / (1 + i 1 ) ((w / P) 2 L) / (1 + i 1 )


set the period one and period two constraint equal to each other:

(w / P) 1 L + i 0 ((B 0 / P) + K 0 ) ((B 0 / P) + K 0 ) C 1 = C 2 / (1 + i 1 ) + ((B 2 / P) + K 2 ) / (1 + i 1 ) ((w / P) 2 L) / (1 + i 1 )


reorder the terms:

C 1 + C 2 / (1 + i 1 ) + ((B 2 / P) + K 2 ) / (1 + i 1 ) = (w / P) 1 L + ((w / P) 2 L) / (1 + i 1 ) + (1 + i 0 )((B 0 / P) + K 0 )


The left hand side of the equation contains uses of funds over the two periods. The right hand side of the equation contains the sources of funds over the two periods. The fact that period 2 values are discounted and period 0 values are shown as future values indicates that the budget constraint is formulated from the point of view of period 1.