1.

Place each of the following transactions in one of the four components of expenditure: consumption,
investment, government purchases, and net exports.
a.
b.
c.
d.
e.

Boeing sells an airplane to the Air Force.

Boeing sells an airplane to American Airlines.
Boeing sells an airplane to Air France.
Boeing sells an airplane to Amelia Earhart.
Boeing builds an airplane to be sold next year.

government purchases
Investment
net exports
consumption
investment

2. Abby consumes only apples. In year 1, red apples cost $1 each, green apples cost $2 each, and Abby
buys 10 red apples. In year 2, red apples cost $2, green apples cost $1, and Abby buys 10 green apples.
a. Compute a consumer price index for apples for each year. Assume that year 1 is the base year in
which the consumer basket is fixed. How does your index change from year 1 to year 2?
CPI1 = ($1 x 10 red apples) + ($2 x 0 green apples) x 100 = 100
($1 x 10 red apples) + ($2 x 0 green apples)
CPI2 = ($2 x 10 red apples ) + ($1 x 0 green apples) x 100 = 200
($1 x 10 red apples) + ($2 x 0 green apples)
CPI doubles from year 1 to year 2.
b.

Compute Abbys nominal spending on apples in each year. How does it change from year 1 to year 2?
Nominal GDP1 = ($1 x 10 red apples) + ($2 x 0 green apples) = 10
Nominal GDP2 = ($2 x 0 red apples ) + ($1 x 10 green apples) = 10
Abbys nominal spending does not change from year 1 to year 2.

3. The government raises taxes by $100 billion. If the marginal propensity to consume is 0.6, what
happens to the following? Do they rise or fall? By what amounts?
a. Public saving rises by $100 billion.
b. Private saving will fall because consumers will have to pay more taxes, thus having less disposable
income to use for consumption.
c. National saving will increase - this is due to the increase in Public Savings caused by the
government's policy to raise taxes.
d. Investment will rise.
Use excel file uploaded in groups for numerical example.
A note on answering 3:
Private Saving = Y T C
= Y T [a + b(Y-T)]
= Y T a bY + bT
= (1-b) (Y-T) a

National Saving = Y C G
= Y [a + b(Y-T)] G
= Y a bY + bT G
= (1-b)Y + bT G a

When taxes rise, private saving fall.

When taxes rise, national saving increase.

4. Consider an economy described by the follow- ing equations:

Y=C+I+G
Y = 5,000
G = 1,000
T = 1,000
C = 250 + 0.75(Y T)
I = 1,000 50 r
a. In this economy, compute private saving, public saving, and national saving.
Private Saving = Y T C = 5,000 1,000 [250 + 0.75(5,000 1,000)
= 4,000 3,250 = 750
Public Saving = T G = 1,000 1,000 = 0
National Saving = Private Saving + Public Saving = 750
b. Find the equilibrium interest rate.
Equilibrium condition: S = I(r)
From a, we know that national savings is 750.
750 = 1,000 50r r = 5 or 500%
c. Now suppose that G rises to 1,250. Compute private saving, public saving, and national saving.
Private Saving = Y T C = 5,000 1,000 [250 + 0.75(5,000 1,000)]
= 4,000 3,250 = 750
Public Saving = T G = 1,000 1,250 = -250
National Saving = Private Saving + Public Saving = 500
d. Find the new equilibrium interest rate.
500 = 1,000 50r r = 10 or 10000%