Question 1
Leisure
(hours)
Labour
(hours)
Real GDP
(2013 dollars)
0
200
2,000
40
160
1,920
80
120
1,680
120
80
1,280
160
40
720
200
0
0
The people of Palm Island are willing to work 80 hours a day for a real wage rate of $4 an hour. Then each dollar increase in the real wage, they are willing to work 10 additional hours a day. Palm Island’s production possibilities are in the table above.
a) Draw Palm Island's demand for labour curve. Explain what is the marginal product of labour and its connection to the labour demand curve. (15 marks)
Answer:
The marginal product of labour is the increase in total product that results from a one-unit increase in the quantity of labour employee with all other inputs remaining the same. In macroeconomic, the total product multiply price is the real GDP, so each real GDP increase in the quantity of labour hours. The marginal product is and the value of marginal product is The quantity of labour demanded totally is the quantity at which the value of marginal product of labour equals the wage rate. Therefore, the wage rate equals to (dollar per labour hour).
Labour (hours)
Real GDP (2013 dollars)
The demand of labour is: real wage (dollar per hour) demand of labour (hours)
2
180
6
140
10
100
14
60
18
20
The demand curve is:
b) Show how you calculate the labour hours-real wage combinations for the supply of labour. Draw Palm Island's supply of labour curve. (10 marks)
Answer:
As each dollar increased in real wage will cause 10 additional hours a day. The supply table is: real wage (dollar per hour) supply of labour (hours)
4
80
6
100
8
120
10
140
12
160
14
180
16
200
The supply of labour curve and demand of labour curve are:
c) What are the full-employment equilibrium real wage rate and quantity of labour in Palm Island's economy? (7 marks)
Answer:
The labour market is in equilibrium at which LD = LS, so the real wage rate is 8 dollar per hour and the quantity of labour is 120hours.
d) What is Palm Island's potential GDP? (8 marks)
Answer:
Based on the labour market equilibrium, the quantity of labour is 120hours. Depending on the aggregate production function, the potential GDP is 1680 at the quantity of labour is 120hours.
Question 2
Real interest rate
(percent per year)
Supply of loanable funds
(2013 dollars)
Demand for loanable funds
(2013 dollars)
5
2,000
5,000
7
3,000
4,000
9
4,000
3,000
11
5,000
2,000
The economy of Dream Island, which is isolated from the rest of the world, has the supply of loanable funds schedule and the demand for loanable funds schedule shown in the table above. As it happens, all of the supply of loanable funds are from households’ saving and the entire demand for loanable funds is from firms’ investment demand.
a) Draw the demand and supply curves of the loanable funds market. (5 marks)
b) What are the equilibrium real interest rate, investment and saving? (10 marks)
Answer:
The equilibrium is when the quantity of loanable funds demanded equals the quantity of loanable funds supplied (SLF = DLF), so the real interest rate is 8 percent per year and the loanable funds is 3500dollars.
c) Explain the impact on the loanable funds market equilibrium when the government runs a budget deficit of $1,000 (in 2013 dollars). Add this information to your loanable funds market diagram from part (a). What is the new level of private investment? Explain the crowding-out effect in the context of the $1,000 budget deficit. (15 marks)
Answer:
A government budget deficit increases the demand for funds. The total investment from the demand curve is $4000 - $1000 budget deficit = $3000 private investment. The quantity of private saving is $4000 from the supply curve. There is crowding out of $500 of investment.
To see this, when budget was balanced, private investment was $3500, now
