Agricultural Economics 430
Macroeconomics of Agriculture
Fall 2009
Penson
First Hour Examination
September 24, 2009
NAME: ___ Answer Key ____________________________
This examination consists of six questions. Please read each question carefully. The
term “describe fully” asks that you answer all aspects of the question. Avoid giving
extraneous information (i.e., “filler”). Use graphs/formulas whenever possible to help
tell your story. Make sure you fully label all graphs. Use the back of the page if
necessary.
Question 1 _____ of 10 points
Question 2 _____ of 10 points
Question 3 _____ of 15 points
Question 4 _____ of 25 points
Question 5 _____ of 20 points
Question 6 _____ of 20 points
TOTAL
_____ of 100 points
1
1.
Please graphically illustrate and discuss the difference between a recessionary and
an inflationary gap in the nation’s aggregate product market. Make sure you fully
label all features of your graphs. Please name one policy action you would
recommend the government adopt to close each gap. (10 points)
If a recessionary gap exists, the government should consider adopting expansionary
monetary (lowering interest rates by expanding money supply) and/or fiscal policy
(cut taxes or increase government spending).
If a inflationary gap exists, the government should consider adopting contractionary
monetary (raising interest rates by contracting money supply) and/or fiscal policy
(raise taxes or decrease government spending).
2
2.
Please graphically illustrate the concepts of capacity depreciation and tax
depreciation. Referring to these graphs, identify the nature of the subsidy
contained in the IRS tax code to farmers buying new tractors. (10 points)
The subsidy is in the form of a faster expensing or writing off the cost of a new
tractor than the actual consumption of this depreciable asset. This lowers the
farmer’s annual tax liability and hence increases annual net cash flows early in
the life of the investment. This has important time value of money implications,
and enhances the feasibility of the purchase.
3
3.
Please define or graphically illustrate each of the following terms. Make sure you
correctly label all graphs used in your answers: (3 points each)
Potential GDP
The perfectly inelastic portion of an economy’s aggregate supply curve.
Permanent income
Average personal disposable income over a historical period, or
Yperm,t = a1(Y – T)t + a2(Y – T)t-1 + a3(Y – T)t-2 + … See page 3 in Handout #4.
Income elasticity
Given by the percent change in quantity with respect to a percent change in
disposable income, or %∆Q / %∆(Y-T)
Absolute income theory
Consumption expenditures affected by both disposable personal income and
wealth, or C = Ac + b1(Y - T) + b2(W). See page 3 in Handout #4.
Marginal efficiency of investment
The MEI is the slope of the investment expenditures function
or the %∆I / %∆i. See page 1 in Handout #5.
4
4.
Given the following demand and supply equation for a market, please answer the
questions below:
QD = 100 –2(P) +.85(Y – T)
QS = 10 +4(P)
where P represents price of the product, Y represents personal income and T
represents personal taxes.
Assume disposable personal income in 2008 in this economy was $700 and is
projected to be 10 percent lower in 2009.
(SHOW ALL WORK FOR FULL CREDIT)
a.
What price would you expect in this market in 2009? (10 points)
100 – 2P = .85(630) = 10 + 4P
100 + .85(630) – 10 = 6P
625.5 = 6P
P = 104.25 Q = 10 + 4(104.25) = 427
b.
If Congress enacts the tax increase being discussed that cuts disposable
personal income by 10 percent in 2009, what price would you expect in
2009? How much would the quantity supplied by producers in this market
change as a result of this tax hike? (10 points)
100 + .85(.90 x 630) – 10 = 6P
100 + 481.95 – 10 = 6P
6P = 571.95
P = 95.33
Q = 10 + 4(95.33) = 391.32 so ∆Q = 427 – 391.32 = 35.68
c.
What is the own price elasticity over this range of the demand curve for this
market? (5 points)
%∆P = (95.33 – 104.25) / 104.25 = - .08556
%∆Q = (391.32 – 427) / 427 = - .08356
EP = %∆Q / %∆P = -.08356 / -.08556 = .9766
5
5.
Given the following equation for total planned investment expenditures, please
answer the questions below:
It = 475 – 25(it)
where:
It
Total planned investment expenditures in year t
Kt-1
Capital stock at the end of the previous year
Dt
Depreciation in year t
it
Interest rate in year t
and where:
Dt = 50
Kt-1 = 750
a.
(Show all work for full credit)
What is the level of total investment expenditures in the economy if interest
rate is 5 percent? (HINT: use 5.0 rather than 0.05) (8 points)
I = 475 – 25(5.0) = 475 – 125 = 350
b.
What is the change in the capital stock during year t? (6 points)
∆K = Kt – Kt-1 = It – Dt = 350 – 50 = 300
c.
Name at least three factors other than the rate of interest included in what we
called the implicit rental price of capital. (6 points)
Price of the asset
Cost of equity capital
Tax depreciation
Income tax rate
Capacity depreciation
6
6.
Given the following model for planned consumption expenditures, please answer
the questions below:
Ct = 240 + 0.90(Yt - Tt)
where:
Ct
Total planned consumption expenditures in year t
Yt
Personal income in year t
Tt
Total personal taxes due in year t
Gt
Total government spending in year t
and where:
Yt = 1,000
Tt = 50 + 0.25(Yt-1)
Gt = 600
(Show all work for full credit)
a. If total personal income last year was $750, what is the level of budget surplus
or deficit in the current year (year t)? (8 points)
Tt = 50 + .25(750) = 50 + 187.50 = 237.50
Gt = 600
Surplus = -362.50; Deficit = 362.50
b. What is the level of saving out of current income in year t? Are consumers
saving or dis-saving? (8 points)
Ct = 240 + .90(750 – 237.50)
= 240 + .90(512.50)
= 240 + 461.25
= 701.25
St = Yt – Tt – Ct = 750 – 237.50 – 701.25 = - 188.75; dis-saving.
c. What is the marginal propensity to consume in year t? (4 points)
MPC = .90