Question

MACROECONOMICS

a. Which of the following events would increase the real interest rate in our neoclassical model?

[] a newly elected Congress cuts government purchases significantly

[] the state legislature cuts taxes significantly

[] investment demand drops because of uncertainty during a crisis (e.g. pandemic)

[] C(Y-T) is Keynesian and the MPC declines

b. Suppose that investment in commercial real estate leads to a large capital stock, what happens in our neoclassical model with endogenous P? (check the boxes ONLY for true statements)

[] Y up

[] W/P up

[] R/P up

[] L up

[] K up

[] P up

Answer 1

a. For this question, the correct option is:

The state legislature cuts taxes significantly. Reason: When the taxes fall, the disposable income(Y-T) increase, therefore the consumption increases. As a result of this the IS(Investment Savings) curve shifts rightward, causing the real interest rate to rise. In all the other cases, the IS curve shifts downwards because of which the real interest rate falls.

b. The correct options are:

Y up and K up.

Reason: The increase in investment leads to an increase in capital, therefore K goes up. The whole output function is a function of capital(K) and labour(L), so increase in K also leads to an increase in Y. The other options are incorrect because either it is not affecting the factors or the increase in K is affecting the other factors in the opposite direction. For instance, the higher the stock of capital, the lower will the real rental price of capital.