Question

For each statement below write true or false and then provide a short explanation.

a. If the nominal interest rate is greater than inflation, then the real interest rate is negative.

b. The substitution effect of an increase in the interest rate is a decrease in the current consumption.

c. The income effect of an increase in the wage rate is an increase in working time.

d. If the user cost of capital is fixed, a permanent positive technological shock increases the equilibrium quantity of capital in the economy.

e. A positive change in technology leads to an increase in the real income and consumption.

Answer 1

a. False. Real Interest rate = Nominal Interest rate - Inflation Rate. This formula shows that if nominal interest rate is greater than inflation rate, then real interest rate will be positive and will be negative when nominal interest rate is less than inflation rate.

b. True. When rate of interest in the economy increases, then substitution effect induces the person to increase their savings rate as returns on savings increases and decrease their consumption level.

c. False. The income effect of increase in wage rate will induce the worker to work for less number of hours because overall income earned increases for each unit of labor supplied and thus income effect leads to fall in the working time of the individual.

d. True. A positive technological shock in the economy will increase the demand for capital in the economy and this increases equilibrium quantity of capital in the economy.

e. True. A positive change in technology will increase the level of aggregate supply in the economy and this increases production level in the economy which leads to increase in real income and increase in income also increases disposable income which increases consumption expenditure in the economy.