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Short Answer Problem Set #2 Instructions: You are required to answer all questions. Question 1: Briefly explain how one or more of the microeconomic components, namely consumption, investment, supply and demand for money influence macroeconomic outcomes and formulations of the following macroeconomic theories: a. Solow Growth Model (5marks) b. The Mundell-Fleming model (6marks) c. Neoclassical Model of Investment (5marks) Use mathematical equations and graphs where necessary. Question 2: a. Discuss and graphically depict Keynes’s three conjectures about the consumption function. (6 marks) b. Present and explain Keynesian’s consumption function that was created from these conjectures. (2 marks) c. What is meant by "autonomous consumption"? (2marks) d. Explain the consumption puzzle? (3marks) e. How does the Life-Cycle Hypothesis resolve the puzzle? (4marks) Question 3: a. Discuss the assumptions of the Fisher’s Intertemporal Choice Model (4marks) b. Using Fisher's Intertemporal Choice model, consider the following scenario: i. Suppose Milo earns $1,750 in the first period and $2,500 in the second period. If he consumes $1,200 in the first period and $1,550 in the second period, what is the interest rate? (2 marks) ii. Now if Milo’s consumption changes to $1,800 in the first period and $2,000 in the second period, what is the new interest rate? (2 marks) c. Graphically depict and explain the Consumer’s optimum in the Fisher’s Intertemporal Choice Model. (6 marks) Question 4: a. Using the Neoclassical model of Investment, mathematical equations and graphs, explain the real cost to rental firms of owning capital. (5marks) b. Account for what motivates rental firm’s investment decisions? (3marks) c. With the use of the neoclassical model of investment, explain what would happen to the rental price of capital, the cost of capital, and investment if a hurricane destroys some portion of the capital stock. (3marks) Question 5: a. The central bank of a country directly influences the components of money supply through 100-percent-reserve-banking or fractional reserve banking. By distinguishing between these two methods, explain how the central bank directly influences the components of money supply. (6marks) b. The following equation is used to model money supply under fractional-reserve banking: i) Identify the variables within the equation (2marks) ii) Explain how the exogenous variables within the equation influence money supply and cause it to change. (6 marks) iii) Suppose the banks in an economy have a reserve-deposit ratio of 12 percent and the currency-deposit ratio is 25 percent. Also, the Central Bank increases the monetary base by $400 through open market operations, how would the money supply change? (3 marks) c. If the central bank desired to increase spending in the economy, using the instruments of monetary policy, explain how the central bank can indirectly achieve this. (9marks) d. Explain the difference between portfolio and transactions theories of money demand. (6marks) Rubric for assessing Problem Set #2 Assessment will be graded out of 15% with conversions of total score /90 to award of marks as follows: Criteria Excellent (80 – 100) Good (60 – 79) Acceptable (30 – 59) Unacceptable to poor quality (0 – 29) Understanding of question requirements (54) Demonstrated a very good understanding of what the questions are asking and require. Answers were logically presented. Demonstrated a good understanding of what the questions are asking and require. Answers were attempted logically but final answer incorrect with respect to some parts of the question. Demonstrated a fair understanding of what the questions are asking and require. Some answers were attempted logically but final answers were mostly correct. Demonstrated a poor understanding of what the questions are asking and require. Final answers largely incorrect and incoherent logic presented or the question was not attempted at all. Clarity of argument (18) Excellent expression and argument in terms of explaining answers and/or giving reasons for answers. Good articulation and argument given and/or giving reasons for answers. Fair articulation and argument in terms of explaining answers and/or giving reasons for answers. Argument is unclear. 0 points where no explanations are provided. Graphs and equations provided where appropriate (18) Provided appropriate graph which included title, correct axes, and correct curves. Provided appropriate graph which missed one of the following elements: title, correct axes, and correct curves. Inappropriate graph provided. 0 points if no graph is provided at all. • Score Breakdown: • The maximum points you will be awarded for this assessment item total 90 points. • However, note that your final grade will be out of 15%. • You will see this final grade listed against your name on the course page. For example, if you are awarded 70/100 points your final grade for this assessment item will be 11.7% (70/90 * 15)