1. PART 1 (35 points total –

5 points for each part and 10 points for the diagram) You own a golf course in

Florida and you need to determine how many golf carts you need to buy to

maximize profits. Please answer the following questions given the information

below.

A brand new golf cart

costs 300 rounds of golf and the rate of depreciation is 15% (.15).

The real interest

rate is 5% (use .05 in calculations).

The expected marginal

product of capital is given by MPK^{f} = 200

– 5K.

a)

What

is the user cost of capital and what is it expressed in?

b) How

many golf carts should you buy to maximize profits (i.e., what is K*)?

c) Draw

a graph (the uc / MPK graph) depicting the state of affairs and label this

initial profit maximizing point as **point A**.

c)

Now suppose the (local) government with all their financial shortfalls embarks

on a campaign to raise revenue to fund the fire department by imposing a

socalled “luxury tax” (we know it as ?) equal to 25% of gross revenue What

happens to the profit maximizing number of golf carts?

Please

show all work and label as **point B** on your uc/MPK graph.

d)

Now explain why your profit maximizing K* has changed. Please be specific using

**the firm’s** **profit maximizing condition (explain the intuition!)**.

Start your answer with “** If I did not change my capital input (my**…….(you can finish the rest!)

K*), then I would not be

……………..”

e)

The Federal government, knowing all about the financial pains encountered by

state and local governments given the Great Recession, decide to offer an

investment tax credit equal to 20% (this is in addition to the tax already

imposed by the local government). What is your desired capital stock (K*) now?

(Hint: An investment tax credit effectively reduces the price of capital to the

firm – think of it as this – under the investment tax credit – you buy a golf

cart (cost = 300 rounds of golf) and you get a 20% rebate from Uncle Sam so the

investment tax credit adjusted price of the golf cart is now 240 rounds of golf

[(1.20) x 300 = 240]. **Please show all work** **again**and label this

as point C on your uc/MPK diagram.

1. PART 2 (NEW GRADER – 35 points – 5

for f) and g) 10 for h) and 15 for graph)) Draw a desired investment diagram

(completely labeled with **all** the shift variables noted next to the function

in parentheses with signs (+ or )) depicting the **initial** equilibrium as

point A (simply draw a negatively sloped I^{D} curve going through point A). Label

the initial real interest rate as r*_{A}

=

.05 (as is given above) and the initial level of desired investment as I^{d}_{A}.

Note importantly that we do not have numbers for desired investment, but that’s

ok, we are focusing on the change in desired investment, given the same real

rate = .05. Be sure to include **all of** the shift variables in parentheses

next to this initial I^{D} function.

f) Why did the level of desired investment change, even though the

real rate of interest did not? Please be specific using the equation that

connects the desired capital stock (K*) to desired investment (as we did in

class (equation 4.6…in text).

Label

this (new) level of desired investment as I^{d}_{B}

(again, we don’t have specific numbers for I^{d}_{B}. Be

sure to include **all of** the shift variables in parentheses next to your

new I^{D} function

Finally,

show how the investment tax credit maps to your desired investment diagram and

label this final point as point C. Label this (new) level of desired investment

as I^{d}_{C}

(again, we don’t have specific numbers for I^{d}_{C}).

Make sure you include **all of** shift variables in parentheses next to your

new I^{D} function.

g) Suppose

that the Federal Reserve had a goal to get the capital stock (the number of

golf carts purchased) back to its initial level as in part b (this would create

jobs and get the economy back to full employment). Given all the changes (the

imposition of the tax by the local government and the investment tax credit

offered by the Federal Government), what would they have to do to the real rate

of interest to achieve their objective? Please show all work and I am looking

for a specific number (i.e., r = ?).

h) (10

points) Finally, explain how this most previous development (a change in r)

would influence your two diagrams and why. Show on your two diagrams as point

D. I am asking for a discussion for each diagram (this question is worth ten

points!)

2**. (45 points total – 5 points each part except part e)** A closed economy has

full employment level of output (Y) of 2,000. Government purchases,

**,**

*G*are 200, taxes (T) are 400. Desired consumption (C

^{d})

and investment (I

^{d}) are:

*C*^{d}**= 550 + 0.5(**** Y**–T)

600

*r**I*^{d}**= 600 400***r*

a) Solve

for the desired savings function in intercept slope form (note, the intercept

is an integer).

b)

Now

solve for the goods market clearing interest rate. Please show all work.

Draw a desired

savings/investment diagram locating this initial equilibrium and point A.

We now have a change in the desired investment function – it is

now:

*I*^{d}**= 570 **

400*r*

c) Name four reasons why the desired

investment function would change the way it did.

d) Resolve for the goods market clearing interest rate

and the associated levels of desired savings and investment.

e) (10 points – discussion = 5 and correct and completely labeled

diagram = 5) Choose one and only one of the reasons from part c and show the

movement from point A to point B using a user cost – MPK^{f} diagram. Please be clear on which of the 4 reasons from c) you

are using and clear on why exactly K* changes using the profit maximizing

condition (give me the intuition).

f) What has happened to the level of desired

consumption and why? Be sure to refer to the substitution effect in your

answer! Be specific with numbers.