1) Franco, a twenty-five year old, has just started a job as an officer in the Swiss Navy. He plans that he will earn (in real, net terms) $25,000 per annum for ten years, $45,000 for the ten years after that, and $55,000 for the last twenty years of his career. He expects to live to the age of eighty-five. The current value of Franco's assets is estimated at $3,000.

a) Assuming a zero real interest rate and no superannuation payments, what is Franco's level of consumption per year if he intends to consume a constant amount over the rest of his life?

b) What key assumption needs to be made so that Franco can consume this amount in the early stages of his career?

c) How would the introduction of a guaranteed superannuation benefit affect Franco's consumption and savings decisions?

2) Consider Calvin. He thinks of the world as consisting of today and his destiny. Calvin has income of Yt today and is destined to get income of Yd. Because his friend Hobbes requires more tuna, Calvin's desired consumption today (Ct) exceeds the income he receives today. Unfortunately for Calvin, he cannot borrow today because an acquaintance, Susie, has informed everyone that Calvin is a bad credit risk.

a) Use a diagram to show both Calvin's consumption today and his destined consumption. b) Now assume that Mrs Wormwood is the Minister of Finance and introduces a compulsory savings scheme. Use your diagram from a) to show how this policy affects the welfare of Calvin. Is he better or worse off?

3) The management of Cobb and Douglas Ltd are trying to work out if they should expand their business. Their accountants and engineers have provided them with details of their company which they are working through to make a capital investment decision. The engineers have informed them that the overall production structure of the company can be described by y = 4K1/2L 1/2 , where y is output, K is capital, and L is labour. The engineers also report that this implies that: MPK = 2L 1/2 K1/2 . The managers have a statement from the company's accountants reporting that the price of capital is currently $50 per unit, the price level is 8, the rate of depreciation is 20%, the current real interest rate is 3%, and the firm currently owns 64 units of capital, and employs 25 hours of labour input.

a) If you were one of the managers trying to maximise Cobb and Douglas Ltd's profits would you want to alter its current capital stock, and if so, in what direction? Explain your answer.

b) Say that in a subsequent meeting reviewing the original decision, that managers now know that the research and development work of the engineers of Cobb and Douglas has recently led to a technological innovation that means that the company can produce more output with the same level of resources. The engineers report that the overall production structure of the company can now be described by y = 6K1/2L 1/2 and MPK = 3L 1/2 K1/2 . Would the managers' decision in a) change? What would the explanation would they give for changing or not changing their decision?

c) Last year, the Reserve Bank repeatedly cut the Official Cash Rate in an attempt to prevent an economic recession in New Zealand. Would this make the decision reached about how much to invest or disinvest in Cobb and Douglas Ltd's capital seem wise in retrospect?