1. In an open economy, how would each of the following events affect the real interest rate and the quantity of investment? A. A natural disaster destroys bridges and roads in California leading to increased investment spending to rebuild. B. Future taxes on businesses are expected to be increased. C. The government proposes a new tax on savings, based on peoples balances on December 31 each year.

2. How would the following events affect aggregate saving (private & public) in the United States? Hint: Distinguish between expectations and actual changes. A. News of a discovery of oil reserves in Montana 10 times as large as those in the Middle East. B. The economy grows twice as fast as expected, owing to higher productivity growth, so unemployment falls substantially. C. Reconstruction projects in Eastern Europe require $1 trillion, causing an increase in the world real interest rate.

3. Suppose that the government plans to undertake one of two possible spending projects: Project A involves spending $10 billion to build more military aircraft; project B involves spending the same amount to improve local bridges and water systems. Project A has no effect on investment, but project B improves the profitably of businesses by lowering their costs for transportation and water. Show how this difference leads to a different real interest rate, depending on which project is chosen and assuming a closed economy. Do you think this result is generally true? In which case is the economy better off? 4. Two countries alike in all other respects differ markedly in their provision of social insurance. One country provides old-age retirement pensions, unemployment insurance, and catastrophic illness insurance; the other country provides no social insurance. What is your prediction about the difference in household saving rates between the two countries? Why?

5. Most economists argue that a boom in the stock market is a sign that profitable business opportunities are expected for the future. Describe the likely effects on business investment and the expected real interest rate of such a boom. What assumptions did you make?