5. If demand is price inelastic, then buyers do not respond much to a change in price b. buyers respond substantially to a change in price, but the response is very slow c. buyers do not respond much to advertising, fads, or general changes in tastes d. the demand curve is very flat 6. According to the graph on the right, the equilibrium price in the market before the tax is imposed is a. $3.50 b. $5.00 c. $6.00 d. $8.00 7. Market failure is the inability of some unregulated markets to allocate resources efficiently b. a market to establish an equilibrium price c. buyers to place a value on the good or service d. buyers to interact harmoniously with sellers in the market Claudia would be willing to pay as much as $100 per week to have her house cleaned. John's opportunity cost of cleaning Claudia's house is $70 per week. Assume Claudia is required to pay a tax of $40 when she hires someone to clean her house for a week. Which of the following is correct? a. Claudia will now clean her own house b. John will continue to clean Claudia's house, but his producer surplus will decline. C. Claudia will continue to hire John to clean her house, but her consumer surplus will decline. Total economic welfare (consumer surplus plus producer surplus plus tax revenue ) will increase. 9. Within a country, the domestic price of a product will equal the world price if a. trade restrictions are imposed on the product b. the country chooses to import, but not export, the product c. the country chooses to export, but not import, the product d. the country allows free trade4:14 A - 80 ... OB/s ~ all .ill C 39% 27 IV.9 Short questions (functional income distribution, stylized facts, rate of return). a) "If and only if the production function is Cobb-Douglas, does the Blan- chard OLG model predict that the share of labor income in national income is constant in the long run." True or false? Give a reason for your answer. b) Are predictions based on the Blanchard OLG model (with exogenous Harrod-neutral technical progress) consistent with Kaldor's stylized facts? Why or why not? c) Suppose we want a concise economic theory giving the long-run level of the average rate of return in the economy as an explicit or implicit function of only a few parameters and/or exogenous variables. Does the Blanchard OLG model give us such a theory? Why or why not? d) Briefly, assess the theory of the long-run rate of return implied by the Blanchard OLG model compared with that of the Ramsey model. That is, mention what you regard as strengths and weaknesses of the Blanchard theory. IV.10 Short questions a) What does Barro's dynasty model conclude about the hypothesis of Ricardian equivalence? b) What does Blanchard's OLG model conclude about the hypothesis of Ricardian equivalence? c) What is the basic reason that the two models lead to different conclu sions in this regard? IV.11 Short questions a) "Considering the different Slutsky effects, the consumption function of the individual in the Blanchard OLG model (with logarithmic in- stantaneous utility) is such that a higher tax on interest income lowers current consumption." True or false? Why? b) "When the real interest rate remains above the GDP growth rate of the economy, then the NPG condition for the government is a necessary and sufficient condition for fiscal sustainability." True or false? Comment. CHAPTER 4. OVERLAPPING GENERATIONS IN DISCRETE 28 AND CONTINUOUS TIME IV.12 Some quotations. a) Two economists - one from MIT and one from Chicago - are walking down the street. The MIT economist sees a 100 dollar note lying on the sidewalk and says: "Oh, look, what a fluke!". "Don't be silly, obviously it is false", laughs the Chicago economist, "if it wasn't, someone would have picked it up". Discuss in relation to the theoretical concepts of arbitrage and equilibrium. b) A riddle asked by Paul Samuelson (Nobel Prize laureate 1970): A physi- cist, a chemist, and an economist are stranded on an island, with noth- ing to eat. A can of soup washes ashore. The physicist says "let us smash the can open with a rock". The chemist says "let us build a fire and heat the can first". Guess what the economist says?4:15 A -70 ... OB/s ~ all .ill C 39% and the condition that for any fixed pair (v, to), where to 2 0 and v s to, lim aure- Sig (f(())-5+mids = 0. (3) Notation: kr = Ki/(T,L:) and & = Ct/(T,L() = at/It, where K, and C, are aggregate capital and aggregate consumption, respectively, L, is population = labor supply, and 7, is the technology level, all at time t. Finally, f is a production function on intensive form, satisfying f(0) = 0, f' > 0, f" To- After this shock everybody rightly expects T to grow forever at the same rate, 9, as before. d) Illustrate by the phase diagram ( or a new one) what happens to & and con impact, i.e., immediately after the shock, and in the long run. e) What happens to the rate of return on impact and in the long run? f) Why is the sign of the impact effect on the real wage ambiguous (at the theoretical level) as long as f is not specified further?! g) What happens to the real wage in the long run? V.3 Fiscal sustainability. Consider the government budget in a small open economy (SOE) with perfect mobility of financial capital, but no mo- bility of labor. The real rate of interest at the world financial market is a positive constant r. Time is continuous. Let Y = GDP at time t, = government spending on goods and services at time t, T = net tax revenue (gross tax revenue - transfer payments) at time t, Be = public debt at time t. All variables are in real terms (i.e., measured with the output good as nu- meraire). Taxes and transfers are lump-sum. Assume there is no uncertainty and that the budget deficit is exclusively financed by debt issue (no money financing). a) Write down an equation describing how the budget deficit and the increase per time unit in public debt are linked. Suppose Y grows at a constant rate equal to g + n, where g is the rate of Harrod-neutral) technical progress and n is the growth rate of the labor force = employment). Suppose r > g +n > 0. Assume T, = TY, and G; = Y, where + and y are constant over time, 0