Question

Need help on this question, I tried the ones i know.

a The consumption function is C = 1.5 + 0.75(Y-T). What is the marginal propensity to consume,
MPC? What is the marginal propensity to save, MPS?
ans: MPC=0.75 and MPS=1-MPC=0.25 correct?

b The trade balance is TB = 5(1-[1/E])-0.25(Y-8).What is the marginal propensity to consume foreign goods,MPCF ? What is the marginal propensity to consume home goods, MPCH?

c The investment function is I=2-10i. What is investment when the interest rate i is equal to 0.10=10%?
ans: I=2-10(0.1)=1

d Assume government spending is G. Add up the four components of demand and write down the expression for D.

e Assume forex market equilibrium is given by i = ([1/E]-1)+0.10 where the two foreign return terms on the right are expected depreciation and the foreign interest rate. What is the foreign interest rate?
What is the expected future exchange rate?

Answer 1

a) correct.
b) the "imports" part of the equation is .25(Y-8). So the MPCF is .25
Alone, I don't think there is enough information to determine the MPCH -- Unless you can use the overall consumption function from a). If so, the MPCH=.75-.25 = .50
c)correct
d) D=C+I+G+(E-M) = 1.5+.75(Y-T) + (2-10i) + G + (5(1-1/E)-.25(Y-8))
e) something seems missing here. Is i is the foreign interest rate or the domestic interest rate? is E exports or the expected depreciation rate. I am confused.

Answer 2

e) i believe i is the domestic interest rate and ([1/E]-1) is the expected depreciation and 0.10 is the foreign interest rate. E i think is the spot exchange rate.

I don't get why its asking for foreign interest rate again?

Answer 3

I don't understand why depreciation is in the equation. I think of depreciation as the degradation of a physical asset over time. Depreciation affects interest rates in a round-a-bout way.

That said, is it possible that 0.10 is the depreciation rate and 1/E-1 is the foreign interest rate, where E is not the nominal spot exchange rate but normalized exchanged rate;

Anyway, I'm stumped

Answer 4

For d) the text this question is from uses the formula i(home)=i(foreign)+[E(expected)+E]/E. Assuming the question is just meant to recall knowledge of the formula from earlier in the chapter: i(foreign) = (1/E)-1 and expected depreciation = 0.1.