# student Essay

2677 WordsOct 8, 201411 Pages
Name _____ ____________ last 4 PSU ID _____ Please check section that you are registered in: Section 002 - MWF 8:00 - 8:50 am: 102 Forum Building _______ Section 001 - MWF 1:25 - 2:15 pm: 101 Thomas Building ________ Fall 2014 Chuderewicz - YOU MUST HAND IN HW IN THE SECTION YOU ARE REGISTERED FOR - NO EXCEPTIONS YOU MUST USE THIS AS A TEMPLATE – THAT IS – MAKE SPACE FOR YOUR ANSWERS BY HITTING ENTER (you certainly don’t need to type this assignment)– LEAVE THE QUESTIONS AS THEY ARE – AND PLEASE STAPLE! NOTEBOOK PAPER (OR ANY PAPER) STAPLED TO THE BACK IS NOT ACCEPTABLE (GETS A ZERO). ALSO, PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME IN THE TOP RIGHT HAND CORNER OF THIS PAGE SO THAT WE…show more content…
Recalculate Dagwood’s ‘new’ optimal consumption point and label on your graph as point C*B. Is Dagwood worse off or better off? Explain (hint, what has happened to his budget constraint (aka opportunity set)). C*B = [(1+0.05)(600+50)+200]/(2+0.05)=[(1.05)(650)+200]/(2.05)=(882.5)/(2.05)=430.5 Dagwood is worse off now. Since the current wealth falls from \$200K to \$50K, the budget constraint shifts inward. Thus, Dagwood will consume less than before. THE FED TO THE RESCUE! c) (5 points) In steps Ben Bernanke and the Fed and they conduct massive amounts of open market purchases and get the real rate of interest all the way down to - .05 (negative 5% = -.05). Recalculate the optimal bundle for Dagwood and add this point to your graph and label as point C*C. (Note, point C*C incorporates the shock to wealth in part b)) C*c = [(1-0.05)(600+50)+200]/(2-0.05)=[(0.95)(650)+200]/(1.95)=419.2 d) (5 points) Is Dagwood better or worse off due to the fall in the real rate of interest? Explain being sure to discuss exactly how the substitution and income effects play a role here. Be sure to define what the income and substitution effects are and how they play a role in Dagwood’s decision to alter his previously optimal bundle (we are comparing part b) to part c)). Also, comment on whether these income and substitution effects work in the same or opposite direction (i.e., is it a tug of war or do they work in the same