Section 001 11:15 SPARKS MWF

Spring 2011Chuderewicz

YOU MUST USE THIS AS A TEMPLATE – NOTEBOOK PAPER IS NO LONGER ACCEPTED - 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! ALSO, PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME IN THE TOP RIGHT HAND CORNER OF THIS PAGE SO THAT WE CAN ALPHABETIZE THESE EASILY. THANKS IN ADVANCE!

Economics 304

Homework #4 – Desired Capital, User Cost and Goods Market Equilibrium

Due Wednesday, 2/16 at the beginning of class – no late papers accepted!

Instructions: Please show all work or points will be taken off. Good luck!

1. PART 1 (35 points total – 5 points for each part and 10 points for the diagram) You own a golf course in Florida and you need to determine how many golf carts you need to buy to maximize profits. Please answer the following questions given the information below.

A brand new golf cart costs 400 rounds of golf and the rate of depreciation is 18% (.18).

The real interest rate is 2% (use .02 in calculations).

The expected marginal product of capital is given by MPKf = 500 – 5K.

a) What is the user cost of capital and what is it expressed in??

b) How many golf carts should you buy to maximize profits (i.e., what is K*)?

Draw a graph (the uc / MPK graph) depicting the state of affairs and label this initial profit maximizing point as point A.

[pic]

A completely labeled and correct graph is worth 10 points.

c) Now suppose the (local) government with all their financial shortfalls embarks on a campaign to raise revenue to fund the fire department by imposing a so-called “luxury tax” (we know it as τ) equal to 20% of gross revenue What happens to the profit maximizing number of golf carts? Please show all work and label as point B on your uc/MPK graph.

d) Now explain why your profit maximizing K* has changed. Please be specific using the firm’s profit maximizing condition (explain the intuition!). Start your answer with “If I did not change my capital input (my K*), then I would not be …….(you can finish the rest!) ……………..” e) The Federal government, knowing all about the financial pains encountered by state and local governments given the Great Recession, decide to offer an investment tax credit equal to 15% (this is in addition to the tax already imposed by the local government). What is your desired capital stock (K*) now? (Hint: An investment tax credit effectively reduces the price of capital to the firm – think of it as this – under the investment tax credit – you buy a golf cart (cost = 400 rounds of golf) and you get a 15% rebate from Uncle Sam so the investment tax credit adjusted price of the golf cart is now 340 rounds of golf [(1-.15) x 400 = 340]. Please show all work again and label this as point C on your uc/MPK diagram.

1. PART 2 (NEW GRADER – 35 points – 5 for f) and g) 10 for h) and 15 for graph)) Draw a desired investment diagram (completely labeled with all the shift variables noted next to the function in parentheses with signs (+ or -)) depicting the initial equilibrium as point A (simply draw a negatively sloped ID curve going through point A). Label the initial real interest rate as r*A = .02 (as is given above) and the initial level of desired investment as IdA. Note importantly that we do not have numbers for desired investment, but that’s ok, we are focusing on the change in desired investment, given the same real rate = .02. Be sure to include all of the shift variables in parentheses next to this initial ID function.

[pic]

A completely labeled and correct graph is worth 15 points.

Then show, as point B, the new level of desired investment, at the same real rate = .02.

f) Why did the level of desired investment change, even though the real rate of interest did not? Please be...