5.
Now suppose instead that marginal utility of consumption in each period is given by:
t=1
:
MU
(
C
1
)
1
C
1
t=2:
MU
(
C
2
)
=
1
Based on these expressions for marginal utility of consumption each period, solve for the consumer’s optimal
consumption in each period while still assuming that
β
=1, 1+
r
=1, and the consumer’s income is 2 in the first
period and 4 in the second.
Show all of your work
.
(4 points)
5.
Explain
intuitively
how the change in the functional form of marginal utility affects the consumer’s
optimal consumption decisions.
(2 points)
=
10

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Part 6:
Extreme Macroeconomic Events
(20 points total)
a)
Using the IS-LM diagram,
illustrate and briefly explain
what a deflationary spiral is.
(5 points)
b)
List and discuss three factors which amplified the effects of initial shocks in the Great Depression and
contributed to its depth and length.
(5 points)
11

c)
Explain the mechanisms through which the decline in housing prices in the U.S. since 2006 could
generate a world-wide financial crisis.
(5 points)
d)
What does Finland’s experience over the course of the 1990s tell us about the East European
transition to capitalism during the same time period?
(5 points)
12

Equations for Final Exam:
National Income Accounting Identity:
Y
=
C
+
I
+
G
+
NX
Private Saving:
S
p
=
Y
−
T
−
C
Government Saving:
S
g
=
T
−
G
Aggregate Saving:
S
=
S
p
+
S
g
Aggregate Consumption Function:
C
=
C
(
CS ,Y
−
T ,r
)
Aggregate Investment Function:
I
=
I
(
SP,r
)
Aggregate Savings Function:
S
=
S
(
Y ,T ,G ,CS ,r
)
Money Demand:
(
M
P
)
d
=
L
(
Y ,MT ,r
)
IS Curve:
IS
(
T ,G ,CS ,SP
)
LM Curve:
LM
(
M , P,MT
)
Aggregate Demand Curve:
AD
(
M , MT ,CS ,SP,T ,G
)
Marginal Product of Capital:
M P
K
=
αA K
α
−
1
N
1
−
α
Marginal Revenue:
MR
=
(
1
1
+
μ
)
P
Marginal Product of Labor:
M P
N
=
(
1
−
α
)
A K
α
N
−
α
Marginal Cost of Production:
MC
=
W
MP
N
=
W
(
1
−
α
)
A K
α
N
−
α
13

Labor Demand:
W
P
=
M P
N
(
1
+
μ
)
=
(
1
−
α
)
(
1
+
μ
)
A K
α
N
−
α
Labor Supply:
W
P
=
P
e
P
z
Natural Level of Output:
Y
n
=
A
1
/
α
K
[
1
−
α
z
(
1
+
μ
)
]
1
−
α
α
Unemployment Rate:
U
=
L
−
N
L
=
1
−
N
L
Natural Rate of Unemployment:
U
n
=
1
−
[
(
1
−
α
)
z
(
1
+
μ
)
]
1
/
α
A
1
/
α
(
K
L
)
Short-Run Aggregate Supply Curve:
SRAS
(
A ,K , μ,z , P
e
)
Long-Run Aggregate Supply Curve:
LRAS
(
A , K ,μ, z
)
14