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1 Consider the goods market model where consumption is given by: C = c0 + c1(Y-T), investments given by I = b0 + b1Y-b2i, and G and T are given
1 Consider the goods market model where consumption is given by: C = c0 + c1(Y-T), investments given by I = b0 + b1Y-b2i, and G and T are given. Assuming c0 = 100, c1 = 0.6, b0 = 150, b1 = 0.2 and b2 = 1000. Keeping all other things constant, what will be the change in the equilibrium investment (I*) in the goods market if autonomous consumption, c0, is increased by $10?
2
Suppose we have 5 mutually exclusive projects, A,B,C,D and E, whose IRR on incremental investment between projects is given as in the following table. (For example IRRIA-B)=11%. IRR(B-D)=8%). Which project should be selected at MARR=10%, please sort the projects. D E 11% 13% 12% 18% 13% 8% 12% 9% 11% 12% A A B ? IC ? D E Select one: a. A>B>D>E>C b. A>D>B>C>E OC. A>B>D>C>E d. A>D>B>E>C e. D>E>C>A>B f.B>D>E>CA
Expert Solution
1
Multiplier = [1 / (1 - MPC)] where MPC = c1 = 0.6
Multiplier = [1 / (1 - 0.6)] = 2.5
Change in autonomous consumption by 10 will change investment by 10 * Multiplier = 10 * 2.5 = 25
2
Ans)- Since MARR = 10%.
So here if incremental IRR of any project ‘X’ over ‘Y’ i.e. IRR(X-Y) is greater than 10%, then the project ‘X’ would be chosen and if IRR(X-Y) is less than 10%, then project ‘Y’ would be chosen.
Hence, here we have the following Incremental IRR from table-
IRR(A-B) = 11%, here IRR(A-B)>10% so project ‘A’ would be preferable over project ‘B’.
IRR(A-C) = 13%, here IRR(A-C)>10% so project ‘A’ would be preferable over project ‘C’.
IRR(A-D) = 13%, here IRR(A-D)>10% so project ‘A’ would be preferable over project ‘D’.
IRR(A-E) = 13%, here IRR(A-E)>10% so project ‘A’ would be preferable over project ‘E’.
IRR(B-C) = 13%, here IRR(B-C)>10% so project ‘B’ would be preferable over project ‘C’.
IRR(B-D) = 8%, here IRR(B-D) <10% so project ‘D’ would be preferable over project ‘B’.
IRR(B-E) = 12%, here IRR(B-E)>10% so project ‘B’ would be preferable over project ‘E’.
IRR(C-D) = 9%, here IRR(C-D)<10% so project ‘D’ would be preferable over project ‘C’.
IRR(C-E) = 11%, here IRR(C-E)>10% so project ‘C’ would be preferable over project ‘E’.
IRR(D-E) = 12%, here IRR(D-E)>10% so project ‘D’ would be preferable over project ‘E’.
Hence by concluding, we can say that project ‘A’ would be preferable over project B, C, D and E.
Project ‘D’ would be preferable over project B, C and E.
Project ‘B’ would be preferable over project C and E.
And Project ‘C’ would be preferable over project ‘E’.
Hence, here option ‘b’ is correct. i.e. A>D>B>C>E.
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