1. Why would households be interested only in the real values of consumption, income, and assets such as bonds? Think about how households would feel if the nominal values of consumption, income, and assets all doubled, and the price level, P, also doubled.

2. Distinguish clearly between a household’s initial asset position and the change in that position. If a house- hold has negative saving, is that household necessarily a borrower in the sense of having a negative position in bonds?

3. Derive the budget line shown in Figure 6.2. What does this line show?

4. How does an increase in the real wage rate, w/P, affect the quantity of labor demanded, Ld? Where does the assumption of diminishing marginal product of labor (MPL) come in?

5. How does an increase in the real rental price, R/P, affect the quantity of capital services demanded, Kd? Where does the assumption of diminishing marginal product of capital (MPK) come in?

8. Financial intermediaries Consider a financial intermediary, such as a bank, that participates in the credit market. This intermediary borrows from some households and lends to others. (The loan from a customer to a bank often takes the form of a deposit account.)

a. Does the existence of intermediaries affect the result that the aggregate amount of loans is zero?

b. What interest rates would the intermediary charge to its borrowers and pay to its    lenders? Why must there be some spread between these two rates?

c. Can you provide some reasons to explain why intermediaries might be useful?

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