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Michigan constructs two inde… Show more (20 points) Consum

Michigan constructs two inde… Show more (20 points) Consumer and Investor Optimism. The University of Michigan constructs two indexes that somehow measure expectations of consumers and investors about the economy. These indexes are the “Index of Consumer Sentiment” (ICS) and the “Index of Investor Expectations” (IIE). The ICS rose from 103.9 in Jan. of 1999 to 112 in Jan. of 2000, indicating expectations of a strong economic growth. Similarly, the IIE rose from 105 to 114 in the same period. In this problem you will study the impact of the facts described above. We start by assuming that the increase in the IIE results from investors expecting an increase in future productivity and the increase in the ICS results from consumers expecting to earn a higher income in the future (in this case, this expectation is possibly associated to the expected increase in future productivity). a. Explain, with the help of a graph, what happens to a firm’s desired level of future capital for any given level of the expected real interest rate. b. Explain, with the help of a graph, what happens to the desired level of investment for any given level of the expected real interest rate and to the desired investment curve. c. Explain what happens to households’ optimal level of current and future consumption and savings everything else constant. d.Explain, with the help of a graph, what happens to the desired savings curve. e.Assume that the goods and services market is initially in equilibrium. Explain, with the help of a graph, what happens to the equilibrium real interest rate, level of savings and investment. Discuss all possibilities. • Show less

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