1. A production function can exhibit increasing, constant or decreasing returns to scale. Describe the meaning of this statement using a simple production function Y = F (K, L), where K is capital and L is labor. Why might it exhibit increasing or decreasing returns to scale?
2. Consider an economy described as follows:
Y = C + I + G
Y = 10,000
G = 3,000
T = 2,200
C = 1500 + 0.75(Y - T)
I = 1000 - 75r
a. Compute private saving, public saving and national saving in this economy
b. Fin the interest rate that maintains equilibrium in the economy.
c. Suppose that G is reduced by 500. Compute private saving, public saving and national saving and new equilibrium interest rate
d. Suppose that T is increased to 3,000. Compute private saving, public saving and national saving and the effect on the equilibrium interest rate.