INSTRUCTIONS:

• This comprehensive assignment covers Chapters 25-28

• Show all calculations with formulas clearly stated

• Draw graphs where required and label all axes, curves, and equilibrium points

QUESTION 1: The Tale of Two Economies (Chapter 25)

Economists studying economic development have long been fascinated by why some countries grow faster than others. Consider two neighboring countries in Southeast Asia that share similar cultures and technologies but have accumulated different amounts of capital over their development paths. Both economies can be described by the same production function:

Y  =  A  ×  KO.3  ×  LO.7,

where output depends on technology (A), physical capital (K), and labor (L).

Economy A represents a more developed nation that has accumulated substantial capital over decades. With a technology level of A = 10, this country has built up its capital stock to K = 1,000 billion baht while employing L = 100 million workers. Meanwhile, Economy B is an emerging market with the same technology level (A = 10) and labor force size (L = 100 million workers), but has only accumulated K = 125 billion baht in capital, reflecting its earlier stage of development.

a)   As  an  economic consultant, you are asked to evaluate the productivity levels in both economies. Calculate the output per worker (Y/L) for each country using the production function. Then, to understand the return to additional investment, compute the marginal product of capital (MPK) for each economy. You can approximate MPK by calculating how much output would increase if capital increased by 10 units: MPK ≈  .

Your analysis should demonstrate the principle of diminishing returns to capital—showing that Economy B, with less capital, achieves a higher marginal product from each additional unit of capital investment compared to the capital-rich Economy A.

b)   Development economists often observe the “catch-up effect”, where poorer countries tend to grow faster than richer ones, other things being equal. Given that both economies save and invest 20% of their GDP each year, apply the concept of diminishing returns to explain which economy you would expect to grow faster over the coming decade. Your answer should discuss why the marginal product of capital matters for growth rates and how the relationship between capital per worker and productivity creates opportunities for rapid growth in capital-scarce economies.

QUESTION 2: The Government Deficit Dilemma

Thailand's loanable funds market connects savers and borrowers through financial intermediaries. The supply of loanable funds comes from national saving—households setting aside income for the future and firms retaining earnings for expansion. The demand for loanable funds comes from firms seeking to invest in capital equipment, technology, and infrastructure. Market analysts have estimated that the supply function can be expressed as Q^S = 500 + 200r, meaning that at higher interest rates, more saving flows into the market. Meanwhile, investment demand follows Q^D = 2,000 - 100r, reflecting that firms find fewer projects profitable as the cost of borrowing rises. In these equations, r represents the real interest rate expressed in percentage points, and Q represents the quantity of loanable funds in billions of baht.

a)   In  the  absence  of  government  intervention,  market  forces  determine  the  equilibrium interest rate where the quantity of funds supplied by savers equals the quantity demanded by investors. Set the supply equal to demand (s  = D ) and solve algebraically for the equilibrium interest rate and the equilibrium quantity of loanable funds. Show each step of your calculation clearly, as you would present to Thailand’s Ministry of Finance.

b)  Now suppose the government increases spending on infrastructure projects by 300 billion baht without raising taxes, creating a budget deficit. This deficit absorbs national saving that would otherwise be available for private investment, shifting the supply curve leftward to Qs  = 200 + 200r. Calculate the new equilibrium interest rate and quantity of loanable funds under this fiscal policy. Then determine how much crowding out occurs—that is, by how much does private investment fall when the government borrows these funds? To illustrate this phenomenon, draw a carefully labeled graph of the loanable funds market showing the original supply curve (s1), the new supply curve (s2), the demand curve (D), both equilibrium points (E1 and E2), and clearly indicate the amount of crowding out on your diagram.

c)   Using the  loanable funds framework, explain the economic mechanism through which government budget deficits lead to higher interest rates and reduced private investment. Then connect this analysis to long-run growth by discussing what happens to capital accumulation when private  investment  is  crowded  out  year  after  year.  What  are  the implications for productivity and GDP per capita over the next generation?

QUESTION 3: The Real Estate Investment Decision

Bangkok Real Estate Development Company faces a strategic decision that will shape its future. The firm’s investment committee is evaluating two major projects, each requiring substantial upfront capital but promising different streams of future cash flows.

The first opportunity is an office building in the central business district. This project would require an initial investment of 100 million baht paid immediately for land acquisition and construction. The building would generate rental income of 20 million baht at the end of the first year, 30 million baht at the end of the second year, 40 million baht at the end of the third year, and 45 million baht at the end of the fourth year.

The second opportunity is a modern shopping mall in a rapidly growing suburban area. This larger project demands an initial investment of 150 million baht today. However, it promises higher returns: 30 million baht at the end of year 1, 50 million baht at the end of year 2, 60 million baht at the end of year 3, and 70 million baht at the end of year 4. The current market interest rate, which reflects the opportunity cost of capital and the return the company could earn on alternative investments, stands at 8% per year.

a)   To make a rational investment decision, the company must calculate the Net Present Value (NPV) of each project. The NPV represents the value of the investment in today’s terms, accounting for the time value of money. Calculate the NPV for both Project A (office building) and Project B (shopping mall) using the formula:

NPV  =  一Initial Cost  +  [CF1/(1 + r)1] + [CF2/(1 + r)2] +  [CF3/(1 + r)3] + [CF4/(1 + r)4],

where CF represents the cash flow in each year and r = 0.08.

Show your calculation for each year’s present value separately before summing them. Based on the NPV decision rule—which states that projects with positive NPV should be accepted because they add value to the firm—advise the company on which project(s) to undertake. Explain your reasoning carefully.

b)   Financial markets  are dynamic, and interest rates fluctuate with monetary policy and economic conditions. Suppose that shortly after your initial analysis, the Bank of Thailand raises interest rates to combat inflation, and the market interest rate increases to 12% per year. Recalculate the NPV of Project A (the office building) at this new interest rate. Compare your result to the NPV at 8% and explain why the project’s net present value decreases when the interest rate rises. Finally, use this analysis to explain a fundamental principle in macroeconomics: why does the economy’s investment demand curve slope downward? That is, why do firms invest less when interest rates are high and more when interest rates are low?

QUESTION 4: The Power of Compound Growth

Somchai, a 30-year-old professional working in Bangkok, has decided to begin saving seriously for his retirement. He visits a financial advisor who explains that understanding the time value of money and the power of compounding is crucial for long-term wealth accumulation. Today, Somchai deposits 500,000 baht into a savings account. The financial advisor presents him with three different investment options offered by various financial institutions, each promising different annual interest rates: a conservative government bond fund offering 4% per year, a balanced mutual fund projecting 7% per year, and a growth-oriented equity fund targeting 10% per year. All three options compound interest annually, meaning that each year's interest earnings are added to the principal and earn interest in subsequent years.

a)   To help Somchai understand how his wealth will grow over a decade, calculate the future value (FV) of his 500,000 baht investment after 10 years for each of the three scenarios using the compound interest formula:

FV  =  PV  ×  (1  +  r)- ,

where PV is the present value (initial deposit), r is the annual interest rate expressed as a decimal, and n is the number of years.

Calculate separately for Scenario 1 with r = 0.04, Scenario 2 with r = 0.07, and Scenario 3 with r = 0.10. Show all your calculations step by step. After obtaining the three future

values, compare them and explain to Somchai how the power of compounding—earning interest on interest—causes even small differences in interest rates to create substantial differences in wealth over time.

b)   The financial advisor mentions a useful approximation called the Rule of 70, which states that the doubling time for any investment is approximately 70 divided by the growth rate (in percentage terms). Apply this rule to estimate how many years it would take for Somchai's investment to double at each of the three interest rates: 4%, 7%, and 10%. Then, to verify the accuracy of this approximation, calculate the exact doubling time for the 7% scenario by solving the equation (1.07)-    =   2 for n (you may use logarithms or trial and error). Finally,  explain why understanding  compound  growth  is  essential  for  making informed decisions about saving for retirement, investing in education, or any other long- term financial goal.

QUESTION 5: Balancing Risk and Return

Anong, a successful entrepreneur who recently sold her business, now has 1,000,000 baht to invest for her future. She consults with a financial advisor who explains that all investments involve a tradeoff between risk and return. The advisor presents her with two contrasting asset classes. The first option is Asset A, a portfolio of Thai government bonds that are considered risk-free because the government has never defaulted on its debt. These bonds offer an expected return of E(RA )   = 5% per year with zero volatility (standard deviation σA     =   0%). The second option is Asset B, a diversified portfolio of stocks traded on the Stock Exchange of Thailand (SET), which offers a higher expected return  of E(RB )   =   13% per  year  but  comes with  considerable uncertainty, measured by a standard deviation of σB     =  25%.

The financial advisor explains that Anong doesn’t have to choose one or the other exclusively— she can construct a portfolio that combines both assets in different proportions. By adjusting the weights (proportions) allocated to bonds and stocks, she can select a risk-return profile that matches her personal preferences and financial goals.

To illustrate the risk-return tradeoff, calculate the expected return and risk for three different portfolio allocations. Portfolio 1 is the most conservative option with 100% invested in bonds (WA = 1.0, WB  = 0). Portfolio 2 represents a balanced approach with 50% in bonds and 50% in stocks (WA  = 0.5, WB  = 0.5). Portfolio 3 is more aggressive with 25% in bonds and 75% in stocks (WA  = 0.25, WB  =  0.75). For each portfolio, calculate the expected return using the formula E(Rp )  = WA   ×  E(RA )  +  WB   × E(RB ), and calculate the portfolio risk using σp     =  WB   ×  σB , where w represents the weight (proportion) allocated to each asset. Present your results in a clearly organized table showing the portfolio composition, expected return, and risk level for each of the three portfolios.

QUESTION 6: Understanding Thailand’s Labor Market

The National  Statistical  Office  of Thailand  has released  its  latest  labor  force  survey  results, providing a comprehensive picture of the nation's employment situation. According to the survey, Thailand has an adult population (persons aged 15 and above) of 60 million people. Of these adults, 38 million people are currently employed in various sectors ofthe economy, working in agriculture, manufacturing,  services,  and  other  industries.  Another  2  million  people  are  classified  as unemployed—they do not currently have jobs but are actively searching for employment and are available to work. The remaining adults are outside the labor force, including students, retirees, homemakers, and those who have become discouraged and stopped searching for work.

a)   As an economist working for the Ministry of Labor, you are tasked with preparing a report on the state of Thailand's labor market. Calculate three key statistics that policymakers use to assess labor market conditions. First, determine the size of the labor force, which includes all adults who are either employed or actively seeking employment. Second, calculate the unemployment rate, which measures the percentage of the labor force that is currently  without  work,  using  the   formula:  Unemployment  Rate  =   (Number  of Unemployed / Labor Force) × 100. Third, calculate the labor force participation rate, which indicates what fraction of the adult population has chosen to participate in the labor market, using the formula: Labor Force Participation Rate = (Labor Force / Adult Population) ×

100. Show all calculations clearly and interpret what these numbers tell us about Thailand’s economy.

b)   The Thai government is debating whether to raise the minimum wage in the agricultural sector to help low-income farm workers. Labor economists have studied this market and estimated that labor demand follows the function Q)   =  5  一  0.2w, where a higher wage reduces the quantity of labor that farms are willing to hire. Labor supply follows Qs   = 1 + 0.3w, reflecting that more workers are willing to work in agriculture when wages are higher. In these equations, W represents the daily wage measured in hundreds of baht (so W = 8 means 800 baht per day), and Q represents the quantity of labor measured in