Question

(25pts) 2. Suppose the government wants to reduce its budget deficit. Using the long-run model of the economy developed in Chapter 3, illustrate graphically the impact of the alternative fiscal policy measures indicated in parts (a) and (b) below. Be sure to label: (i) the axes, (ii) the curves, (iii) the initial equilibrium values; (iv) the direction curves shift; and (v) the final equilibrium values. (15) a) Suppose the government decides to reduce the government's budget deficit by reducing government expenditures. What happens to: (i) national saving; (ii) the real interest rate; (iii) investment; (iv) consumption, and (v) output? Illustrate graphically and explain in words why these variables change or why they do not change. (10) b) Suppose the government decides to reduce both government expenditures and taxes by the same amount this is a "balanced budget" change). What happens to: (i) national saving; (ii) the real interest rate; (iii) investment; (iv) consumption, and (v) output? Illustrate graphically and explain in words why these variables change or why they do not change. (45pts) 3. Assume that the consumption function and the investment function are given by: C = 300 +0.75(Y-T) 1 = 1800 - 65r Assume that government expenditures are given by G = 1000, taxes are given by T = 300, and where r is the real interest rate. (Here is measured in percent. Use the values r=1, r=3 and r = 5 etc., rather than 0.01, 0.03 and 0.05.) (8) a) Find the equation for aggregate demand Y as a function ofr. (30) b) Suppose that long run aggregate supply, Y. is produced according to the following technology: Y = A(K) where the technology parameter A-340, capital K = 25 units and labour L = 36 units. (1) Find the value of Y. (ii) Using the aggregate demand function you obtained in part 3(a) and the value of Y you obtained in part 3(b)(i) find the equilibrium interest rate r". (iii) What is national saving? Calculate and explain briefly. (iv) What is the government budget deficit? Calculate and explain briefly. (v) Draw a graph to illustrate the equilibrium in the financial (loanable funds) market. (Your graph does not have to be drawn to scale.) Show your work in each part of the question. Round off numbers to the third digit after the decimal point (For ex. 2.5436 2.544) (7) c) Suppose now that the government decides to reduce taxes to T = 200. What is the new equilibrium interest rate r"? Calculate. What is the new level of national saving? Calculate. (Assume that Y is the same as what you found in part 3(b)(1).) Draw a graph to illustrate the impact of the decrease in T and explain briefly

Answer 1

When The government reduces the budget deficit by increasing taxes on house holds, this will shift the Saving curve to the leftwards from Sto s Thus, the interest rate will Increase from ritory Scanned with CamScanner