Question

Question Two: Assume the following equations summarize the structure of an economy. С C+0.7(Y-T) са 2,000 - 5r T 150 +0.157 (M/P)+ - 0.3Y - 10r MS/P 3,000 2,000 -10r G 4,000 - 2y NX - 1,500 -0.1 Y-5r A. Calculate the equilibrium real output (Y) and (r). B. If government spending increases by 100, compute by how much the fed must increase the money supply if it wants to avoid the crowding out of expansionary fiscal policy. Make sure to support your answer with the relevant graph. (20 noints)

Answer 1

• Goods market in economy is at equilibrium when Aggregate Demand = Aggregate Supply = Income

Aggregate Demand = C + I + G + NX

Ca + 0.7 (Y - T) + I + G + NX = Y

(2000 - 5r) + 0.7 (Y - 150 - 0.15Y) + 2000 - 10r + 4000 - 0.2y + 1500 - 0.1Y - 5r = Y

2000 - 5r + 0.7 (0.85Y - 150) + 2000 + 4000 + 1500 - 10r - 5r - 0.2y - 0.1Y = Y

2000 - 5r + 0.595Y - 105 + 2000 + 4000 + 1500 - 10r - 5r - 0.2y - 0.1Y = Y

2000 - 105 + 2000 + 4000 + 1500 - 5r - 10r - 5r + 0.595Y - 0.2y - 0.1Y = Y

9395 - 20r + 0.295Y = Y

9395 - 20r = Y - 0.295Y

0.705Y = 9395 - 20r .... (1)

• Money market is in equilibrium when money demand = money supply

( M / P ) ^d = M^s / P

0.3Y - 10r = 3000 .....(2)

• Solving simultaneous eqtns (1) & (2)

0.705Y + 20r = 9395

[ 0.3Y - 10r = 3000 ] x 2 → 0.6Y - 20r = 6000

1.305Y = 15395

Y = 15395 / 1.305

Y = 11796.9 ≈ 11797

r = 53.9 ≈ 54