Question

a. Suppose that the macroeconomic model of an economy is given as follows:

Consumption functionC = 150 + 0.85Yd ,     Investment function   I = 350 – 10i

Government spendingG = 200,     Tax function    T = 80 + 0.25Y

Transfer paymentsTRo = 60, Total transactions demand for money  MT = 0.45Y

Speculative demand for money  Msp = -40i, Real moneysupply of  Ms = 400

Where Yd is disposable income,  i is the interest rate, figures are in billions of shillings.

Using this model compute the following:

(i) The equilibrium rate of interest and income.

(ii) The tax multiplier in the Keynesian system

(iii) The crowding-out effect of additional government spending of 80 billion shillings on the equilibrium income and the interest rate.

(iv) The increase in real money supply required to counter balance the crowding out effect of government expenditure.

(v) The effect of an increase in tax rate from 0.25 to 0.30 on the equilibrium income, given the increase in government spending.

b. Consider the following table on expected interest rate and amount of investment in billions of shillings:

Expected interest rate	(%)	16	14	12	10	8	6
Amount of Investment	Bill Kshs.	20	30	40	50	60	70

 

i. Obtain the investment-demand schedule

ii. Autonomous investment demand

iii. Estimate investment level at an interest rate of 1.5%

iv. What is the responsiveness of investment to changes in the interest rate?