Question

ch4.p3 - macroeconomics

The money and commodity markets are as described in problems 1 and 2 and the real money supply equals $2,750, so that the economy’s equilibrium is initially the same as in part d of problem 2.

(a) During the Congressional election of 2010, Party A proposes to increase government spending on roads and bridges by $120 billion and to pay for that spending by raising taxes by that amount. If Party A’s proposal were to be enacted, derive what the new equations for autonomous planned spending, Ap, and the IS curve, Y = kAp, would be. Graph that new IS curve when the interest rate equals 4.7, 5.0, 5.3, 5.6, and 5.9.

(b) Using your answer to part a, explain at what interest rate and at which level of real income the commodity and money markets would both be in equilibrium under Party A’s proposal.

(c) During the same campaign of 2010, Party B pro- poses to cut taxes by $80 billion and not change government spending. If Party B’s proposal were to be enacted, derive what the new equations for the autonomous planned spending, Ap, and the IS curve, Y = kAp, would be. Graph that new IS curve when the interest rate equals 4.7, 5.0, 5.3, 5.6, and 5.9.

(d) Using your answer to part c, explain at what interest rate and at which level of real income the commodity and money markets would both be in equilibrium under Party B’s proposal.

(e) Explain how the economy would be similar and different under the proposals of Parties A and B.

Answer 1

Given information:

Autonomous planned expenditure Ap is 2180–20r–.6(1920) +2400–60r+2120–300= 5248–80r.

a.

Fiscal policy intervention:

The new equation of planned expenditure is 2180–20r–.6(1920) +2400–60r+2120–300= 5248–80r. And the IS curve will be

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Figure -1

In figure -1, horizontal axis measures quantity and vertical axis measures interest. The downward curve indicates the demand for money. When the interest rate is 4.7% money demand would be $12,180. The increasing interest rate to 5.9% leads to decreases the money supply to 11,940.

b.

Interest rate and income level:

The new interest rate is 5.3. And the income level is 12,060. Because of the economy showing the equilibrium point in the following point in the IS-LM curve

c.

Autonomous spending:

The real income crowded out by increasing the spending. There is .3 percentage interests increasing, that is the actual level of increasing the spending. But if there is no increase in the interest rate the economy will be the equilibrium at the point of 12,120 when there is increasing energy spending.

d.

Fed`s intervention:

To prevent the crowding out of the economy from the energy spending, fed would increase the money supply to 2,780. Also the par d shows that real income will be 12,120 and the interest rate is 5.3. Fed will be willing to take the risk a rise in the inflation rate. It affects in the real GDP rate, it will be at least12, 060. And if the GDP rate is less than 12,060 the fed should increase the money supply and market will be in equilibrium at 12,060. So the real GDP exceed the natural real GDP, which will be cause the pressure on the increasing inflation rate.

e.

Change in GDP:

If the GDP is 12,000, economy automatically will be in the inflation rate. But fed should take the action to prevent to increase in the real income when the expenditure is increases. Fed should reduce the money supply when the energy spending is increases. Because the previous part represent the Fed reduce the money supply and causes the new equilibrium attain in the point is (12,000, 5.6).