Question

IV. Consider the following model and again answer related questions where DI =Y - T Y=C+I+G + X - IM C = 300 + 0.75DI I = 600 - 1000r G= 300 X-IM = 100 T= 0 a. How much is equilibrium level of income or output if Fed decides to set the rate of interest at 10 percent (r=0.10). b. In an effort to cool down the economy, the Fed raises the rate of interest to r =0.15. By how much will Y change? c. To coordinate the fiscal and monetary policies, assume government decides to balance the budget by raising taxes by 300. At the same time Fed decides to counter the contractionary effect of the tax hike and lowers the rate of interest to r = 0.05. Can you predict the change in Y?

Answer 1

a) Y= C+I +G+X-IM

Y =300+0.75(Y-0)+600-1000(0.1)+300+100 T=0 r=0.1 goven

Y = 300+ 0.75Y + 600 -100 +400

0.25Y= 1200

Y = 4800

b) Fed raises r to 0.15

Y= C+I +G+X-IM

Y =300+0.75(Y-0)+600-1000(0.15)+300+100 T=0 r=0.15 goven

Y = 300+ 0.75Y + 600 -150 +400

0.25 Y = 1150

Y =4600

Therefore change in Y is 4800-4600=(200)

c) Raises tax by 300 and r is 0.05

  Y= C+I +G+X-IM

Y =300+0.75(Y-300)+600-1000(0.05)+300+100 T=300 r=0.05 goven

Y = 300+ 0.75Y-225 + 600 -50 +400

0.25Y = 1250

Y=5000

So change in Y in comparison to first part is 200 and in comparison to second part is 400