Question

Question 1. Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C= 200 + 2/3(Y-T). Planned investment is 300, as are government spending and taxes. (18 points) a. If Y is 1,500, what is planned spending? Should equilibrium Y be higher or lower than 1,500? (4 points) b. What is equilibrium Y? (Hint: Substitute the values of equations for planned consumption, investment, and government spending into the equation Y C+I+ G and then solve for Y.) (4 points) c. What are equilibrium consumption, private saving, public saving, and national saving? (5 points) d. How much does equilibrium income decrease when G is reduced to 200? What is the multiplier for government spending? (5 points) Question 2. (18 points) Use the Keynesian cross to predict the impact on equilibrium GDP of a. An increase in government spending (6 points) b. An increase in taxes (6 points) c. An equal increase in both government spending and taxes (6 points) Question 3. (18 points) Assume that an economy is characterized by the following equations: C 100+(2/3)(Y- T T 600 G 500 I 800 (50/3)r Ms/P Ma/P 0.5Y - 50r a. Write the numerical IS curve for the economy, expressing Y as a numerical function of G, T, and r. (4 points) b. Write the numerical LM curve for this economy, expressing r as a function of Y and M/P. (4 points) c. Solve for the equilibrium values of Y and r, assuming P= 1.0 and M = 1,200. How do they change when P 2.0? Check by computing C, I, and G. (6 points) d. Write the numerical aggregate demand curve for this economy, expressing Y as a function of G, T and M/P. (4 points)

Answer 1

Solution

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C=200 +MO'. 1), where Y represents income a. T represents taxes. Planned investment is 300, as are government spending and taxes

. a. If 1, is 1,500, what is planned spending? What is inventory accumulation or decumulation? Should equilibrium Ybe higher or lower than 1,500?

if Y is 1500, Planned pending, E =C+1+G

=200. 2/3(,)+300+300

= 800.2/3(1500-300 )

=800.2/3(1200)

=800+800

=1600
So, at ,1500, planned spending is 1600

Since at Y=1500, planned spending (1600) is higher than current output, there will be unplanned

inventory decumulation The amount of inventory decumulation = (E-Y)= (1600-1500)= 100. 615=1500, firms meet the excess demand supplying goods from their inventones, resulting in to  unplanned reduction in their stock of goods Firms would respond to this decline in inventores by,producing  more goods 5, the equilibrium must be higher than 1500

What is the planned expenditure function? What is equilibrium level of income? Show your results in a diagram clearly indicating the intercepts and equilibrium values.

The planned expenditure function E =C+I.G

200 +2/3(Y-T)+300+300

= 800.2/3(-300)

= 800 +2/3Y -200

=600 +2/3Y

So, the planned expenditure ,function, E, is 600 +2/3Y

if, is 0, E=600_ So, the vertical intercept (E-intercept) of the expenditure function is 600

The equilibnum condition Y= E

or, Y=600 +2/3y

or, Y-2/3Y = 600

or, 1/3Y = 600

or, Y=1800

So, equilibnum level of income is 1800

What are equilibrium consumption, private saving, public saving, one national saving?

, The equilibrium consumption, C =200 +2/3(Y-T)

=200+2/3(18.300)

=200+2/3(1500)

=1200

So, the equilibrium consumption is 1200

The equilibrium private saving, = Y-C-T

=1800-1200-.300

=300

So, the equilibrium Private saving 300

-5 equilibrium public saving, S_G =T-G

=300?300
So, the equilibrium public saving is 0

The equilibrium national savings, S = Y-C-T

=1800-1200-300

=300

So, the eguilibrium national saving is 300

d. How much does equilibrium income decrease when G is reduced to 200?

, What is the multiplier for government spending?

The government spending multiplier =1/(1-MPC)

= 1/(1-2/3 = 1/(1/3)= = 3

So, the government spending multiplier is 3 We can use this multiplier to find the change in the equlibrium income

Change in eguilibrium income = Government spending multiplier Change

= 3* (-100) =300

So, the equilibrium income decreases by 300 when G is reduced to 200 .