Question

1.Consider a closed economy with no taxes, whose consumption function, investment level & government spending level are given by the following equations:

C= 5,000 + .80Y

I= 9,000

G= 2000

whereGrepresents government spending. The equilibrium condition is, as always, that the value of the economy’s output (Y) must be matched by aggregate demand, but now aggregate demand contains a third element, G.

a.         What is the equilibrium level of aggregate output for this economy?

b.         What is the saving function for this economy?

c.          Check the solution, as we did in class, by showing that at the equilibrium level of Ytotal spending exactly matches the level of output. At the equilibrium level ofY, what is the level of saving in the economy?

d.         Sketch the solution in a graph.

e.          What is the Keynesian multiplier for this economy? If Gdecreases by $100, what will be the new equilibrium level of Y?

2.         The following equations describe a particular macroeconomic system:

C= 100,000 + .85Y_d

I= 85,000

G= 55,000

T= .04Y

a.        Find the equilibrium level of aggregate output Y; the economy’s tax bill T; the level of disposable income Y_d; consumption spending C; and the level of Saving when the economy is in equilibrium. Check your results and illustrate the solution in a diagram.

What is the multiplier in this economy?

b.        If the full employment level of aggregate output is $1,325,000, how much would the government have to increase or decrease its spending to bring aggregate demand into line with Y_fe?

c.         Suppose the tax code were altered to include a tax credit for households at low level of incomes, so that the fourth equation were now:

T= –2,000 + .04Y

Find the equilibrium level of aggregate output Y; the economy’s tax bill T; the level of disposable income Y_d; consumption spending C; and the level of Saving when the economy is in equilibrium. Check your results and illustrate the solution in a diagram. What is the multiplier in this economy?

3.         The following equations describe a particular macroeconomic system:

C= 250,000 + .92Y_d

I= 140,000

G= 175,000

T= .06Y

a.        Find the equilibrium level of aggregate output Y; the economy’s tax bill T; the level of disposable income Y_d; consumption spending C; and the level of Saving when the economy is in equilibrium. Check your results and illustrate the solution in a diagram.

b.         Suppose the tax rate increases to 8%. Find the equilibrium level of aggregate output Y; the economy’s tax bill T; the level of disposable income Y_d; consumption spending C; and the level of Saving when the economy is in equilibrium. Check your results and illustrate the solution in a diagram.

5.          A bond that will mature in three years has a coupon payment of $100; interest is paid and compounded annually. Its face value is $1,000 and the yield on bonds of similar risk and maturity is 7.5%.  What will be the price of this bond?  Suppose the market rate of interest rose to 12%; what would happen to the price of the bond? Use Excel(or some other spreadsheet software) to graph the relationship between the interest rate and the price of this bond.

5.          A bond that will mature in three years has a coupon payment of $1200; interest is paid and compounded annually.  Its face value is $25,000 and the yield on bonds of similar risk and maturity is 4.0%. What will be the price of this bond? Suppose the market rate of interest fell to 3.5%; what would be the new price of the bond? Use Excel (or some other spreadsheet software) to graph the relationship between the interest rate and the price of this bond.

Answer 1