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Unformatted text preview: NX= 20 T= 250 C: the 400r means: a one percentage increase in the real interest rate reduces consumption by 400*.01 = 40 I^P: a one percentage increase in r: reduces I^P by 600*.01 = 6 Compute the PAE function PAE = [640 + .8(Y250) 400r] + (250600r) + 300 + 20 C I^P G NX = [1010 1000r] + .8y ^Autonomous expenditures + ^Induced expenditures If r = 5%, what is the equilibrium level of output in the shortrun? PAE = 1010 1000(.05) + .8Y = 960 + .8Y Since PAE = Y Y = 960 +.8Y = 4800 So Y = 4800 Suppose Y* = 5000 (Y*Y) = 200 = recessionary gap Q. What can the fed do to fight this recessionary gap? Change the interest rate. If the fed changes the interest rate, we know that automatically affects consumption and planned investment. Therefore PAE and output will change. With the multiplier 1/1mpc = 1/1.8 = 1/.2 = 5 PAE needs to increase only 4 to increase output 200...
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 Spring '08
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 Interest Rates

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