f07 ec51 ps5

# f07 ec51 ps5 - Economics 51D 1 October 2007 PROBLEM SET 5 1...

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Economics 51D 1 October 2007 PROBLEM SET 5 1. Suppose we’re thinking about the short run equilibrium where there is sufficient slack in the economy so that firms can supply as much output as is demanded at the current price level. The autonomous level of consumption is \$100 billion per year, the marginal propensity to consume out of after-tax income is .92, investment demand is \$460 billion, government spending is \$600 billion per year, and taxes (these are lump-sum taxes) are \$550 billion per year. Exports are equal to imports at \$400 billion per year. A. Given these numbers, find the short-run equilibrium GDP. B. Using Excel, graph the Keynesian Cross diagram for the equilibrium. Create a column with Y (actual output) and then a column with Planned Expenditures (a + b*(Y-T) + I + G + X – M). Graph the two lines where Y is on the horizontal axis and Y E is on the vertical axis. C. Now suppose that the government raises taxes by \$100 billion. Re-calculate the equilibrium level of GDP, using the same method you used in Part A. D. Now calculate the (lump-sum) tax multiplier and find the change in equilibrium GDP associated with this tax increase. Does this answer agree with your answers to Parts A and B? E. What are the medium-run and long-run effects of this policy change on GDP and the price level? Use a diagram to show what happens, and explain your answer. 2. Suppose that the autonomous level of consumption is \$40 billion per year, the marginal propensity to consume is .9, investment demand is \$1200 billion, government spending is \$900 billion, and lump-sum taxes are \$800 billion per year.

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