07f101ps4solutions

07f101ps4solutions - Economics 101 ‘ Problem Set #4 —...

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Unformatted text preview: Economics 101 ‘ Problem Set #4 — Answer Sheet Question 1 Part I Part LA Part I.B Part I.C Part II Part ILA Part II.B Part ILC Part III Part III.A Part 1113 Part III.C Fall 2007 Professor E. Bogan Suppose: C = 125 + O.75YD I = 50 G = 150 X = 50 M = 100 T = 100 The Equilibrium Value of GDP Y = C + I + G + X — TM Y = 125 + O.75*(Y — T) + 50 +150 + 50 — 100 Y = 275 + O.75*Y — O.75*T Y — O.75*Y = 275 4 O.75*100 0.25*Y = 200 Y = 800 I _ Multiplier to any change in autonomous spending 2 1/(1-MPC) = 1/(0.25) = 4 AY = Multiplier*AI = 4*50 = 200 and Ynew = 1000 Now suppose: T = 0.4*Y = t*Y Equilibrium GDP Y = C + I + G + X — [M Y = 125 + O.75*(Y — 0.4*Y) + 150 Y + 275 + O.45*Y Y ~— O.45*Y = 275 Y = 500 Multiplier '= 1/(1-MPC*(1-t)) = 1/(1-O.75*0.6)=1/0.55 = 1.81 The multiplier in Part II is lower than the multiplier in part I because additional increments in income are now reduced by taxes. Thus an increase in income will not increase consumer spending by as much as before. Now suppose T = 0.4*Y and IM = 0.25*Y = im*Y Equilibrium GDP Y = C + I + G + X — ]M Y =125 + O.75*(Y— 0.4*Y) + 50 +150 + 50 — 0.25*Y- Y = 375 + O.45*Y — 0.25*Y ' Y — 0.20*Y = 375 0.80Y = 375 Y = 468.75 p Multiplier = 1/(1-MPC*(1—t)+im) = 1/(1—0.75*O.6+O.25)=1/0.8 = 1.25 This multiplier is even smaller than the one in part II because there is yet another leakage in the economy. That is, additional increments in incomes are now reduced by imports as well as by taxes. This is because imports are now dependent on income (as was the case with taxes in Part II). Increases in income do not increase consumer spending on domestic goods by as much as before. Question 2 Assume Real Consumption (C) = 50 + 0.5*Y + 0.05*(W/P) Real Investment (1) = 50 Real Export (X) = 10 Real Import (IM) = 10 Nominal Wealth (W) = 2,000 Part A Aggregate Demand Curve - Y=C+I+G+X—IM Y = 50 + 0.5**Y 0.05*(2000/P) + 50 +10 — 10 = 100 + 0.5*Y +100/P 0.5*Y = 100 +100/P Y = 200 + ZOO/P P = 1 Y = 400 P = 2 Y = 300 Part B Now Investment rises by 50 Part B.I Y =i'C + I + G + X — IM Price level AD AD, Y = 50 + 0.5*Y + 0.05*(2000/P) + 100 Y = 300 + (ZOO/P) For each price level aggregate demand is 100 more in B than in A. Thus the AD curve shifted right by 100 for each price level. s Real 300 400 500 GDP Part 8.11 If AS is horizontal at P = 2, equilibrium Price level AD AD, income is 300 when investment is 50. When investment increases by 50 as in part I, the new equilibrium income is 400. Thus the equilibrium income went up by 100. This could have been predicted. The multiplier is equal to 1/(1—MPC) = l/0.5 = 2 and we would expect equilibrium income to increase by 100 when investment increases by 50 under the assumption of a horizontal supply curve. Question 3 — B Question 4 - D Question 5 - D Question 6 — D 300 400 GDP ...
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This note was uploaded on 07/09/2008 for the course ECO 101 taught by Professor Elizabethc.bogan during the Fall '08 term at Princeton.

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07f101ps4solutions - Economics 101 ‘ Problem Set #4 —...

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