14.02 Principles of Macroeconomics
Problem Set # 2, Answers
Part I
1.
False
. The multiplier is 1/ [1 c
1
(1 t)]. The effect of an increase in
autonomous spending is dampened because taxes respond proportionally to
any increase in output.
2.
False
: A decrease in G shifts the IS to the left, Y
↓
and i
↓
, so C
↓
because
income has decreased (assuming the income effect dominates the interest
effect or no interest effect on consumption), but the effect on I is
ambiguous (because, in general, we cannot assume similar assumption
regarding the investment).
3.
False
: GDP will definitely increase, but interest rate change depends on the
entity of the shifts and the slopes of the IS and LM.
4.
True
: the introduction of the ATMs reduces demand for money, which
shifts the LM to the right, resulting in lower interest rate and higher GDP.
5.
True
: While an expansionary fiscal policy shifts the IS to the right, increases
Y and the inflationary pressure, the Fed can sell Tbills through open
market transactions, which reduces money supply, and in turn, shifts the
LM to the left to offset the increase in Y and the inflationary pressure. The
result of the fiscal expansion, in this case, will be an increase in the interest
rate.
Part II
1. c
0
is the minimum consumption for survival, which represents the sensitivity
of the consumption w.r.t. the exogenous variables. c
1
is the marginal
propensity to consume (MPC), which represents the sensitivity of the
consumption w.r.t. the disposal income. Note,
c
1
(1 – t)
is the slope of the
consumption line in the space YC (goods market graph). c
2
is the sensitivity
of the consumption w.r.t. the interest rate. c
3
is the sensitivity of the
consumption w.r.t. the net wealth.
c
0
 c
1
T
 c
2
+ c
3
=
is the intercept of the
consumption line in the space YC (goods market graph). b
0
represents the
sensitivity of the investment w.r.t. the exogenous variables. b
1
is the marginal
propensity to invest, which represents the sensitivity of the investment w.r.t.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview.
Sign up
to
access the rest of the document.
 Fall '09
 Geurrieri
 Macroeconomics, Interest Rates, money demand, equilibrium condition, goods market graph

Click to edit the document details