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a05-part2 - 9 The behavioural equations for a hypothetical...

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Unformatted text preview: 9. The behavioural equations for a hypothetical. economy are: C = 50,000 + aY ' Id = 5,000 + bY G= 2,000 T = 2,500 There are no exports, imports and transfer payments initially and ‘a’ is the marginal propensity to consume and ‘b’ is the marginal propensity to invest, where ‘a’ plus ‘b’ are less than one. For this question, you can assume that the economy has too high a level of unemployment with price stability. There is no need to calculate the initial equilibrium level of Y. However, you do need to calculate an expression for the spending multiplier. The government now introduces a new autonomous tax of 1,000 units and considers two alternative ways to spend this incremental tax revenue of 1,000 units: \ a) on domestically produced computer equipment; b) on imported computer equipment. Reguired: - For each of the two tax-and-spend options, provide an expression which would represent the overall change in the level of real final goods and services [NDP] for this economy. Show separately, the impact of the new autonomous tax by itself and then the impact associated with the spending option. ' Thus, in each part, develop an expression for the impact 01‘ the tax increase; the impact of the government spending option and the net impact on the economy. Page 12 ofl6 PART IV To be answered by students from Professor Indart’s section (L0201) AnSwer any 5 of the following 6 questions. Each'question is worth 10 marks. Question 1 Peter consumes only two goods, Good X and Good Y, Where Good X is an inferior good to Peter. His income is $1,000 per month, the price of Good X is $2.00 and the price of Good Y is $2.50. Peter maximizes his utility when he spends half of his income in the consumption of Good X. a) In a clearly labelled diagram, sketch Peter’s budget line (clearly indicate the values of the vertical and horizontal intercepts). Without drawing any indifference curve, indicate Peter’s utility- maxirnizing combination quantities of Good X and Good Y (label this combination as point “A”). (2 marks) - b) Suppose now that the price of Good X increases to $4.00. In the same diagram, draw Peter’s new budget line clearly indicating the values of the vertical and horizontal intercepts. Suppose that Peter still maximizes his utility when he spends half of his income in the consumption of Good X. Without drawing any indifference curve yet, indicate Peter’s utility-maximizing combination of Good X and Good Y (and label it point “B”). (2 marks) c) Assuming smooth and convex indifference curves, clearly show in your diagram the substitution and the income effects keeping in mind that Good X is an income-independent good. [Now you can and must draw the appropriate indifference curves.] (Note: draw the indifference curves with pencil, not pen. Do not worry too much about the “beauty” of your smooth and convex curves.) (2 marks) d) Define the substitution effect and the income effect. (2 marks) e) Measured in units of Good X, how much is the substitution effect in part c) above? How much is the income effect? (2 marks) Question 2 The market demand and supply curves for sugar are given by the following equations: . Demand: P =‘3.0 — 0.2 Q Supply: P = 0.6 + 0.1 Q where P is the money price of a pound of sugar and Q is pounds (in thousands) of sugar per day. [It is suggested that you draw the demand and supply curves in a free hand diagram to help you answering this question] a) If the market for sugar is a free market, what is the equilibrium price of sugar? (2 marks) Page 13 of16 b) Suppose that the government irnposes an effective price ceiling of $1.00 per pound of sugar. How .c) many pounds are now sold? (1 mark) Is there an excess supply or excess demand? If so, how much is this excess supply or demand? (1 mark) If a “black market” arises in this situation, what would the black market price for sugar be? (2 marks) Now suppose that instead of imposing a price control, the government pays sugar producers a unit- subsidy on the sugar fliey supply. d) e) If the government wants sugar to be available to consumers for $1.00 per pound, how large will the subsidy per pound need to be? (2 marks) How much will the subsidy cost the government per day? (2 marks) Question 3 The widget industry is a perfectly competitive, constant cost industry, initially in long run equilibrium. Each firm has the traditional U-shaped cost curves. a) b) c) d) Briefly explain why the firm’s AVC and MC curves are U-shaped. (1 mark) Show the initial equilibrium in two interrelated diagrams: one for the representative firm and one for the industry. Use subscripts P1, ql, Q1, etc. (1 mark) Suppose an invention reduces average variable costs by $10 at each level of output. Show the ‘ impact on the firm and the industry in the short run only. Use subscripts P2, qz, Q2 etc. Show clearly , whether the price changes by $10 or by more / less than $10. Show each firm’s profits, if any. State whether there will be any change in the number of firms in the short run. (3 marks) Return to the original equilibrium of part a) above. Suppose widget producers are able to form an association (cartel) that establishes effective quotas for each producer in order to maximize the ' cartel’s profits. Drawing. a new set of diagrams, show the impact in the short run on each firm and the industry if producers are indeed able to form an effective cartel. Use subscripts P3, q3, Q3 etc. Show each firm’s profits, if any. (3 marks) Clearly show in your diagram in d) above the consumer surplus, producer surplus, and the deadweight welfare loss as a result of the creation of the cartel. (2 marks) Page 14 of 16 Question 4 Consider the following information about an economy: Consumption expenditure: C = 20 + 0.8 YD Government purchases: G = 30 Investment: I = 40 Exports: X = 60 Imports: [M = 0.1 Y Taxes: TA = 0.25 Y Government transfer payments: TR = O Disposable income: YD = Y — TA + TR a) What is the expression for aggregate expenditure (AB)? (2 marks) b) What is the level of equilibrium GDP (Y *)? (2 marks) / c) What is the value of the expenditure multiplier (mg)? (2 mark) (1) What is the value of the marginal propensity to consume out of national income (MPCy)? (0.5 marks) e) What is the level of consumption expenditure in equilibrium (0")? (0.5 marks) i) What is the level of taxes in equilibrium >(TA*)? (0.5 marks) g) What is the level of disposable income in equilibrium (YD*)? (0.5 marks) Vh) What is the level of imports in equilibrium (IM*)? (0.5 marks) i) " What is the level of the current account balance (net exports) in equilibrium (NX*)? (0.5 marks) j) What is the level of (private) savings in equilibrium (3*)? (0.5 marks) k) What is the level of the government budget surplus in equilibrium (BS*)? (0.5 marks) Question 5 ' Assume real national income is equal to real GDP. The aggregate supply (AS) and aggregate demand (AD) curves of an economy are given by: AS: P=1+0.01Y AD: P=111—0.1Y . where P is the price level and Y is the level of real national income. Potential real GDP is constant at . 1000. a) What are the equilibrium levels of P and Y? What is the value of the output gap? Is the output gap- inflationary or recessionary? In a clearly labelled diagram, draw the AS and AD curves and indicate the equilibrium levels of P and Y. (2 marks) Page 150f16 b) Suppose now that the aggregate demand fimction changes to P = 116.5 — 0.1 Y. What are the new short-run equilibrium levels of P and Y? What is the value of the output gap? Is the output gap inflationary or recessionary? Draw the new AD curve in your diagram in part a) and show the new' equilibrium. (2 marks) ' Given the shift of the AD curve, what factor price adjustments do you anticipate? What happens to the AS curve as these adjustments occur? What happens to the output gap? (2 marks) What long run levels of P and Y would you anticipate? Show this long run equilibrium in your diagram in part a) above. (2 marks) Go back to the initial equilibrium in part a) above and draw a new diagram reproducing this equilibrium. Suppose'now that a sudden rise in the price of energy increases cost of production throughout the economy and causes the AS curve to shift up by 5.5 at each level of Y. What are the new short-run equilibrium levels of P and Y? What is the value of the output gap? Is the output gap inflationary or recessionary? Draw the new AS curve in your diagram and show the new equilibrium. (2 marks) Question 6 Suppose that the demand for money function is given by MD = 2 Y — 20 i where MD is the quantity of money demanded, i is the rate of interest (e.g., a value of 10 means 10 percent in this problem), and Y is real national income which currently is 100. The supply of money is 100. The price level does nOt change in this problem. a). b) d) What is the expression for the demand for money curve corresponding to Y = 100? What is the equilibrium value for the interest rate? In a clearly labelled diagram, draw the demand for money and the supply of money curves placing i (the rate of interest) on the vertical axis and M (quantity of money) on the horizontal axis. (3 marks) ' Suppose now that real national income increases from 100 to 160. What is the expression for the demand for money curve corresponding to Y = 160? Draw the new demand for money curve in your diagram above. Ifthe supply of money remains at 100, what situation exists in the money market at the initial interest rate of part a) above? What will the new equilibrium value for the interest rate be if the money supply remains at 100? (2 marks) Given the circumstances described in b) and assuming the Bank of Canada is determined to maintain an interest-rate target of 5 percent, What change in the money supply would be required. Be specific about the exact required change in the money supply. (3 marks) Clearly explain how the Bank of Canada will induce the change in the money supply indicated in 0) above. What will be the most likely impact of this change in the money supply on Y? (2 marks) Page 16 of16 PLEASE . ‘ DO NOT WRITE ON THIS PAGE OR ON THE BACK OF THIS PAGE. # THANK-YOU. ...
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