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Problem 6. Answer Key Problem 1. a) deficit = current spending – current revenue (annual) = Flow debt = sum of deficits accumulation of deficits = stock b) a 1 period deficit can be compensated for by a future period surplus, while the accumulation of debt implies persistent deficits or a sustained period of excessive spending to revenues. This is more problematic because it reflects a pattern or trend over spending and implies larger sums which are harder to work down. c) ↓spending ↑ taxes grow the economy Problem 2. a) Excel b) C = A + b(Y - T) => C = 100 + 0.9(Y-50) AD = C + I + G => AD = 100 + 0.9(Y-50) +75+100 =230 + 0.9*Y c) AD = Y => 230 + 0.9*Y = Y => 230 = 0.1*Y => Y = 2300 d) Excel More generally: C + I + G = A + b(Y - T) + I + G = Y => A + bY - bT + I + G = Y A – bT + I + G = Y – bY A – bT + I + G = (1-b)Y Y = (A – bT + I + G )/(1-b) = (100 – 0.9*50 + 75 + 100)/(1-0.9) Y = 230/0.1 = 2300 e) AD = 100 + 0.9(Y-50) +100+100 =255 + 0.9*Y AD = Y =>255 + 0.9*Y = Y => 255 = 0.1*Y => Y = 2550 OR : Y = (A – bT + I + G )/(1-b) = = (100 – 0.9*50 + 100 + 100)/(1-0.9) Y = 255/0.1 = 2550 f) New equilibrium : A + b(Y-T) + I + G = Y G = Y – A – b(Y –T) – I = Y(1-b) – A + bT – I

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