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Econ420S10_HW5_Solution

# Econ420S10_HW5_Solution - Economics 420 Spring 2010...

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Economics 420 - Spring 2010 Mike Aguilar UNC at Chapel Hill HW # 5 Due - 03/01/2010 Instructions : Please explain your answers thoroughly and show all necessary work. State your assumptions carefully. There may be more than one correct solution. Please type your answers whenever possible. Students may work together, but each must submit their own work. The honor code is in eﬀect. Note: Maintain a ceteris paribus assumption when interpreting all shocks. 1. (8pts) Consider a closed Keynesian economy, which is described as follows: I = ¯ I - i 1 r , C = α 0 + α 1 ( Y - T ) - α 2 r , and M d = c 0 + c 1 Y - c 2 r , and G and M s are exogenous. In the following, examine two cases: Case 1: α 2 = 0; Case 2: α 2 > 0. Compare the government spending and tax multpliers in both cases. Answer: From class, we know that when c 2 = 0, ∂Y ∂G = 1 1 - α 1 . When c 2 > 0, we must solve for the multplier via the IS curve as follows: Y = α 0 + α 1 ( Y - T ) - α 2 r + ¯ I - ı 1 r + G Y (1 - α 1 ) = α 0 - α 1 T + ¯ I + G - r ( α 2

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Econ420S10_HW5_Solution - Economics 420 Spring 2010...

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