CECN 204 - Assignment#2

# CECN 204 - Assignment#2 - Page | 1 1 a As per question a =...

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P a g e | 1 1 a) As per question, a = 200 and b = 80% Therefore, the consumption function is C = 200 + 0.8Y (Figure 1.1) If C = 200 + 0.8Y, the savings function is S = 0.2Y – 200 (Figure 1.2) Note: Y = Income(GDP) on the x-axis

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P a g e | 2 b) The equilibrium GDP is where income(Y) is equal to consumption(C) which is at \$1 trillion as shown in Figure 1.1 c) Marginal Propensity to Consume (MPC) relates the change in desired consumption to the change in disposable income. MPC = C/ Y = 160/200 = 0.8 Marginal Propensity to Save (MPS) relates the change in desired savings to the change in disposable income. MPS = S/ Y = 40/200 = 0.2 All disposable income (Y) is either spent or saved, which means MPC + MPS = 1 d) Multiplier = 1/ (1 – MPC + MPS) = 1/ (1 – 0.8 + 0.2) = 1/ 0.4 = 2.5 e) If investment spending of \$20 billion is added in the system, the GDP will rise by 2.5 times (Multiplier Effect), which is \$50 billion. 2 a) The three distinct but related reasons for a fall in the price level increasing the quantity of goods and services demanded are: i – Consumers feel wealthier, which stimulates the demand for consumption goods.
P a g e | 3 Ii – Interest rates fall, this stimulates the demand for investment goods. Iii – The exchange rate depreciates, stimulating demand for net exports. Based on these explained reasons the aggregate demand curve is downward sloping assuming that the money supply is fixed. b) c) d) e) 3 a) Y AE = 200 + 0.75Y 0 200 200 350 400 500 600 650 800 800 1000 950 1200 1100 1400 1250 1600 1400 Therefore, according to the table above the equilibrium GDP (closed economy) is \$800 billion where desired aggregate expenditure (AE) equals actual national income(Y). b) Net Exports (NX) = 60 – (15+ 0.25Y) = 45 – 0.25Y AE in an open economy = 200 + 0.75Y + (45 – 0.25Y) = 245 + 0.5Y

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P a g e | 4 Y AE = 245 + 0.50Y 0 245 245 367.5 490 490 735 612.5 980 735 Therefore, according to the table above the equilibrium GDP (open economy) is \$490 billion.
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