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Section+Exercise+17+solns - 2011 Berkeley Doraiswamy Spring...

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Department of Economics            Spring  2011 University of California          Economics 1 Berkeley    Head GSI: Swetha  Doraiswamy Section Exercise 17 For 4/5/11 & 4/6/11 1) You have been called in by the Arbocali Minister of Finance. The full-employment level of  output is 124,000 opeks. She tells you that an econometrician has provided the following  model of the Arbocali economy. The currency is opeks. Consumption function: C = 6,000 + 0.75 Y d   Investment function:  = 11,000  Government spending:  = 20,000  Net taxes:  = 16,000 Disposable income:  Y d   –  Equilibrium:  a.  Calculate the current equilibrium income level. Note that Y = C + I + G in equilibrium in this economy. Typically, our model tells us that Y = C  + I + G + NX in equilibrium, but we can think of Arbocali’s economy as a closed economy, with  no international trade, so NX = 0. However, on an exam, always use Y = C + I + G + NX to  determine equilibrium income. Y = C + I + G +NX     = 6,000 +  0.75 Y d  + 11,000 + 20,000 +0 (NX = 0)     = 37,000 +  0.75 Y d Y d   –  T, so: Y = 37,000 + 0.75(Y – T)     = 37,000 + 0.75Y – 0.75*16,000  => 0.25Y = 25,000 =>  Y* = 100,000 b.  Determine the value of the government spending multiplier and the tax multiplier. To determine the value of the government spending multiplier and tax multiplier, you will need  to identify the marginal propensity to consume (mpc). You can locate this in the above equation  for consumption, C = 6,000 +  0.75 Y d . This tells you that households consume 75% of each  additional dollar of disposable income, so mpc = 0.75. Q1: Case and Fair, Chapter 24       Page  1  of 5 Q2: Olney,  Macroeconomics as a Second Language,  Chapter 8
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Department of Economics            Spring  2011 University of California          Economics 1 Berkeley    Head GSI: Swetha  Doraiswamy The equation for the government spending multiplier is: G multiplier =  1 1 - mpc = 1 1 - 0.75 = 1 0.25 = 4 The equation for the tax multiplier is: T multiplier =  - mpc 1 - mpc = - 0.75 1 - 0.75 = - 0.75 0.25 =- 3
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