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ECON 305: INTERMEDIATE MACROECONOMICS MARK MOORE SPRING 2011 PROBLEM SET 2: SOLUTIONS CHAPTER 3 QUICK CHECK 1. a. True. b. False. Government spending excluding transfers was 19% of GDP. c. False. The propensity to consume must be less than one for our model to make sense. d. True. e. False. f. False. The increase in equilibrium output is one times the multiplier. g. False. 2. a. Y =160+0.6( Y -100)+150+150 Y =1000 b. Y D = Y - T =1000-100=900 c. C =160+0.6(900)=700 3. a. Equilibrium output is 1000. Total demand= C + I + G =700+150+150=1000. Total demand equals production. We used this equilibrium condition to solve for output. b. Output falls by (40 times the multiplier) = 40/(1-.6)=100. So, equilibrium output is now 900. Total demand= C + I + G =160+0.6(800)+150+110=900. Again, total demand equals production. c. Private saving= Y - C - T =900-160-0.6(800)-100=160. Public saving = T - G =-10. National saving equals private plus public saving, or 150. National saving equals investment. This statement is mathematically equivalent to the equilibrium condition, total demand equals production. In other words, there is an alternative (and equivalent) equilibrium condition: national saving equals investment. Dig Deeper 4. a. Y increases by 1/(1- c 1 )
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b. Y decreases by c 1 /(1- c 1 ) c. The answers differ because spending affects demand directly, but taxes affect demand indirectly through consumption, and the propensity to consume is less than one. d. The change in Y equals 1/(1- c 1 ) - c 1 /(1- c 1 )=1. Balanced budget changes in G and T are not macroeconomically neutral. e. The propensity to consume has no effect because the balanced budget tax increase aborts the multiplier process. Y and T both increase by one unit, so disposable income, and hence consumption, do not change.
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This note was uploaded on 05/26/2011 for the course ECON 305 taught by Professor Dekle during the Spring '07 term at USC.

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