ANSWERS TO HOMEWORK WEEK FIVE EC141

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ANSWERS TO HOMEWORK WEEK FIVE EC141 CHAPTER 9 1. The debt starts at 1 million lavs at the end of year one and grows to 10 million lavs at the end of year ten. In year ten the interest on the debt will be 5% of the 10 million lavs: 500,000 lavs. Thus, government spending will be 10,500,000 lavs and taxes will be 9,000,000 lavs. [The key to the problem is that taxes are raised to cover the interest payments each year. Thus, the annual deficit remains at 1,000,000. If the interest was added to the expenditure side but taxes were not raised each year, the total debt would grow from 1 million to over 12.5 million and the interest payment would be 629,000 in year 10.] 7. (a) Equilibrium with government requires that output = spending, or that Y = C + I + G . Since we know that Y = C + S + T by definition, then equilibrium also requires that I + G = S + T . To see if Y = 200 is an equilibrium, add C + I + G to obtain 160 + 30 + 0 = 190. This is not an equilibrium because spending (190) is less than output (200). Alternatively, saving + taxes = 40 + 0 = 40, while investment + government spending = 30 + 0 = 30. Thus,

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