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A NSWERS TO A SSIGNMENT 1 Section I: Multiple Choice Questions (Total Marks 50) 1. A 2. D 3. A 4. D 5. B 6. A 7. B 8. C 9. B 10. C 11. B 12. C 13. B 14. B Section II: Long Question (Total Marks 50) a. By definition, planned expenditure is: E = C + I + G + GX – IM Substitute in all the equations given in the question: E = C 0 + C y (1-t)Y + I 0 – I r r + G 0 + X F Y F + X ε ε 0 – X ε ε r r + X ε ε r r F – IM y Y Now separate each of the components above in those that directly depend on Y and those that do not: E = [ C 0 + I 0 – I r r + G 0 + X F Y F + X ε ε 0 – X ε ε r r + X ε ε r r F ] + [ C y (1-t) – IM y ]Y The component that does not depend on national income (or real GDP) is autonomous expenditure: A = C 0 + I 0 – I r r + G 0 + X F Y F + X ε ε 0 – X ε ε r r + X ε ε r r F And the coefficient on income is the marginal propensity to expend, i.e., it tells you how much planned expenditure will change if income rises by one dollar: MPE = C y (1-t) – IM y Then we can re-write the planned expenditure line as:
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E = A + MPE*Y b. The goods market is in equilibrium when planned expenditure (or aggregate demand) is equal to real GDP (or national income): Y = E Using this equilibrium condition and the behavioral relationship from part (a) you can solve for equilibrium real GDP: Y = A/(1-MPE) See Figure 1 for the income expenditure diagram. In Figure 1 I plot both the
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