ECMA06_Tutorial_3_Solution - ECMA06 Tutorial#3 Answer Key...

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ECMA06 Tutorial #3 Answer Key Question 1 Part (a) The AE function: AE = C + I AE = [60 + 0.75Y] + [100 – 10(r – 0.05)] = [60 + 0.75Y] + [100 – 10(0.05 – 0.05)] AE = 160 + 0.75Y Equilibrium output/income: In equilibrium, Y = AE: Y = 160 + 0.75Y 0.25Y = 160 Y* = 640 Part (b) Suppose that output is set accidentally at 600 (i.e., Y = 600): The level of AE when Y = 600: AE = 160 + 0.75(600) = 610 Mechanism that brings output back to equilibrium: Since Y = 600 & AE = 610, the economy is trying to purchase more output than is being produce; i.e., we have excess demand. Prices are fixed (by assumption) at their current level, firms try to satisfy the excess demand by depleting their inventories that leaves inventories below their desired levels. To replenish inventories to their desired levels, firms would increase their current level of output. This pressure will continue until output increases to its equilibrium level of 640. If Y = 600, how will GDP be measured using the final products approach? If Y = 600, C = 160 + 0.75(600) = 510 & I = 100 In terms of GDP accounting, C = 510 & investment = 600 – 510 = 90.
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