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ECMA06_Tutorial_6_Solution - ECMA06 Tutorial#6 Answer Key...

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ECMA06 Tutorial #6 Answer Key Question 1 Part (a) Without a government sector, DI = Y, so the consumption function is: C = 50 + 0.75Y – (P – 100) The AE function: AE = C + I AE = [50 + 0.75Y – (P – 100)] +[100 – 3(0.04 – 0.04)] AE = 250 + 0.75Y – P The AD function To derive the AD function, we make use of Y = AE. Y = 250 + 0.75Y – P 0.25Y = 250 – P Y = 1000 – 4P or P = 250 – 0.25Y The slope of the AD function is downward sloping because dY dP < 0. In this question. dY dP = – 0.25. Part (b) P = 50 P = 100 P = 200 AD: Y = 1000 – 4P 800 600 200 See page 2 for the linked diagram. Part (c) Suppose at r = 0.04 investment increases to 125: The new AE function: AE = C + I AE = [50 + 0.75Y – (P – 100)] +[125 – 3(0.04 – 0.04)] AE = 275 + 0.75Y – P The new AD function To derive the AD function, we make use of Y = AE. Y = 275 + 0.75Y – P Y = 1100 – 4P or P = 275 – 0.25Y The shift in AD: The multiplier: M = dY dAE - 1 1 = 0.75 - 1 1 = 4 The shift in AD = M × I = 4 × 25 = 100 (for any given price level, AD shifts to the right to AD 1 by 100) Proof: If P = 100, Y = 1100 – 4(100) = 700, which is 100 more than the case in part (a).
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