Assignment 2 key-2

# Assignment 2 key-2 - Here is the textbook answer key 4 a b...

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Here is the textbook answer key 4. a. Y increases by 1/(1- c 1 ) 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. 5. a. Y = c 0 + c 1 Y D + I + G implies Y =[1/(1- c 1 + c 1 t 1 )][ c 0 - c 1 t 0 + I + G ] b. The multiplier=1/(1- c 1 + c 1 t 1 )<1/(1- c 1 ), so the economy responds less to changes in autonomous spending when t 1 is positive. After a positive change in autonomous spending, the increase in total taxes (because of the increase in income) tends to lessen the increase in output. After a negative change in autonomous spending, the fall in total taxes tends to lessen the decrease in output. c. Because of the automatic effect of taxes on the economy, the economy responds less to changes in autonomous spending than in the case where taxes are independent of income. Since output tends to vary less (to be more stable), fiscal policy is called an automatic stabilizer. 6. a. Y =[1/(1- c 1 + c 1 t 1 )][ c 0 - c 1 t 0 + I + G ] b. T = t 0 + t 1 [1/(1- c 1 + c 1 t 1 )][ c 0 - c 1 t 0 + I + G ] c. Both Y and T decrease. d. If G is cut, Y decreases even more. A balanced budget requirement amplifies the effect of the decline in c 0 . Therefore, such a requirement is destabilizing. 8. a. Y = C + I + G Y =[1/(1- c 1 - b 1 )]*[ c 0 - c 1 T + b 0 + G ] b. Including the b 1 Y term in the investment equation increases the multiplier.

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