# PS_2 - METU Department of Economics Econ 202 Macroeconomic...

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METU Department of Economics Econ 202 Macroeconomic Theory Spring 2010 PROBLEM SET 2 Q.1 You are given the following information about the economy of Dollarland. When income is zero, consumption expenditure is \$100 billion. The marginal propensity to consume out of income is 0.75. Investment is \$500 billion; government purchases of goods and services are \$750 billion; a) If taxes are a constant \$1000 billion and do not vary as income varies. i. Write down the consumption function out of disposable income ) and income (Y). ii. Write down the saving function out of disposable income ) and income (Y). iii. Does MPC out of ) and MPS out of ) sum up to 1? Why or why not? Does the same result hold for the MPC and MPS out of Y? iv. Calculate total autonomous expenditure. v. What would be the autonomous expenditure if 0.75 was MPC out of ܻ ? vi. Calculate the multiplier. vii. Write down the equation that describes the demand for goods (Z). viii. Calculate the equilibrium output algebraically and show it graphically. b) If, in addition to an autonomous amount of \$500 billion, taxes were to increase by \$10 billion when income increased by \$100 billion, how would your answers to parts a.i to a.viii change? Q.2 Suppose in a hypothetical economy with no government, the consumption function is given by ܥ = 250 + 0.6 ܻ , while investment is given by I = 150. a) What is the equilibrium level of income in this case? b) Corroborate your finding in (a) with an alternative way of thinking about the goods market equilibrium. c) If, for some reason, output were at the level of 800, what will happen in the economy? d) If investment were to rise by 100, what will be the effect on equilibrium income? e) Draw a diagram indicating the equilibriums in both (a) and (e). Suppose now we introduce government to this economy. Thus, suppose, fiscal policy is summarized by G = 300, TR (transfer payments) = 100 and marginal tax rate (t) = 0.2. f) Derive the net tax function. g) What is the equilibrium level of income in this more complicated model? Calculate it in two alternative ways (as in (a) and (b)). h)

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## This note was uploaded on 03/22/2012 for the course ECON 202 taught by Professor Tunc during the Spring '10 term at Middle East Technical University.

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PS_2 - METU Department of Economics Econ 202 Macroeconomic...

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