ECMA06_Tutorial_4_Solution

ECMA06_Tutorial_4_Solution - ECMA06 Tutorial#4 Answer Key...

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ECMA06 Tutorial #4 Answer Key If r is held fixed at 0.05 & E is held fixed at 0.85 US$ per C$, then I = 50 – 5(0.05 – 0.05) = 50 X = 220 – 3(0.85 – 0.85) = 220 IM = (3/11)Y + 2.5(0.85 – 0.85) = (3/11)Y Question 1 Disposable income, DI: DI = Y – T + TR DI = Y – (44 + 0.3Y) + (110 – 0.1Y) = 0.6Y + 66 C = C(Y): C = 10 + (10/11)(0.6Y + 66) C = 70 + (6/11)Y The AE function: AE = C + I + G + X – IM AE = [70 + (6/11)Y] + 50 + 300 + 220 – (3/11)Y AE = 640 + (3/11)Y Equilibrium output: In equilibrium, Y = AE: Y = 640 + (3/11)Y (8/11)Y = 640 Y* = 880 Question 2 Suppose government spending increases by 40 to 340, i.e., G = 340: The new AE function: AE = C + I + G + X – IM AE = [70 + (6/11)Y] + 50 + 340 + 220 – (3/11)Y AE = 680 + (3/11)Y New equilibrium output: In equilibrium, Y = AE: Y = 680 + (3/11)Y Y* = 935 G = 300 G = 340 Change Equilibrium output, Y* 880 935 935 – 880 = 55 GBB = T – TR – G – 14 – 32 – 32 – (– 14) = – 18 Trade balance = X – IM – 20 – 35 – 35 – (– 20) = – 15 When government spending increases by 40, the government budget deficit increases by 18 (GBB falls by 18). In addition, the country’s trade deficit also widens when government spending rises.
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