# 201FA06_final_answers - 1 The following table gives you...

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Unformatted text preview: 1. The following table gives you data on disposable income, consumption, and taxes in 2003 and 2004. IMPORTANT: you have to assume that the consumption function and the tax function is the same in 2003, 2004, and 2005. In this fictitious economy taxes are income dependent (T = T A + t.Y). YD C T 2003 800 600 100 2004 1000 750 150 2005 a. What is total investment in this economy in 2005, when the government runs a budget surplus of 150 in the year 2005, and equilibrium GDP equals 1800 in 2005? We assume for now that this is a closed economy. C=A+MPC*YD = 0.75*YD T= -80 + 0.2*1800 = 280 YD in 2005 = 1520 C in 2005 = 1140 I=S+T-G T-G = 150 S= 1520-1140=380 I=380+150 = 530 b. What is government spending in this economy in 2005? T = -80 + 0.2*1800 = 280, G = 280-150 = 130 Also G = 1800 – C – I = 1800 – 1140 - 530 = 130 2. (Harder) The next economy is open for trade. Exports are constant and equal to 300, and imports behave according to the following equation: IM = 10 + 0.15*Y. Investment equals 100, government spending equals 100, and taxes are fixed and also equal 100. The consumption function equals: C = 20 + 0.6*Y. a. Compute equilibrium GDP (Hint: Derive the formula for equilibrium GDP with the only change that IM is no longer a constant but depends on Y.) Y = (20 – 0.6*100 + 100 + 100 + 300 – 10) / (1 – 0.6 + 0.15) = 450 / 0.55 = 818.18 b. What is the trade balance at equilibrium GDP expressed in percentage of equilibrium GDP in 2006? 300 – 10 – 0.15*818.18 = 167.27 3. The following economy has income-dependent taxes. (T A = 100 ). Investment is constant and equals 100, government spending equals 250, exports equal 100, and imports equal 50.. Y Taxes Household Savings 400 200 110 600 250 200 a. Write down the consumption function for this economy. (C=A+MPC*YD) Row1: YD=200, C=90 Row2: YD= 350, C=150 MPC=60/150 = 0.4, A=10 C= 10 + 0.4*YD b. Write down the tax function for this economy. (T=T A + t*Y) T = 100 + t*Y 200=100+t*400, t = 0.25 T = 100 + 0.25*Y c. Calculate equilibrium GDP. Y = (A – MPC*T A + I + G + X - IM) / (1 – MPC + MPC*t) Y = (10-0.4*100+100+250+100-50) / (1-0.4+0.4*0.25) = 370/0.7=528.6 d. Calculate the government budget balance at equilibrium GDP. T-G = 100+0.25*528.6 – 250 = 232.15 – 250 = -17.85 e. By how much does equilibrium GDP change when we increase both taxes (T) and government spending by 50? Change in Y = 50*m G + 50*m T = 50/0.7 – 50*0.4/0.7 = 71.43 – 28.57 = 42.86 . f. If we want to decrease GDP by 150, by how much do we have to change imports? -150 = change in IM * m IM , change in IM = -150*(-0.7) = +105 g (Harder) Government wants to give the economy a serious boost without deteriorating the government budget too much....
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201FA06_final_answers - 1 The following table gives you...

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