Econ Homework Essay

604 Words Sep 23rd, 2012 3 Pages
Chapter 3:Problem 2

2. Consider an economy in which taxes, planned investment, government spending on goods and services, and net exports are autonomous, but consumption and planned investment change as the interest rate changes. You are given the following information concerning autonomous consumption, the marginal propensity to consume, planned investment, government purchases of goods and services, and net exports:

Ca=1500-10r ,c=0.6 ,T=1800
Ip=2400-50r ,G=2000 ,NX=-200

a. The marginal propensity to save equals: 1-C=1-0.6=0.4

b. Autonomous planned spending, Ap, equals Ca − cTa + Ip + G + NX = 1,500 − 10r −.6(1,800) + 2,400 − 50r + 2,000 − 200 = 4,620 − 60r. Therefore, at an interest rate equal to 3,
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Since the multiplier equals 2.5 and income must increase by 300 billion to restore income to its initial equilibrium level of 11,100, fiscal or monetary policymakers must take actions that increase autonomous planned spending by 300 billion in order to restore equilibrium income to 11,100.

* If fiscal policymakers increase government spending, G, and there are no changes in either taxes or the interest rate, then ΔAp = 120 = ΔG. Therefore, fiscal policymakers must increase government spending by 120 billion to restore equilibrium income to 11,100, given no changes in taxes or the interest rate. * If fiscal policymakers decrease taxes, Ta, and there are no changes in either government spending or the interest rate, then ΔAp = 120 = −cΔTa = −.6ΔTa. Therefore, 120/(−.6) = -200 = ΔTa. Therefore, fiscal policymakers must cut taxes by 200 billion to restore equilibrium income to 11,100 * If fiscal policymakers increase government spending and taxes, then given no change in the interest rate, ΔAp = ΔG − .6ΔTa = 120. Furthermore, since fiscal policymakers at the same time don’t change the government budget balance, then ΔG = ΔTa, so that ΔAp = ΔG − .6ΔG = 120 or .4ΔG = 120 or ΔG = 300. Therefore, fiscal policymakers increase both government spending and taxes by 300 billion to restore equilibrium income to 11,100, given no changes in the government budget balance or the interest rate.

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