part4. display a Keynesian cross that would show the comparative statics from the previous question. Show how the expenditure function changes. Label the original equilibrium with E0 and the current disequilibrium with D. Show clearly the change in inventories with "delta inv". Label axes and curves.
Answers are part 2) 29.5, part 3) -2.25, and part 5) 5.75;
Graph Part 4 and part 6
Part 1. A government runs the budget at government spending G=8 and income tax T=7. The NX=0. The investment is I=5. The parameters of households' consumption function are starvation level consumption slc = 3 and marginal propensity to consume MPC = 0.6.
Write down two conditions:
- the consumption function
- the goods
part 2. Use the conditions you wrote down for the above economy to find the equilibrium output.
part 3. Now the population is becoming optimistic about the future in a mood that Alan Greenspan in 1996 termed "irrational exuberance". The MPC goes to 0.7. In the short run, in absence of price signals, the goods market is in disequilibrium. The firms do not react to the growing expenditure and keep the output at your answer from part 2. Find the change in the firms' inventories.
part4. display a Keynesian cross that would show the comparative statics from the previous question. Show how the expenditure function changes. Label the original equilibrium with E0 and the current disequilibrium with D. Show clearly the change in inventories with "delta inv". Label axes and
part 5. In 1996, as Greenspan talked about irrational exuberance, the treasury backed words with actions and engaged in fiscal contraction, attempting to cool down the overvalued dotcom stocks and pay down Reagan's federal government debt. So, propose a value of G at which the economy would return to the original equilibrium from your part 2, even while the MPC remains at 0.7.
part 6. Insert the graph of the comparative statics between the boomy expenditure function (characterizing the MPC=0.7) and the the expenditure function under the crunch of your fiscal contraction from the previous question. Label everything relevant. In particular, mark the policy target equilibrium (with E0, since it should be the same as in your previous graph).
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