   Chapter 16, Problem 11PA

Chapter
Section
Textbook Problem

Consider an economy described by the following equations:       Y = C + I + G       C = 100 + 0.75(Y – T)       I = 500 – 50r       G = 125       T = 100where Y is GDP, C is consumption, I is investment, G is government purchases, T is taxes, and r is the interest rate. If the economy were at full employment (that is, at its natural rate), GDP would be 2,000. a. Explain the meaning of each of these equations. b. What is the marginal propensity to consume in this economy? c. Suppose the central bank’s policy is to adjust the money supply to maintain the interest rate at 4 percent, so r = 4. Solve for GDP. How does it compare to the full-employment level? d. Assuming no change in monetary policy, what change in government purchases would restore full employment? e. Assuming no change in fiscal policy, what change in the interest rate would restore full employment? To find additional study resources, visit cengagebrain.com, and search for “Mankiw.”

Subpart (a):

To determine

Equations describing the economy.

Explanation

Y=C+I+G : Output is the summation of consumption, investment, and government expenditure. The equation explains the equilibrium condition for GDP or output in a closed economy.

C=100+0.75(Y-T) : The equation implies the consumption as a function of disposable income

Subpart (b):

To determine

Equations describing the economy.

Subpart (c):

To determine

Equations describing the economy.

Subpart (d):

To determine

Equations describing the economy.

Subpart (e):

To determine

Equations describing the economy.

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