Exercise
Answer the following questions with TRUE, FALSE or UNCERTAIN and say why. Each response should not exceed 1/2 page.
1. In equilibrium, an increase in the money supply leads to a decrease in bond prices.
2. The income tax cuts promised by the candidates during the electoral campaign
should lead to an increase in national savings and investments.
3. An exogenous increase in the marginal propensity to consume increases GDP
equilibrium in a closed economy.
4. A drop in consumer confidence (modeled as a drop in the constant C0
in the linear consumption function) decreases the equilibrium GDP and investments in
balance.
5. An increase in the supply of central bank money can be accomplished by purchases on the
open market.
6. In a closed economy, private savings must equal investments in equilibrium.

Consider an economy in which autonomous consumption is 800, the marginal propensity to consume is 0.8, investment is 400, government spending is 500, taxation is 400, and net exports are 100.

A. What is the equilibrium GDP in this economy? Show your work. (3 points)

B. What is the savings at this level of GDP? Show your work. (3 points)

C. What are the spending and tax multipliers? Show your work. (4 points)

D. If government spending increases by 200, what is the new equilibrium GDP and what is the increase over the original equilibrium GDP? Show your work. (4 points)

E. If the government increases both spending and taxation by 200, what is the new equilibrium GDP, and what is the increase over the original equilibrium GDP? Show your work. (4 points)

Assume the following values of an economy.

Planned Investment (Ip) = $20

Autonomous Consumption (C ) = $30

Marginal Propensity to consume (MPC) = .9

What is the equilibrium income?

Y* = aggregate demand at the equilibrium level. (Consumption + investment)

Consumption function = autonomous consumption + mpc * Y.

C=30 + .9Y

AD = 30 + .9Y + 20 = 50 + .9Y

Y= 50 + .9Y.1Y = 50

Y = $500 is the equilibrium level of income.

What is the value of saving at equilibrium?

Savings = income - consumption at the equilibrium level of Y=500,

Consumption = 30 +.9 * 500 = $480

Savings = 500 - 480= 20

c. Does the saving and Investment Identity hold true at equilibrium income OR GDP?

Since planned investment = $20 which is equal to savings calculated, the saving investment identity holds true at equilibrium income.

2. In addition to the values given in question (1) above, assume the government increases its spending by $30 without raising taxes. The government can do this by borrowing from the private sector.

a. Based on this information calculate the new level of equilibrium income.

If Government expenditures = $30, Y = C + I + G

Y = 1/1-.09 * (30+20+30) Y = 800

b. Calculate the total value of consumption at equilibrium.

C = 30 + .9(800) = 750

c. Calculate the total value of saving at equilibrium.

Savings = I - C = 800 - 750 = 50

3. In addition to questions in (1 & 2) above, assume the government decides to raise autonomous taxes by $30 to balance its budget.

What is the new value of equilibrium income?

Y = 1/1-.9 (30-.9(30) +20+30) = 530

What is the value of the autonomous tax multiplier?

-.09/.01 = -9

c. What is the value of autonomous spending multiplier?

1/.1 = 10