1. Suppose that the economy can be described by the following equations: C = 400 + (8/9)*DI I = 300 G = 800 T = (1/2)*Y (X – M) = 0. a. If national income (Y) increased by $1, by how much would consumption increase? What is the name of this concept? b. Find the equilibrium level of output. c. The budget for this fiscal year increases government spending by $50.
1. Suppose that the economy can be described by the following equations:
C = 400 + (8/9)*DI I = 300
G = 800
T = (1/2)*Y
(X – M) = 0.
a. If national income (Y) increased by $1, by how much would consumption increase? What is the name of this concept?
b. Find the equilibrium level of output.
c. The budget for this fiscal year increases government spending by $50.
i) Sketch the effect of the increase in government spending.
ii) Calculate the new equilibrium level of income.
iii) Calculate the change in income and compare to the increase in government spending.
Comment.
iv) Given your numerical answer in part (iii), calculate the change in national income
when government spending increases by one dollar.
v) Derive the actual value of the fiscal multiplier using an algebraic equation. Compare
to part (iv).
Now G assumes its original value of G = 800.
d. Congress decreases the tax rate from (1/2) to (1/4)
i) Sketch the effect of the decrease in the tax rate.
ii) Calculate the new equilibrium level of income.
e. Suppose that voters care more about reducing
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d. Now G assumes its original value of G = 800. Congress decreases the tax rate from (1/2) to (1/4). i) Use a model to sketch the effect of the decrease in the tax rate when the price level is held constant. ii) What is the new marginal propensity to consume? iii) Calculate the new equilibrium level of income.
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