QUESTION ONE Assume that an economy is represented by the following system of equation: C = c₂ (Y-T) 1 = b₂ + b₁y-b₂i M P =c-asi G = G₁ T = To Assume that a, b, b₁,b₂, and c, are all positive and that b, + b₂ <1. For simplicity assume that P = 1 Important: Note that unlike in the short run model we have saw in class, money demand depends on consumption, and not on total output. A. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any level of output and interest rates. From this question onward, the new behavior of firms obeys the following equation: I= b0-A + b₂Y-b₂i with 4> 0 Find the new IS relation (call it IS, ). Show graphically the new equilibrium output and interest rates. Call the new equilibrium output Y1. B. Now suppose the government wants to counterbalance the effect of the drop in investors' confidence on GDP using government spending as a policy instrument. Should the government increase or decrease G? What new level of government spending G1 should the government choose to completely offset the effect of lower business confidence? C. Suppose now the government cannot use fiscal instruments (G or T) because Congress would not allow it. The Central Bank decides to use monetary policy to restore the original equilibrium output Y. Should the Central Bank increase or decrease M,? Draw the new equilibrium after the change in money supply.
QUESTION ONE Assume that an economy is represented by the following system of equation: C = c₂ (Y-T) 1 = b₂ + b₁y-b₂i M P =c-asi G = G₁ T = To Assume that a, b, b₁,b₂, and c, are all positive and that b, + b₂ <1. For simplicity assume that P = 1 Important: Note that unlike in the short run model we have saw in class, money demand depends on consumption, and not on total output. A. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any level of output and interest rates. From this question onward, the new behavior of firms obeys the following equation: I= b0-A + b₂Y-b₂i with 4> 0 Find the new IS relation (call it IS, ). Show graphically the new equilibrium output and interest rates. Call the new equilibrium output Y1. B. Now suppose the government wants to counterbalance the effect of the drop in investors' confidence on GDP using government spending as a policy instrument. Should the government increase or decrease G? What new level of government spending G1 should the government choose to completely offset the effect of lower business confidence? C. Suppose now the government cannot use fiscal instruments (G or T) because Congress would not allow it. The Central Bank decides to use monetary policy to restore the original equilibrium output Y. Should the Central Bank increase or decrease M,? Draw the new equilibrium after the change in money supply.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
Related questions
Question
Transcribed Image Text:QUESTION ONE
Assume that an economy is represented by the following system of equation:
C = c₂ (Y-T)
I= bo + b₂Yb₂i
M4
P
= C-a i
G = Go
T = To
Assume that a, b, b₁,b₂, and c, are all positive and that b₂ + b₂ < 1. For simplicity assume that P = 1
Important: Note that unlike in the short run model we have saw in class, money demand depends on
consumption, and not on total output.
A. There is a sudden drop in business confidence, and firms decide suddenly to invest less for any
level of output and interest rates. From this question onward, the new behavior of firms obeys
the following equation:
1 = b0 A + b₁y-b₂i with A> 0
Find the new IS relation (call it IS₁). Show graphically the new equilibrium output and interest
rates. Call the new equilibrium output Y1.
B. Now suppose the government wants to counterbalance the effect of the drop in investors'
confidence on GDP using government spending as a policy instrument. Should the government
increase or decrease G? What new level of government spending G1 should the government
choose to completely offset the effect of lower business confidence?
C. Suppose now the government cannot use fiscal instruments (G or T) because Congress would
not allow it. The Central Bank decides to use monetary policy to restore the original equilibrium
output X. Should the Central Bank increase or decrease M,? Draw the new equilibrium after the
change in money supply.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 4 steps with 4 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education