ECO 3203 Problem Set Questions

Problem Set due Monday, June 17

1. Let us consider a hypothetical economy that is described by the equations shown below:
C = 300 + 0.75 YD – 300 r
T = 100 + 0.20 Y
I = 200 – 200 r
L = 0.5 Y – 500 i
YD = Y – T
Where full-employment level of Income ?= 2500; Government Spending G = 600;
Nominal Money Supply M = 133,000; Expected Inflation is ?e = 0.05; and the fixed Price Level P = 120.
a. Determine the equation for the IS Curve.
b. Determine the equation for the LM Curve.
Problem Set due Monday, June 17
c. Find the short-run equilibrium real interest rate and level of income.
d. Determine the equilibrium values for Consumption (C), Taxes (T), Investment (I) and nominal interest rate (i).
e. Determine the long-run equilibrium.
Problem Set due Monday, June 17
f. Using the IS and LM curves found above, find the equation for the Aggregate Demand (AD) curve. (Hint: Use the LM curve without specifying the value of Price Level, P)

2. Consider the following simple model of a closed economy:
E = C + I + G
C = 200 +0.75 (Y – T)
I = 500; G = 300; T = 200
a. Determine the autonomous expenditure for this economy?
b. Using the Keynesian Cross model, what is the equilibrium value of real aggregate income (Y) for this simple economy?
c. What is the equilibrium value of aggregate income if government purchases (G) are
increased from 300 to 500?
Problem Set due Monday, June 17
d. What is the equilibrium value of aggregate income if income taxes (T) are reduced from 200 to 100?
e. Determine the simple spending multiplier for this economy?

3. Consider the production function Y = F(K,L) = A (2 K + 3 L).
a. Does this production exhibit increasing, decreasing or constant returns to scale? Demonstrate and explain in order to receive full credit.

4. Consider the following production function y = F(K,L) = A K0.4 L1.0
a. Calculate the marginal product of labor.
Problem Set due Monday, June 17
b. Does this production function exhibit increasing, decreasing or constant returns to scale? Demonstrate and explain.
c. Does the production function exhibit diminishing marginal productivity of labor?

5. During the early 1980s President Ronald Reagan was attempting to institute a tax cutting revolution, while the U.S. Federal Reserve Bank Chairman Paul Volcker, was attempting to subdue high rates of inflation.
a. President Reagan’s tax policies were central to his overall economic plan. In fact, he proposed a 30% tax cut over three years. Using the IS-LM model demonstrate graphically how these tax cuts would affect the U.S. economy. Assume the Fed leaves monetary policy unchanged in response to this fiscal action.
b. Now assume that President Reagan’s fiscal policies were expansionary and the Fed responds with a tight monetary policy. Using the IS-LM model, explain and graphically demonstrate the result of these two simultaneous policies. Write a brief narrative to support your graph. Can anything definitive be said about how output and interest rates would change?

6. Consider the following model of a closed economy;

a. Find the equation that describes the IS curve for the economy
b. Find the equation taht describes the LM curve for this economy.
c. Find the equillbrium values of real interest rate (r) and income (y) for this economy.
d. If autonomous consumption rises from 3-- to 400, how will this affect equillibrium level of income (Y)?