Economics 576 Project II Questions Answers

Economics 576 Project II

Given the basic Keynesian three-sector model
Y = C + I + G i = interest rates
where C = a + bYd Y = aggregate income
and I = f ( i …) but I ? f ( Y f = is a function of
with G = Go
and Tx = Txo
1. Assume: C = 22.3 + .75Yd
Now assume that government spending is increased by $22 billion. That would
(increase/decrease) the level of income by how much?
2. Assume: S = -35.1 + .25Yd
Now assume that taxes are cut by $15 billion. That would (increase/decrease) the
level of income by how much?
3. Assume: C = 42 + .8Yd
Now increase taxes and government spending (simultaneously) by $33 billion.
That would lead to a (decrease/increase) of __________ billion in the level of
income 4. Assume: C = 20 + .7 Yd
Now cut taxes by $20 billion. This would have the effect of shifting the
consumption function (upward/downward) by _________ billion. (Think
Keynesian cross model)
5. Assume that the current level of income in the economy is $700 billion. It is
determined that in order to reduce the unemployment rate to the desired level, it
will be necessary to increase the level of aggregate income to $760 billion.
Assume that S = -25 + .2Yd. How much would government spending have to be
increased in order to accomplish the desired outcome?
6. Assume that the current level of income in the economy is $700 billion. It is
determined that in order to reduce the unemployment rate to the desired level, it
will be necessary to increase the level of aggregate income to $760 billion.
Assume that S = -25 + .2Yd. How much would taxes have to be cut in order to
accomplish the desired outcome?
7. Given a saving function of S = -25 + .2Yd, a $10 billion increase in
government spending will bring about how many dollars of change in
consumption?
8. Now, let’s modify our model a bit. Let’s add a fourth sector of spending so
that Y = C + I + G + Xn with X = Xo and M = f (Y). Will this change, by itself,
increase, decrease or not affect the magnitude of the government spending
multiplier? Explain!
9. Thinking about modifications in the model again: Go back to the original
model again, but add a marginal propensity to invest, this is, assume that
I = f ( i and Y). The MPI is defined as ?I/?Y and has a positive value. Will this
increase, decrease or not affect the value of the government expenditures
multiplier? Explain! 10. Now if we assume (more realistically) that tax collections are related to the
level of income, that is, rather than assuming Tx = Txo, we assume that
Tx = To + tY where t is the tax rate, what will that change do to the magnitude of
the investment multiplier? Explain!
11. In plain English, how is it (according to Keynesian theory) that a $1 increase
in government spending can increase the level of aggregate income by more than
$1? (Assume that the MPC is 0.8)
12. Rather than the initial (top of first page) model, now assume a three sector
economy with a tax rate (assume it is both average and marginal rate) of t and a
marginal propensity to invest of f. Will this new model yield larger multipliers
(say, government expenditures multiplier), smaller, or the same size as the initial
model? Explain!