Suppose the initial conditions of the economy
Question # 00417063
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Updated on: 11/02/2016 05:03 AM Due on: 11/02/2016
Suppose the initial conditions of the economy are characterized by the following equations. In
this problem, we assume that prices are fixed at 1 (the price index is 100 and when we deflate,
we use 1.00) so that nominal wealth equals real wealth.
1) C = a0 + a1 (Y-T) + a2 (WSM) + a3 (WRE) + a4 (CC) + a5 (r)
1’) C = a0 + a1 (Y-200) + a2 (10,000) + a3 (15,000) + a4 (100) + a5 (3)
2) I = b0 + b1AS + b2CF + b3 (r)
2’) I = b0 + b1 (160) + b2 (1800) + b3 (3)
3) G = G
3’) G = 400
4) X-M = X-M
4’) X-M = -200
Where: a0 = 200, a1 = .80, a2 = .05, a3 = .10, a4 = .8, a5 = -500, b0 = 300, b1 = .5, b2 = .5, b3 =
-200
Derive an expression for the consumption function and graph it on your sheet. Show all work. 2.
Interpret a2 and a
this problem, we assume that prices are fixed at 1 (the price index is 100 and when we deflate,
we use 1.00) so that nominal wealth equals real wealth.
1) C = a0 + a1 (Y-T) + a2 (WSM) + a3 (WRE) + a4 (CC) + a5 (r)
1’) C = a0 + a1 (Y-200) + a2 (10,000) + a3 (15,000) + a4 (100) + a5 (3)
2) I = b0 + b1AS + b2CF + b3 (r)
2’) I = b0 + b1 (160) + b2 (1800) + b3 (3)
3) G = G
3’) G = 400
4) X-M = X-M
4’) X-M = -200
Where: a0 = 200, a1 = .80, a2 = .05, a3 = .10, a4 = .8, a5 = -500, b0 = 300, b1 = .5, b2 = .5, b3 =
-200
Derive an expression for the consumption function and graph it on your sheet. Show all work. 2.
Interpret a2 and a
3 (i.e., what do they measure) and why are they so important in terms of
measuring the impact of the Great Recession on consumption.
3.
Why is a3 larger than a2?
5.
We now let G rise to 500 as the Federal Government (fiscal policy) authorities are not happy with
the level of GDP. Solve for the new equilibrium output and label as point B on all three of your
diagrams. Please be sure to label your diagrams completely and show all work.
Why is a3 larger than a2?
4. Derive an expression for the aggregate expenditure curve and graph it on your exam sheet
labeling this initial equilibrium output as point A. Also, add this point A to your consumption
function. Show all work.
Draw an aggregate demand and an aggregate supply curve in the right hand graph on your exam
sheet identifying this initial point as point A.
NOTE: We are holding the price level fixed at 100 in this problem. Also, note that you that you
cannot derive an expression for the aggregate demand curve, just draw it with a negative slope
going through point A.
labeling this initial equilibrium output as point A. Also, add this point A to your consumption
function. Show all work.
Draw an aggregate demand and an aggregate supply curve in the right hand graph on your exam
sheet identifying this initial point as point A.
NOTE: We are holding the price level fixed at 100 in this problem. Also, note that you that you
cannot derive an expression for the aggregate demand curve, just draw it with a negative slope
going through point A.
5.
We now let G rise to 500 as the Federal Government (fiscal policy) authorities are not happy with
the level of GDP. Solve for the new equilibrium output and label as point B on all three of your
diagrams. Please be sure to label your diagrams completely and show all work.
6.
What is the government spending multiplier in this problem and what does this government
spending multiplier depend on?
What is the government spending multiplier in this problem and what does this government
spending multiplier depend on?
7.
Suppose, that instead of holding prices fixed as we did in this problem, that prices were perfectly
flexible, as in a classical world. Discuss, do not show, how your graphs would be different. Also,
comment on what would happen to the government multiplier under the assumption of perfectly
flexible prices.
Suppose, that instead of holding prices fixed as we did in this problem, that prices were perfectly
flexible, as in a classical world. Discuss, do not show, how your graphs would be different. Also,
comment on what would happen to the government multiplier under the assumption of perfectly
flexible prices.
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Rating:
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Solution: Suppose the initial conditions of the economy