Question

A simplified economy is specified as follows:

A. Goods market, all values C, I, G and NX values are in billions of C$:

Consumption Expenditure: C = 150 + 0.8(Y-T)Investment Expenditure: I = 1,300 - 420iGovernment Expenditure: G = 340Lump-sum Constant Taxes: T = 340Exports: 90Imports: 10

B. Money market, all M^d values are in billions of C$:

Interest Rate: i = 0.09 or 9%Money Demand: M^d = 780 - 1,900i

Note: Please keep your answers accurate to two decimal places.

a) Given the above information, solve for the following: the equilibrium Y, the money supply M, the consumption expenditure C, and the investment expenditure I.

Y = 0M = 0C = 0I = 0

Now suppose there is an impending federal election, and the government promises to use fiscal policies to stimulate the economy.

b) Find the value of the goods market multiplier.

Goods market multiplier = 0

c) Let G rise to 420. Solve for the new equilibrium Y and C.

Y = 0C = 0

d) Demonstrate how the increase in G affects the economy through the multiplier. Use three rounds of effects to demonstrate the multiplier effects. Let the first round be related to health care spending, the second round related to clothing, and the third round related to food.

Round 1 -> As the government wants to spend $1 (or $1 billion)

on health care, it demands the production of health care equipment

such as hospitals, medicine, equipment, etc. to be built and sold to

the government. So as ΔG = 1, the production ΔY =

0

. This Y is the

income to the nurses, doctors, construction workers, etc.

Round 2 -> As the nurses receive their new income of Y =

0

, theyspend

0

% of this $

0

on clothing ->

0

cents worth of clothing wouldbe produced, or ΔY =

0

-> this

0

cents would be the income of the

workers involved in making the clothing.

Round 3 -> As the clothing workers receive their new income of

Y =

0

, they spend

0

% of this

0

cents on food -> (

0

)(

0

) =

0

or

0

cents worth of food would be produced, or ΔY =

0

-> this would

be the new income to the food workers.

e) Now consider monetary policies only. Suppose the BOC wants to drop the i to 0.04 or 4%, with G still at $340. Solve for the new I and the ΔI compared to when i = 0.09. Given the multiplier, how much would you expect Y to rise by?

I = 0Change in I = 0Change in Y = 0

f) Given the changes in (e), find the equilibrium Y, the money supply M, the consumption expenditure C, and the investment expenditure I.

Y = 0M = 0C = 0I = 0

g) Complete the following statement to demonstrate how the drop in i affects the money supply, then I, then Y, then C.

As i decreases -> ΔM (Select One) -> ΔI (Select One) -> ΔY (Select One) -> ΔC (Select One)

Answer 1

A) equilibrium money supply is equal to money demand

Ms=780-1900*0.09=609

Equilibrium Y ,

Y=C+I+G+NX=150+0.8(Y-340)+1300-420*0.09+340+(90-10)=1560.2+0.8Y

Y=1560.2/0.2=7801

C=150+0.8(7801-340)=6118.5

I=1300-420*0.09=1262.2

B)Goods Market multiplier=1/(1-mpc)=1/(1-0.8)=1/0.2=5

C) Change in G=420

Change in Y=change in G* multiplier=420*5=2100

New Y=7801+2100=9901

Change in Consumption=0.8*change in Income=0.8*2100=1680

New C=6118.5+1680=7798.5

D)

Round 1 -> As the government wants to spend $1 (or $1 billion)

on health care, it demands the production of health care equipment

such as hospitals, medicine, equipment, etc. to be built and sold to

the government. So as ΔG = 1 billion, the production ΔY =

1 billion

. This Y is the

income to the nurses, doctors, construction workers, etc.

Round 2 -> As the nurses receive their new income of Y =

1 billion

, theyspend

0.8 or 80%

on clothing ->

800 million dollars worth of clothing wouldbe produced, or ΔY =0.8 billion or 800 million

-> this

800 million

Dollar would be the income of the

workers involved in making the clothing.

Round 3 -> As the clothing workers receive their new income of

Y =800 million$

, they spend

0.8 or 80%

of this

on food -> (640 million

worth of food would be produced, or ΔY =600 million

this would

be the new income to the food workers.