Question

The town of Cypress Creek is preparing to go to war against the American government. To do this, it is building a giant satellite laser! To build the laser, the government of the town will resort to taxation to fund its expenditure. The initial economy of Cypress Creek can be expressed by the following agents:

Consumers, C = 25 + 0.95(Y-T)

Output, Y = 5000

Government expenditures, G = 2000

Taxation, T = 2000

Investors, I = 750-125r

Markets are fully competitive and the equilibrium condition for markets are:

Goods and service market: Y =C + I + G

Financial market: I = S

When it builds the Satellite, government and taxation change to  

Government expenditures, G = 4000

Taxation, T = 4000

Hank Scorpio, the towns' founder, announces that "even by increasing government spending and taxation, we are not worst off, as production has not changed!"

1. [2 points] check to make sure output does not change.
2. [2 points] find the consumption level in both scenario's (low and high government spending).
3. [3 points] who is paying for the burden of taxation? (how is this new spending/taxation being distributed between investors and consumers)
4. [2 points] as the government increases its spending (G from 2000 to 4000) why won't output change?

Hank Scorpio makes another announcement "People of North Haverbrook! We must all work together in this to crush the American Government - I implore you to save you wages! Don't spend!"

13. [2 points] by how much would consumers need to reduce their Marginal propensity to consume (MPC) such that the market clearing interest rate does not change?  

Answer 1