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An economy has 100 workers producing two goods: coffee and grinders. Each worker can produce either...

An economy has 100 workers producing two goods: coffee and grinders. Each worker can produce either two tons of coffee, or one grinder a year. Currently, 60 workers produce coffee, and the rest produce grinders. The price of a ton of coffee is $150, and that of a grinder is $300. Each worker earns $250 in wages a year. The government sector buys 40 tons of coffee a year. There is no depreciation or ROW in this economy. Assume that firms distribute ALL of their profits to the households as dividends.

  1. Calculate the level of consumption, investment, government expenditures, and national product. Show your work!

  2. The government taxes households’ income at 10%. Calculate the level of government tax revenues, and the government’s budget, and classify as surplus, balanced, or deficit.

  3. Calculate savings of the household and firm sector as well. Verify that aggregate savings equals investment in this economy.

Solutions

Expert Solution

We are provided following information:

  • Number of workers: 100 where 60 produces coffee and 40 produces grinder.
  • Wages of worker: $250 per year.
  • Price of coffee: $150 per ton.
  • Price of grinder: $300 per ton.
  • Government purchase: 40 ton of coffee per year.

(a) Consider, we shall use income and expenditure method to calculate the level of consumption, investment, government expenditure and national product.

According to Income method, all the incomes that accrue to the factors of production by way of wages, profits, rent, interest, etc. are summed up to obtain the national income. In our question, only wages are provided. Therefore, total wages = National income. The total wages are: 100*250 = $25,000.

According to the value added method, the total production in the economy is summation of total production of coffee and grinders. The total production is : TP = PcC+ PgG = 60*150 + 40*300 = 21,000.

The government expenditure is on coffee i.e. 40*150 = $6,000.

Since, we are not provided whether goods are traded or not. We assume what workers produce also consume after deducting for government expenditure.

Therefore, Y = 25,000 C = 15,000 G = 6000. Using national income identity, we find investment level in the economy.

Y = C+I+G ---> 25,000 = 15,000+I+6000 ---> I = 4000.

The total investment in the economy is $4,000.

(b) The government taxes household income by 10%. The tax revenue would be: T = 25,000*0.10 = $2500. We already know Government expenditure is $6000. Therefore. Government budget would be B = T-G ---> 2500-6000 = (-)3500. The government runs deficit budget.

(c) The total amount of private savings (savings by the households and firms) is going to be equal to the amount:

Spvt = Y-C-T = 25,000-15,000-2,500 = 7500

Spub = T-G = (-) 3500.

Therefore, aggregate savings are Spvt+Spub = 7500+ (-) 3500 = $4000. The amount is equivalent ot the aggregate investment ($4,000) we found earlier.

Rahul Sunny answered 6 months ago
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