There is a decrease in income in a closed economy. Derive theimpact of the decrease...

There is a decrease in income in a closed economy. Derive the impact of the decrease in income on the credit market and money market assuming flexible prices. Determine the impact on the equilibrium expected real rate of interest and the price level. Also determine the impact on equilibrium savings, investment, and real balances. You must use graphs to receive full credit.

Expert Solution

A closed economy is one that has no trading activity with outside economies. This economy is self sufficient to fulfil the domestic demand. There is a decrease in income in a closed economy will decrease demand in the economy and demand decrease its decrease price level and output (real GDP) level. Other side decreasing demand will decrease the demand for money and it will negatively affect the credit market and money market. When the income level will decrease its decrease saving and investment.

income = consumption + saving

And

saving = investment.

When the icome will decrease then it will decrease prive level and decreasing price level means decrease inflation and decreasing inflation means appreciating value of money. It will increase supply of money in the system in respect of value and decrease interset rate. The real interest rate is the inflation adjusted interest rate. Here inflation and interest rate both will decrease so, it will not affect the real interest rate more. But the real interest rate will decraese most of the times in this case. Real balance is the the real purchasing power of a money balance. So, it will increase real balances.

We will understand these affect by AD-AS Model aand IS-LM Model:

You can see the economy is equilibrium at the point "E" and decreasing consumption decrease AD and AD curve shift left from AD to AD1 and the new equilibrium point is "E1" where price and output (real GDP) level are "P1" and "Q1" both are lower than previous level.

Graph:

In IS LM model you can see that decreasing demand or AD level shift IS curve shift left (from IS toIS1) that decrease interest rate and output level.

Graph:

Rahul Sunny answered 2 years ago

6. (14 pts) There is a decrease in income in a closed economy. Derive the impact...

6. (14 pts) There is a decrease in income in a closed economy. Derive the impact of the decrease in income on the credit market and money market assuming flexible prices. Determine the impact on the equilibrium expected real rate of interest and the price level. Also determine the impact on equilibrium savings, investment, and real balances. You must use graphs to receive hill credit

Show income determination in a closed economy in contrast to an open economy using the concepts...

Show income determination in a closed economy in contrast to an open economy using the concepts of income as determined by injections (like investment and exports) and leakages (like saving and imports). Discuss in words like Singapore, with a high reliance on international trade and capital flows, is an open economy.

In a closed economy with no government, the equilibrium level of income is £22 billion, the...

In a closed economy with no government, the equilibrium level of income is £22 billion, the full employment level of income is £25 billion. To reach full employment would require an injection of £1 billion. Explain how could the economy reach full employment equilibrium level of income £25 billion?

Consider a closed economy income-expenditure model of the economy where the country begins in a long-run...

Consider a closed economy income-expenditure model of the economy where the country begins in a long-run equilibrium. • Investment (I) and government spending (G) are ﬁxed: I = 41.5, G = 26. • The income tax rate is t = 6.25%, so tax revenue equals T = tY . • The consumption function is C = 12 + 0.8Yd, where Yd = (1 − t)Y . For the calculations below, write your answers as either a fraction or to two...

An Economic Model of National Income in a Closed Private Economy in the Short Run (We...

An Economic Model of National Income in a Closed Private Economy in the Short Run (We are assuming for this model that there is no trade, no government, and no business saving.) C = 280 + 0.80*Y Consumption Function [$Billion/year] I = 620 Planned Investment (Purchase of new capital goods and services) [$Billion/year] Y National Income [$Billion/year] Part 1. What is the aggregate expenditure function in this model? Part 2. Suppose firms expect to sell, and produce, 4725...

Consider the AD-AS model for a closed economy. If today’s income decreases, the AD curve will...

Consider the AD-AS model for a closed economy. If today’s income decreases, the AD curve will ; the SAS curve will ; and the LAS curve will . Note: For each of the above blanks, fill in one of the following three choices: A. move to the right; B. move to the left; C. stay where it was.

A. Derive and explain the national income identity for an open economy. B. Does spending necessarily...

A. Derive and explain the national income identity for an open economy. B. Does spending necessarily have to equal output in an open economy? C. Is there a relationship between a country’s national budget deficit and its trade deficit?

For a closed economy – i.e. an economy in which there are no international transactions –...

For a closed economy – i.e. an economy in which there are no international transactions – GDP is $12 trillion, consumption is $7 trillion, taxes are $3 trillion, and the government runs a deficit of $1 trillion. (Assume transfer payments are zero.) a) It follows that private saving is ________. b) National saving is __________.

Assume that the equations below represent a closed economy. Hints: YD: Disposable Income Y = C...

Assume that the equations below represent a closed economy. Hints: YD: Disposable Income Y = C + I + G + NX is for part a): so, Y = 80 + MPC (YD) + I + G C = 80 + 0.6(YD) YD = Y - T I = 1000 T = 400 NX = (X – Im) = 0 G = 500 1. Solve for: Equilibrium GDP (Y) Disposable Income (YD) Consumption Spending (C) Private Saving Public Saving The...

7. Consider the following income-expenditure model of a closed economy. The aggregate consumption function is C...

7. Consider the following income-expenditure model of a closed economy. The aggregate consumption function is C = 100 +0.8(Y – T); taxes are T = 380; investment, I, is 300 and government expenditure, G, is 200. (a) Calculate the multiplier, equilibrium income and the government budget surplus [6 marks] (b) Now let taxes, T = 10 + 0.25Y. Recalculate the multiplier, equilibrium income and the government budget surplus. Try to explain any differences between your answers and your answers to...

Question