Question

1. The next several questions refer to the case of an economy with the following equations: Y = 3K + 2L, with K = 1000 and L = 1500 G = 1230, T = 500 I = 1020 - 1000r C = 1070 + 0.5(Y-T) (Assume a closed economy: Y = C + I + G; NX = 0) Compute the equilibrium level of the interest rate.

choices

0.07

0.05

0.3

0.1

2. For the case above, compute the equilibrium level of investment.

980

900

1000

750

950

3. For the case above, compute the equilibrium level of consumption.

3700

3820

3750

4000

4200

4. For the model economy above, suppose government spending is raised to 1250 (instead of 1230). Compute the amount by which investment falls.

10

15

0

30

20

5. In the case above, the amount by which investment falls is _____ the amount by which government spending rises.

less than

more than

the same as

Answer 1

Y = 3K + 2L, K = 1000 and L = 1500

So, Y = (3*1000) + (2*1500) = 6000

G = 1230, T = 500

I = 1020 - 1000r

C = 1070 + 0.5(Y-T) = 1070 + 0.5(6000 – 500) = 3820

(Assume a closed economy: Y = C + I + G; NX = 0)

1. So, Y = C + I + G

Or, 6000 = 3820 + 1020 – 1000 r +1230

Or, 1000 r = 6070 - 6000

Or, r = 70/1000 = 0.07

So, r^* = 0.07 [ option a is correct ]

1. I^* = 1020 – (1000 * 0.07) = 950 [ option d is correct ]
2. C^* = 1070 + 0.5(Y-T) = 1070 + 0.5(6000 – 500) = 3820 [ option b is correct ]
3. For the model economy above, suppose government spending is raised to 1250 (instead of 1230).

So, G_New = 1250

Now, Y = C + I + G_New

Or, 6000 = 3820 + 1020 – 1000 r_New +1250

Or, 1000 r_New = 6090 - 6000

Or, r_New = 90/1000 = 0.09

So, I_New^* = 1020 – (1000 * 0.09) = 930 [ option d is correct ]

So, change in investment = (930 – 950) = (- 20)

investment falls by 20 units [ option d is correct ]

1. In the case above, the amount by which investment falls is the same as the amount by which government spending rises. [ option d is correct ] { as government rises its spending by (1250 – 1230) = 20 units and investment falls by 20 units also}

Hope all answers are clear to you. Thank you.