Question

A. Answer both of the following questions thoroughly. Show all your graphical and mathematical work in order to get partial credit. Limit your decimal places to one thousandths.

1. The following equations describe the economy in Rouge Terra. Use them to answer the succeeding questions.

C= 300+0.7Y_D

I_P= 700

G= 600

T= 400+0.1Y

X= 450

M= 150+0.03Y

a. Determine the AE_P function for Rouge Terra.

b. Determine the equilibrium level of income for Rouge Terra, mathematically, and show it graphically from both an aggregate planned expenditures=income and leakages=injections approach.

c. At the equilibrium level of Y, determine the government’s budget position and the foreign trade position in Rouge Terra.

d. If Rouge Terra import consumers became more desirous of goods from other countries so that their autonomous import expenditure level rose to 250, show mathematically using the multiplier relationship what the change in the equilibrium level of income would be.

e. Return to your original variables. Suppose the Y_FE=4350. The fiscal policymakers want to use a policy that would produce the largest surplus possible. Which fiscal policy would they use? (Show all of your work.)

Answer 1

a)AEp funtion = 300 + 0.7YD + 700 + 600 + 450 - 150 -0.03Y

AEp = 1900 + 0.7( Y - 400 - 0.1Y ) - 0.03Y

AEp = 1900 + 0.7Y - 280 - 0.07Y -0.03Y

AEp = 1620 + 0.6Y

b) Y = AE

Y = 1620 +0.6Y

0.4Y = 1620

Y = $4050

c) Government budget position = Tax - G

budget position = 400 + 01*4050 ) - 600 = 805 - 600 = $205 ( budget surplus)

foreignt trade position = exports - imports

foreign trade = 450 - 150 -121.5 = $178.5

d) import multipleir = 1/ 1- ( MPC - MPI)

import multipleir = 1/ 1- ( 0.7 -0.03) = 1/ 1 - 0.67 = 1/ 0.33 = 3

autonomous import expenditure increase by 100 will decreaase equilbrium income bvy = 100 * 3 = $ 300

e) if YFe = 4350 .so shortage in potential GDP = 4350 - 4050 = 300

spending multiplier = 1/ 1- MPC = 1/ 0.3 = 3.33

tax multiplier = MPC / 1- MPC = 0.7 / 0.3 = 2.33

fiscal policy makes would increase its spending by = 300 / 3.3 = $90