Question

In: Economics

1. The following equations describe an economy: Consumption : C = 30 + 0.9YD Investment :...

1. The following equations describe an economy:

Consumption : C = 30 + 0.9YD

Investment : I = 500 - 14i

Government Spending : G = 200

Transfer Payments: TR = 200

Taxes: TA = 0.2Y

LM Curve : Y = 2,500 + 100i

Re al Money Demand : L = kY - hi

Money Suppy : MS = 1,500

Price Level: P = 2

where Y is income, i is the percentage of interest rate, YD is the disposal income, and k and h are parameters that govern the real money demand.

(a) [ 8 points] What are the values of (i) marginal propensity to consume out of disposal income and (ii) marginal propensity to consume out of total income? Show your work.

(b) [12 points] Derive the IS equation for the economy. Show your work.

(c) [12 points] Find the values of (i) k and (ii) h that are consistent with the money market equilibrium. Show your work.

(d) [ 8 points] What is the value of h when the economy is in a liquidity trap? Explain your answers.

(e) [10 points] What is the value of h when the economy is in a “Classical” case? In this case, is there going to be a crowing-out effect associated with an increase in government spending? Explain your answers.

(f) [20 points] Solve for the equilibrium levels of (i) output, (ii) interest rate, (iii) consumption, (iv) investment and (v) government budget surplus. Show your work.

(g) [12 points] Derive the aggregate demand (AD) curve for the economy. Show your work.

(h) [ 8 points] Suppose that the money supply is increased from 1,500 to 4,500. What would be the new price level that will keep the equilibrium interest rate and income as in part (f) unchanged? Explain your answers.

Expert Solution

Rahul Sunny answered 1 year ago

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