An economy is described by the following equations: C = 3000 + 0.5 (Y – T)...

An economy is described by the following equations: C = 3000 + 0.5 (Y – T)

Ip = 1500

G = 2500

NX = 200 T = 2000 Y* = 12000

a. For the economy, find the following: autonomous expenditure, the multiplier, short- run equilibrium output, and the output gap if any.

b. Illustrate this economy’s short-run equilibrium on a Keynesian-cross diagram.

c. Calculate the amount by which autonomous expenditure would have to change to eliminate the output gap if any.

d. Suppose that the government decided to close the output gap by reducing taxes. By how much must taxes be reduced in order to do this?

Expert Solution

a. All calculations in image. There is an inflationary gap as equilibrium output is greater than Y*

c. Autonomous expenditure has to decrease to close the output gap. The autonomous expenditure would become 7000. So decrease is 7200-7000 = 200

d. If the government reduced taxes, disposable income would increase and so would consumption. Increase in spending would increase gap. So taxes have to be increased. The increase in tax will be 2400-2000 = 400

(To solve c and d, I have plugged in the potential output to which Y has to be reduced and then found the unknown A(bar) and T in the respective situations)

Rahul Sunny answered 2 years ago

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