Question

Attempt all the questions.

1. You are given the following four-sector Keynesian income model.
   C = 120 + 0.75Yd
   I = 230
   T = 40 + 0.20Y
   G = 560
   M = 30 + 0.10Y
   X = 360
   H = 25
   Where C is consumption, Yd is disposable income, T is tax, I is autonomous investments, G is government expenditure, M is imports, X is exports and H is net capital outflows.

a. Calculate the equilibrium level of income.
b. Calculate the balance of trade and interpret the results.

c. Calculate the foreign trade multiplier and interpret the results.  

d. What is the new equilibrium level of income when government expenditure increases by 100.     
e. Using the results in parts (a) and (d), explain the effectiveness of fiscal policy.

Answer 1

A. the formula for the equilibrium level of income is when aggregate supply (AS) is equal to aggregate demand (AD), where AS = AD.

the formula becomes Y = C + I + G, where Y is aggregate income, C is consumption, I is investment expenditure, and G is government expenditure.

According to the question:

C= 120+0.75yd

I= 230

G= 560

Y=C+I+G

Y= 120+0.75yd+230+560

Y= 120+0.75(y-t)+230+560

Y= 120+0.75(y-(40+0.20y)+230+560

y= 120+0.75(y-40-0.20y)+230+560

y=120+0.75y-40-0.15y+230+560

y-0.75y+0.15y=120-40+230+560

0.4y=870

y= 2175

B. Balance of trade

formula is X-M=TB

X= 360

M= 30+0.10y

y= 2175

TB= 360-30+0.10(2175)

TB= 360-30+217.5

TB= 547.5

C. foreign trade multiplier:

Formula is Y=C+I+X-M

C= 120+0.75YD

I=230

X=360

M=30+0.10Y

Y= 120+0.75(y-(40+0.20y)+230+360-30+0.10Y

Y= 120+0.75y-40-0.15y+230+360-30+0.10Y

Y-0.75Y+0.15Y-0.10Y= 120-40+230+360-30

0.3Y= 700

Y= 2333.3

D. NEW EQUILIBRIUM LEVEL OF INCOME

Y = C + I + G

C=120+0.75YD

I=230

G= 660

Y= 120+0.75YD+230+660

Y= 120+0.75(y-(40+0.20y)+230+660

Y-0.75Y+0.15Y-0.10Y=230+660

0.4Y= 890

Y= 2225

e. effectiveness of fiscal policy

The effects of fiscal policy on economic growth are driven by many factors such as the employment in the economy, the transparency of government, the composition of government expenditures, or even the government size