Question

Suppose the initial conditions of the economy are characterized by the following equations. In this problem, we assume that prices are fixed at 1 (the price index is 100 and when we deflate, we use 1.00) so that nominal wealth equals real wealth.

1) C = a₀ + a₁ (Y - T) + a₂ (WSM) + a3 (WRE) + a4 (CC) + a₅ (r)

1’) C = a₀ + a₁ (Y - 200) + a2 (10,000) + a3 (15,000) + a4 (100) + a₅ (3)

2) I = b₀ + b₁ AS + b₂ CF + b₃ (r)

2’) I = b₀ + b₁ (150) + b₂ (2000) + b₃ (3)

3) G = G

3’) G = 300

4) X - M = X - M

4’) X - M = - 100

Where: a₀ = 165 , a₁ = .75, a₂ = .05, a₃ = .10, a₄ = .8, a₅ = - 500, b₀ = 210, b₁ = .5, b₂ = .5, b₃ = - 200

Derive an expression for the aggregate expenditure curve and graph it on your exam sheet labeling this initial equilibrium output as point A. Also, add this point A to your consumption function. Show all work.

Draw an aggregate demand and an aggregate supply curve in the right hand graph on your exam sheet identifying this initial point as point A.

NOTE: We are holding the price level fixed at 100 in this problem. Also, note that you that you cannot derive an expression for the aggregate demand curve, just draw it with a negative slope going through point A.

Answer 1

This question is solved in the context of aggregate supply and aggregate demand model of macroeconomics. We know that at equilibrium condition aggregate demand is equal to aggregate supply. National income can be measured in terms of the expenditure approach. Therefore aggregate expenditure is determined first. Further details are described in picture.

The above graph shows the equilibrium point of the economy. The economy is in equilibrium at a national income of $6800 where aggregate supply and aggregate demand curve intersect each other.