Qik 2 Problem 1 (The Goods irket) Suppose that the economy is characterised by the following behavioural equations: C= 160+ 0.6 Yp I= 150 G=150 T= 100 (a) Solve for equilibrium GDP (Y), Disposable income (Yp) and Consumption Spending (C) Demand: Z=C+1+G Z= cote Ypt1+G Z=co+e (¥-T)+1+G In equilibrium, Demand = Production so that Z = Y Y=co+e)(Y-T)+1+G y= fe -ersi+e] le, y=—+_fi60~0.6x100+150+150] 1-06 Y=1000 Disposable Income: Yo=Y-T Yp = 1000-100 Yp = 900Consumption Spending: C= 160 +0.6 Yo C= 160 + 0.6 (900) C=700 (b) Is total demand equal to production? Explain By definition, in equilibrium, Total demand Z = C +1 + G equals production Y. This is the equilibrium condition that we used to solve for output in part (a). Z=C+1+G=700 + 150 + 150 = 1000 = Y (c) Assume that G is now equal to 110. Solve for equilibrium output. Compute total demand. Is it equal to production? Explain Using equation (1) derived in part (a), Y zu [c,-eT+1+G] qd) [160-0.6x100+150+110] ‘Total Demand: Z=C+I1+G Z= 160 +06 Yp+1+G Z= 160+ 0.6 (Y-T)+1+G Z= 160 + 0.6 (900 — 100) + 150+ 110 Z=900 Once again Total demand is equal to Production since this is the equilibrium condition.(d) Assume that G is equal to 110, so output is given by your answer to (c). Compute private plus public saving. Is the sum of private and public saving equal to investment? Explain. Private Saving: Public Saving: PS=Yp—C PS =Yp~ 160—0.6 Yp PS = 0.4 Yp— 160 PS =0.4(Y—T)—160 PS = 0.4 (900 — 100) — 160 PS = 160 GS=T-G GS = 100-110 GS =-10 National Saving: S=PS+GS=160~10 S= 150 which is equal to investment. ‘This statement is mathematically equivalent to the equilibrium condition that total demand equals production. To see this, Z=C+I1+G=Y C+1+G=Y-T+T I=(Yp-C) +(T-G) I=PS+GS=SProblem 2 Suppose that the economy is characterized by the following equations: C= 09+ ¢)Yp Yp=Y-T T=bo + biY G=G constant Note that investment now increases with output. (a) Solve for equilibrium output Demand: Z=C+I4G Z= cq +e) Yp + by + bY +G Z= cq te) (Y-T) +b) +b)Y+G In equilibrium, Demand = Production so that Z = Y Y = cg +0 (Y—T) + by +b Y+G Tena er tht] (b) What is the value of the multiplier? How does the relation between investment and output affect the value of the multiplier? For the multiplier to be positive, what condition must ¢; +b, satisfy? Explain your answers, Multiplier: > oe I-e, Allowing investment to depend on output increases the value of the multiplier.Intuitively, an increase in autonomous spending now has a multiplier effect through 2 channels: consumption and investment. For the multiplier to be positive, we need ¢; +b) <1. (©) Suppose that the parameter bo, sometimes called business confidence, increases. How will equilibrium output be affected? Will investment change by more or less than the change in by? Why? What will happen to national saving? Equilibrium output increases by: Investment will increase by more than the increase in business confidence since the increase in output also leads investment to increase: 1" Round: AL= Abo AZ = Al = Aby AY = AZ = AI= Abo 2" Round: AI=b;AY Ete... Total change in I: AI = Abo + BAY + .. In equilibrium National Saving equals Investment. ‘Thus, if investment increases in equilibrium, then so does National Saving.