I. Consider an economy described by the following equations:Y = C + I + G + NXC = XXXXXXXXXX9YDI =...

Question

I. Consider an economy described by the following equations:

Y = C + I + G + NX

C = XXXXXXXXXX9YD

I = XXXXXXXXXX,000i

NX = 100 – 0.05Y – 1,000i

M = (0.4Y – 1,000i)P

With government spending G = $100 billion, the tax rate t = 0.5, the nominal

money supply M = $180 billion, and the price level P = 1.

Assume that prices adjust according to the following price adjustment equation

inflation rate = (Y-1 - Y*)/Y*, where Y* is potential GDP.

Decrease government spending by $20 starting from potential GDP.

1. Put together a 3-year full adjustment path

2. Compare the following starting and ending economic factors:

Y

i

C

Sp

I

NX

P

nominal wage rate

real wage rate

Unemployment rate

II. Show graphically (draw) how an increase of the marginal propensity to save would

be represented using:

1. the goods and services market model

2. the money market model

3. IS-LM model

4. AS/AD model

Dr. Smita · Accepted Answer

Macro Economics
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)
Macro Economics		[Type the document subtitle]		[Pick the date]		Student Name	
National Income Determination in the 4 sector Model with Taxes
Y = C + I + G + NX
C = 400 + 0.9YD
I = 300 - 2,000i
NX = 100 – 0.05Y – 1,000i
M = (0.4Y – 1,000i)P
With government spending G = $100 billion, the tax rate t = 0.5, the nominal
money supply M = $180 billion, and the price level P = 1.
Solution:
YD=Y-tY
YD= Y- 0.5Y
C= 400+ 0.9YD
C=400+ 0.9(Y-0.5Y)
Marginal propensity to consume is 0.9 => Marginal Propensity to save or i= 0.1
Putting the value of C,I,G,NX in Y equation
Y=C+I+G+NX
Y= 400 +0.9(Y-0.5Y) +300-2000(0.1)+100+100-0.05Y-1000i
Y=300 when G=100
M=(0.4Y-1000i)P => 180=0.4(300)-1000i =>i= -(0.06)
Hence, the economy is showing recessionary tendency.
When Government spending is reduced by $20
Y=C+I+G+NX
Y= 400 +0.9(Y-0.5Y) +300-2000(0.1)+80+100-0.05Y-1000i
Y=115
Marginal Propensity to Save:
A marginal propensity to save refers to the proportion of an aggregate raise in their income that a consumer spends on saving rather than on the consumption of goods and services. The marginal propensity to save is a component of Keynesian macroeconomic theory and is calculated as the change in savings divided by the change in income.
Marginal propensity to save = change in saving / change in income
Marginal Propensity to save is the slope of the savings function.
Marginal Propensity to Save + Marginal Propensity to Consume=1
Goods and Service Market Model (AD-AS Model)
Change in marginal propensity to save will increase the savings and investments, the slope savings function will become steeper and the consumption function will become flatter. The savings and investments in the economy will increase and consumption will go down.
S2 is the new savings curve which is steeper as compared to S1 representing higher MPS in S2
ISLM Model
An increase in marginal propensity to save would induce more savings and thereby more investments. This would lead to higher investments and higher national income in the long run.

I. Consider an economy described by the following equations: Y = C + I + G + NX C = XXXXXXXXXX9YD I = XXXXXXXXXX,000i NX = 100 – 0.05Y – 1,000i M = (0.4Y – 1,000i)P With government spending G = $100...

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