Answer to Question #212252 in Macroeconomics for Chris

Question

The following equations describe an economy (think of C, I, G, etc as being measured in billions and i as a percentage; a 5 percent interest rate implies i = 5) C = 0.8 (1 – t) Y t = 0.25 I = 900 – 50i G = 800 L = 0.25Y – 62.5.i M / P = 500

What is the value of the simple multiplier (with taxes)By how much does an increase in government spending of ∆G increase the level of income in this model, which includes the money market?By how much does a change in government spending of ∆G affect the equilibrium interest rate?3. How does an increase in the tax rate affect the IS curve? How does the increase affect the equilibrium level of income?4. Show that a given change in the money stock has a larger effect on output the less interest sensitive is the demand for money.(b) How does the respond of the interest rate to a change in the money stock depend on the interest sensitivity of money demand?

Answer 1

3). When the tax rate increase, demand, disposable income and consumption drops. At this case, supply drops so as to maintain equilibrium. For a given interest rate level, corresponding equilibrium output level tends to be lower, hence shifting the IS curve towards the left.

With increase in tax rate, consumption drops contributing to a drop in income or output. Reducing in income minimizes demand for money. Provided money supply is constant, interest rate increase raises the equilibrium level of income.

4b) Increasing product will increase the money demand. If demand for money is extremely sensitive to rates of interest, small increase in rates of interest is inevitable to minimize money demand and regain equilibrium in money market.