Answer to Question #48889 in Macroeconomics for Harun

Question

(a) Given that money supply is KSh 1400 millions, autonomous consumption is KSh120 million, while the responsiveness of consumption to changes in disposable income is estimated to be 80% by the ministry of planning. Aggregate autonomous investment is ksh 200 million investment while one % increase in interest rate changes investment by KSh10 millions. The government collected KSh 200 million as tax revenue and wishes to increase expenditure by 10% above the revenue collected. The transactionary and precautionary demand for money function is expressed as mt/p=0.1y while the speculative money demand ms/p is -100r .
(i)Solve for equilibrium real output and equilibrium interest rate
(ii) What is the effect of the new expenditure plan impact on income and consumption?

Answer 1

MS = 1400 millions, C0 = 120 million, c = 0.8, I = 200 million investment, 1% increase in interest rate changes investment by 10 millions, T = 200 million, wishes to increase expenditure by 10% above the revenue collected. Transactionary and precautionary demand for money mt/p = 0.1y, speculative money demand ms/p = -100r .
(i)Solve for equilibrium real output and equilibrium interest rate
As money demand equals money supply in equilibrium, so MS = MD
0.1y + 100r = 1400
Output Y = C + I + G + NX, where C - consumption, I - investment, G - government purchases, NX - net export.
Y = 120 + 0.8Y + 200 + 200*0.1
0.2Y = 340
Y = 1700 million
As 0.1y + 100r = 1400, then 0.1*1700 + 100r = 1400, r = 12.3%