Answer to Question #83109 in Macroeconomics for Joshua

Question

31. Consider an economy described by the following equations. Ip = 700 X = 100 T = 1500 Y* = 10000 Cd = 1800 + 0.6(Y-T) G = 1500 M = 0 u* = 4 where Cd is consumption on domestically produced goods, G is government expenditure, M is imports, u* is the natural rate of unemployment, P is planned investment spending, X is exports, T is tax revenue and Pis potential output. Derive the equation for planned aggregate expenditure as a linear function of output, Y. Find the short-run equilibrium for this economy. Illustrate the equilibrium on a 45-degree diagram. Suppose there is a decrease in planned investment spending from 700 to 500. a. Calculate the effect on short-run equilibrium. b. Calculate and explain the multiplier. c. Illustrate your answer on the diagram. d. Calculate the change in the output gap for this economy.

Answer 1

I = 700, X = 100, T = 1500, Y* = 10000, Cd = 1800 + 0.6(Y - T), G = 1500, M = 0, u* = 4.

AE = Y = C + I + G + (X - M) = 1800 + 0.6(Y - 1500) + 700 + 1500 + 100,

0.4Y = 3200,

Y = 8000 is the short-run equilibrium output for this economy.

If there is a decrease in planned investment spending from 700 to 500, then:

a. The short-run equilibrium output will decrease. b. The multiplier m = 1/(1 - c) = 1/(1 - 0.6) = 2.5. d. The change in the output gap for this economy is: (500 - 700)*2.5 = -500.