(1) Consider the following macroeconomic model of an economy Y=C+I+G+NX C = 90 +

Question

(1) Consider the following macroeconomic model of an economy Y=C+I+G+NX C = 90 + 0.90 I 900 900R G=Go NX = 525-0. 10Y-500R Net export function M (0.90Y-900R)P Money market equilibrium Income identity Consumption function Investment function Government expenditure (a)Explain why net export is inversely related to interest rate. (b)Find the expression for aggregate real output/income. (c)Determine the value of equilibrium real output and interest rate given that money supply is 1000, government spending is 1200 and price level is one (d)Find C, I, and NX. Comment on the external balance situation for this economy (trade balance, trade surplus or trade deficit). Is there evidence of a twin deficit given a 10% tax rate.

Explanation / Answer

(a) Net export = total export- total import.

It is given that,

NX= 525-.10Y-500R

Suppose R= 1 and Y is fixed.

Then NX= 525-.10Y-500= 25-.10Y

Suppose, R= 2 then

NX= 525- .10Y-1000= -475-.10Y

So, we can get less value of NX if R increases and vice versa.

So, export is inversely related to interest rate.

(b) Aggregte income = Y= C+I+G+NX=90+.90Y+900-900R+G0+525-.10Y-500R = 7575-7000R+5G0

Or, .20Y= 1515-1400R+G0

Or, Y= 7575-7000R+5G0

This is the expression of aggregate income.

C) The money supply function is given by,

M= (.90-900R)P=1000

Or, .90Y-900R=1000

Or, Y= 1000/.90+900/.90=1111.11+1000R-----------------------(1)

Y= 7575-7000R+6000=1575-7000R-----------------------(2)

Equating both (1) and (2) we get,

1111.11+1000R= 1575-7000R

Or, 8000R=1575-1111.11=463.89

Or, R= 463.89/8000=.058

So, Y= 1111.11+58= 1169.11

d) Putting values of Y and R we get,

C=90+(90*1169.11)=1142.20

I= 900-900R

=900(1-.058)= 847.8

NX= 525-(.10*1169.11)-(500*.058)

=525-116.9-29=379.1

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