Question I, continuecd An economy is characterized as follows: Page 2 T--200 +.2

Question

Question I, continuecd An economy is characterized as follows: Page 2 T--200 +.2Y ? 150 + .75Ya :: 300 + .6Y 1=300 + .1 Y-3000 i G-300 Goods market equilibrium (US) is given by Y (113)(900-3000 i) -3000- 10000i 7-./ where 1 is the Central Bank's nominal Money market equilibrium (LM) is given by policy interest rate. Í Cheek your answers. (5 points each, show your calculations) You just computed output at general equilibrium to be Y- i. Do total expenditures equal total output at the general equilibrium you computed? a) Do leakages from the spending stream equal injections into the spending stream at the general equilibrium you computed? ii. The demand for real balances in the economy of this question is MPd .5Y-5000 i where price level, P, is equal to ..and remains equal to I throughout a) What is the supply of money at the general equilibrium you computed in part (a) above? (5 points) M'=

Explanation / Answer

Solution:

We are given IS : Y = 3000 - 10000i. This is the goods market equilibrium.

LM: i = i(hat) = 0.1. This is money market equilibrium.

In general equilibrium, money and goods market equilibrium hold simultaneously, so with i = 0.1

Y = 3000 - 10000(0.1) = 3000 - 1000 = $2000

i) We have evaluated total output, Y = 2000

Total/Aggregate expenditure (TE or AE) = C + G + I + NX ... (*)

C is household consumption function, given as 150 + 0.75 Yd, Yd is disposable income = Y - T (T = taxes)

With given T function, C = 150 + 0.75(Y - (-200) - 0.2Y) = 300 + 0.6Y (as given). Since nothing is given about Net exports (NX), we assume it to be 0

So, with NX = 0, and information given in the function, and using (*) equation,

TE = 300 + 0.6Y + 300 + 300 + 0.1Y - 3000(0.1)

So, TE = 600 + 0.7Y = 600 + 0.7*2000 = 2000 = Y

Thus we can say that at general equilibrium, yes total expenditure = total output

ii) Leakages in our model is reflected mainly by taxes and savings; and injections thus are government expenditure and investment. In other words, what all government receives in form of taxes, does it spend it full on economy, and what all the consumer save, is invested back in the economy.

So, Taxes, T = -200 + 0.2Y = -200 + 0.2*2000 = 200

But the government expenditure = 300 (so injection > leakage, here)

Again Savings, S = Yd - C = (2000 - 200) - (300 + 0.6*2000)

S = 1800 - 1500 = 300

Investment, I = 300 + 0.1*2000 - 3000*0.1 = 200 (here, leakage > injection)

But overall, total leakage = taxes + savings = 200 + 300 = 500

total injection = govt. expenditure + investment = 300 + 200 = 500

So, total leakages from spending stream = total injection into spending stream at the general equilibrium.

We are given demand for real balances as : (M/P)d = 0.5Y - 5000i

With P =1, demand for money, Md = 0.5Y - 5000i . At general equilibrium, money demand = money supply

So, Ms = Md = 0.5Y - 5000i

From above, Ms= 0.5*2000 - 5000*0.1 = 1000 - 500 = 500

So, money supply in this economy = $500.

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