1. Suppose a Keynesian country has a consumption function: C = 100 + 0.9(Y-T) In

Question

1. Suppose a Keynesian country has a consumption function:

C = 100 + 0.9(Y-T)

Investment (I) is 100, the government expenditure (G) is 100 and net exports (Xn) are 50.  Tax revenue (T) is 50.

A.  What is the equilibrium level of income (Y) in this country?

B. If the Full employment level of income is 3500, what should be the new government expenditure to achieve the target income of 3500?

C. Assume now that the government does not act, but the FED is able to increase private investment (I) by 50 for each percentage drop in the interest rate. By how much should the FED change the interest rate to achieve the full-employment level of income?

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2. Conser the problem above. Please drawn an appropriate  Keynidesian Cross diagram to explain (a), (b), and (c).

Explanation / Answer

1.

A)Equilibrium Level,Y can be found by addition of investment ,expenditure,consuption function and net exports

Y=C+I+G+Xn (i.e. tax revenue is not included in equilibrium level)

SO,

Y=100+0.9Y-0.9*50+100+100+50

0.1Y=350-45

Hence, Y=3050

B)Given that Y =3500 (since Y=level of income) and we have to calculate G

SO,

3500=100+0.9Y-0.9*50+G+100+50

3500=250-45+3150+G

Hence G=145

C)Now we have to calculate rate of interest,r for full employment which is there for Y=3500

hence the equation becomes

3500=100 + 0.9(3500-50)+r*100+150

3500-3355=100*r

145=100*r

r=1.45

So FED must change by 1.45% for full employment

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