An economy has full-employment output of 1000. Desired consumption and desired i

Question

An economy has full-employment output of 1000. Desired consumption and desired investment are Cd = 200 + 0.8(Y - T) - 500r; Id = 200 - 50Or. Government purchases are 196, and taxes are T = 20 + 0.25Y. Money demand is Md/P = 0.5Y - 250(r + pie), where the expected rate of inflation, pie, is 0.10. The nominal supply of money M = 9890. What are the general equilibrium values of the real interest rate, price level, consumption, and investment? Suppose that government purchases are increased to G = 216. What are the new general equilibrium values of the real interest rate, the price level, consumption, and investment?

Explanation / Answer

Put Y= 1000 ; T = 250+20=270; at equilibrium Y = C + I + G ; 1000 = 200 +0.8*(1000 -270) -500r +200 - 500r + 196 ; solving we get r = 0.18 ; hence C = 694 ; I = 110; Put Md = 9890 in 2nd equation to get P = 23; Smililarly for part b) follow same steps , to get T = 270 , r = 0.2 ; C= 688 ; I = 100 ; P = 23.27

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