Y = C + I + G + X - IM Consider the following model and again answer related que
ID: 1195860 • Letter: Y
Question
Y = C + I + G + X - IM
Consider the following model and again answer related questions. Y = C + I + G + X - IM C = 300 + 0.75DI where DI = Y - T I = 600 - 1000r G = 300 X-IM = 100 T = 0 How much is equilibrium level of income or output if Fed decides to set the rate of interest at 10 percent (r = 0.10). In an effort to cool down the economy, the Fed raises the rate of interest to r = 0.15. By how much will Y change? To coordinate the fiscal and monetary policies, assume government decides to balance the budget by raising taxes by 300. At the same time Fed decides to counter the contractionary effect of the tax hike and lowers the rate of interest to r = 0.05. Can you predict the change in Y?Explanation / Answer
a. When r= 10%
I = 600-1000(10%) = 600-100 = 500
At equilibrium,
AD = AS
AD = C + I +G +NX
AS = Y
At equilibrium
Y = C + I + G +(X-M)
Since taxes are zero, Y = DI
Y = 300+0.75Y +500+300 + 100
0.25Y = 1200
Y = 1200/0.25 = 4800
Y = $4800 billion
b. If r = 0.15
I = 600-1000(15%) = 600-150 = 450
At equilibrium,
AD = AS
AD = C + I +G +NX
AS = Y
At equilibrium
Y = C + I + G +(X-M)
Since taxes are zero, Y = DI
Y = 300+0.75Y +450+300 + 100
0.25Y = 1150
Y = 1150/0.25 = 4800
Y = $4600 billion
C. If Rate of interest = 5% and taxes = 300 then
I = 600-1000(5%) = 600-50 = 550
At equilibrium,
AD = AS
AD = C + I +G +NX
AS = Y
At equilibrium
Y = C + I + G +(X-M)
Since taxes are 300, DI = Y-300
Y = 300+0.75(Y-300) +550+300 + 100
0.25Y = 1025
Y = 1025/0.25 = 4200
Y = $4200 billion
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