1.In the Keynesian model, suppose that the economy has the following values : C
ID: 1201819 • Letter: 1
Question
1.In the Keynesian model, suppose that the economy has the following values :
C = 100 + 0.75*(Y-T) G = 300 I = 200 NX = 0 T = 200
1a. Suppose that households become nervous about the future of the economy and decide that they will consume less and save more money, so their new consumption function becomes C = 0.75*(Y-T). Solve for the new equilibrium level of output and calculate how much households end up saving.
1b. Ignoring the change in consumption from part d, how much would output increase if government spending increased by 100?
1c. Ignoring the change in consumption from part d, how much would output increase if taxes were cut by 100?
Explanation / Answer
1a)
C = 0.75 (Y-T)
G = 300
I = 200
NX = 0
T = 200
Equilibrium is achieved at the point: Y=C+I+G+X-M
Substitute the given values in the above equation to find the equilibrium values:
Y=C+I+G+X-M
Y=0.75(Y-200)+200+300+0
Y=0.75Y-150+500
0.25Y=350
Y*=1400
C*=0.75(Y-T) = 0.75(1400-200) = 900
Thus, S*=Y*-C* = 1400-900 = 500
Therefore, equilibrium level of output is $1400 and savings is $500.
b)
Substitute the given values in the above equation to find the new equilibrium values:
Y=C+I+G+X-M
Y=100+0.75(Y-200)+200+400+0
Y=0.75Y-150+700
0.25Y=550
Y*=2200
Therefore, new equilibrium level of output is $2200.
c)
Substitute the given values in the above equation to find the new equilibrium values:
Y=C+I+G+X-M
Y=100+0.75(Y-100)+200+300+0
Y=0.75Y-75+600
0.25Y=525
Y*=2100
Therefore, new equilibrium level of output is $2100.
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