PLEASE ANSWER ALL PARTS OF THE QUESTION: Consider an economy where prices are fi
ID: 1201822 • Letter: P
Question
PLEASE ANSWER ALL PARTS OF THE QUESTION:
Consider an economy where prices are fixed. The following functions describe desired spending and taxation:
C=300+ .8Yd
I=200
G = 350
T = 100
X = IM = 0 (there is no international trade)
A) Start by calculating the equilibrium level of GDP.
B) Calculate the level of private saving (S) at equilibrium.
C) Now suppose that people in this country decide to save more at every level of disposable income. Autonomous saving, therefore, increases by 100. Calculate the new equilibrium level of GDP after this increase in autonomous saving.
D) Calculate the level of saving at the new equilibrium you found in part (c).
E) How did the level of saving at equilibrium change in part (d) from part (b)? Did saving go up, go down, or stay the same?
F) The result of part (e) is known in macroeconomics as “the paradox of thrift.” Why is this a paradoxical result? Explain in words the economics.
Explanation / Answer
a)
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=300+0.8(Y-100)+200+350+0
Y=850+0.8Y-80
0.2Y=770
Y*=3850
Therefore, equilibrium level of output is $3850.
b)
Private savings = Y-T-C = 3850-100-300-0.8(3850-100) = $450
Therefore, private savings is $450.
c)
Savings = Y-C = 3850-300-0.8Yd = 3550-0.8Yd
An increase in autonomous savings by $100 will reduce consumption by $100.
Substitute the new values in the above equation to find the equilibrium values:
Y=C+I+G+X-M
Y=200+0.8(Y-100)+200+350+0
Y=750+0.8Y-80
0.2Y=670
Y*=3350
Therefore, new equilibrium level of output is $3350.
d)
Savings = Y-C = 3350-200-0.8(3350-100) = $550
Therefore, new level of savings is $550.
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