#1.

The following information is available for an economy:

Consumption function:           C = 220 + .8(Y-T)

      Investment:                             I  = 400         

            Net Exports:                            NX = - 140

            Full Employment or Potential GDP = 3500

            Currently, G = 500 and T = 400.

Note: G: Govt. Expenditure, T: Taxes, NX: Exports-Imports (in the data above, NX is negative).

(a) Calculate the current level of (equilibrium) GDP.

(b) Suppose that you work for the President's Council of Economic Advisers (not a bad job if you can keep your name out of the press). How will you advise the administration to adjust the level of G in order to ensure that the economy operates at the full employment level? Show and explain your calculations. Note that you are only adjusting G.

(c) Now suppose that some of President's close political advisers are urging him to adjust taxes but not spending. Assuming the same initial level of G (=500), how would you advise the administration to adjust taxes to reach potential GDP? Show and explain all your calculations.

(d) Some senators are urging the administration to design a deficit neutral fiscal package so that no fiscal policy measure affects the level of current budget deficit. In other words, any proposed increase in government spending must be paid for by an equal increase in taxes, or any tax cut must be accompanied by an equal (government) spending cut. Starting from the initial values of G (=500) and T (=400) how would you recommend to adjust both G and T so that the economy produces at the Potential GDP level but the size of the budget deficit remains unchanged? Show and explain all calculations.

#2.

Explain the impacts of an expansionary fiscal policy such as a tax cut on the levels GDP, Consumption, Investment, interest rate and unemployment and price. Explain using separate graphs of C+I+G line and Aggregate Demand-Aggregate Supply curves. In particular explain how your answer depends on the slope of the aggregate supply curve.

#3.

Explain which of the following transactions would be directly counted in 2007's GDP. In each case, explain whether the action causes an increase in Consumption, Investment, Govt. Purchases or Net Export. If the transaction is not included in 2007's GDP, explain why not.

(a) You purchase $5000 worth of Google's stock.

(b) A record company produces 500, 000 CDs of a new artist. Only 100,000 are sold at the price of $15.00.

(c) You purchase a 1999 Lexus for 25,000 and then purchase a set of special tires for $1600.

(d) You fix your friend's car saving him $300.00 and in return, he paints your house saving you $400.00.