Consider the following aggregate expenditure model of the Canadian economy operating with givenwages and other factor prices, price level, interest rates, exchange rates, and expectations:
C = 50 + 0.8YD I = 400 G = 500 T = 0.3Y X = 650 IM = 0.36Y
where C is consumption (the 0.8 term represents the marginal propensity to consume) YD is disposable income, I is investment, G is government spending on goods and services, T is the total value of taxes net of transfers (the 0.3 term represents the net tax rate on national income), X is exports, and IM is imports
(the 0.36 term represents the marginal propensity to import).
(a) Solve for aggregate expenditures (AE) as a function of Y, and calculate the equilibrium level of national income. Illustrate your equilibrium in a diagram with AE on the vertical and Y on the horizontal axis. What is the value of the multiplier?
(b) Calculate the level of disposable income, consumption, private saving, government budget balance, and net exports at the equilibrium. Express the components of aggregate expenditure (C, I, G, and NX) as percentages of GDP (to one decimal place).
(c) Suppose that (due to the decrease in world oil prices) Canadian exports decrease by 100 from 650 to 550. What is the new level of GDP? Illustrate in your diagram. What is the effect on the government's budget balance? What happens to net exports? Can you explain why the change in net exports less than the decrease in exports?
(d) Now suppose that the government decides to use its spending power to restore national income to its original level. By how much must the government increase G to restore the original level of national income? What will happen to the government's budget balance? How do you explain the new level of the budget balance compared to that in part (c) and in part (b)?