Fall 1999: Homework 4-               

Part I:

Problem 1- Lucky Campus is a closed economy. When disposable income is $0, consumption in Lucky Campus is $80 billion (all the numbers are in billion of dollars). Suppose the marginal propensity to consume is 0.75; investment is $400; government purchases of goods and services are $600; and taxes are a constant $500 and do not vary with income. At the expenditure equilibrium (i.e. where aggregate expenditure equals total output) calculate:

(a) real GDP;

(b) consumption;

(c) saving;

(d) marginal propensity to save.

Problem 2- The closed economy of Lakeland can be represented by the following model (all numbers are in billion of dollars, all notation is standard, the definition of new variables are given by formulas):

C=85 + 0.5*DI

I=$85, G=$60

T= -40 + 0.25*Y

DI=Y-T

Equilibrium: Y=C+I+G

Calculate:

(a) the equilibrium level of output for this economy;

(b) the amount the government collects in net tax revenue when the economy is in equilibrium;

(c)  the government budget deficit or surplus when the economy is in equilibrium;

Suppose government purchases increase by $10 billion.

(d) What is the new equilibrium income?

(e) Draw a graph representing the first equilibrium as well as the second equilibrium. Be sure this graph includes the consumption function, investment function, government spending function as well as clear labels for equilibria and any changes that occur.

Problem 3- The closed economy of Dairyland has the following characteristics (all numbers are in billion of dollars):

• autonomous consumption when disposable income is $0 is $100;
• marginal propensity to consume is 0.9;
• investment expenditure is $460;
• taxes are constant and equal to $400;
• government purchases of goods and services is $400.

(a) Calculate the slope of the aggregate expenditure curve for this economy.

(b) Find the equilibrium level of real GDP.

(c) Suppose the government cuts its purchases of goods and services to $300.

(i) What is the change in real GDP?

(ii) What is the government spending multiplier?

(d) Suppose the government continues to purchase $400 worth of goods and services and instead cuts taxes to $300.

(i) What is the change in real GDP?

(ii) What is the tax multiplier?

(e) Now the government simultaneously decreases both its purchases of goods and services and taxes to $300. What is the change in real GDP?

The government of Dairyland is unhappy with the constant taxes and it decides to replace them with a new tax, which depends on the level of real GDP. The new tax is calculated as 10% of real GDP. Use this information to answer the following questions.

(f) What is the equation for taxes now?

(g) What is the new equilibrium level of real GDP? (Round to the nearest billion)

(h) Suppose the government decreases its expenditures to $300 billion.

(i) What is the new equilibrium level of output? (Round to the nearest billion)

(ii) What is the change in consumer expenditure?

(iii) Why was the change in consumption different from the change in government spending?

Part II:

Read an article from an economic or financial publication that has relevance for what we are learning in this class. The "accepted" list of publications is Wall Street Journal, Financial Times, The Economist, Barron's, and Business Week. Obviously, this list is not intended to be comprehensive. If you find a good and interesting article in any publication, printed or on the Internet, you are invited to read it.

Write a one page (single spaced, font 10) review of the article you just read. Attach a copy of the original article.

Your review will be graded according to its relevance for this class, the ideas you put forward, and your knowledge of written English.