Consider following Keynesian economy:-
Consumption:- C = 200 + 0.6(Y − T) – 200r
Investment:- I = 300 – 300r
Taxes:- T = 20 + 0.2Y
Government purchases:- G = 152
Net exports:- NX = 150 − 0.08Y – 500r
Money demand:- L = 0.5Y – 200r
Money supply:- M = 924
Full-employment output:- Y‾= 1000
a) What are general equilibrium (that is, long-run) values of the output, the real interest rate, consumption, investment, net export, and the price level?
b) Starting from the full employment, government purchases are increased by 62 to 214. What are the effects of this change on the output, real interest rate, consumption, investment, net exports, and price level in a short run? In a long run?
c) With the government purchases at their initial values of 152, net exports increase by 62 at any income and the real interest rate so that NX = 212 − 0.08Y – 500r. What are the effects of this change on the output, real interest rate, consumption, investment, net exports, and price level in a short run? In a long run? Compare your answer to that for Part (b).
a) Give an ex of a factor that would increase the public’s expected rate of inflation. All else being equal, how would this increase in the expected inflation rate affect interest rates?
b) Use the concepts of income effect and substitution effect to describe why the effect on saving of an increase in the expected real interest rate is potentially ambiguous.
c) Given income, how are consumption and saving linked? What is the basic motivation for saving?
d) What are the two components of the user cost of capital? describe why each is a cost of using a capital good?
e) Give two equivalent ways of describing equilibrium in the goods market. Use a diagram to show how goods market equilibrium is attained.
f) describe why the saving curve slopes upward and the investment curve slopes downward in the saving-investment diagram. Give two exs of changes that would shift the saving curve to the right, and two exs of changes that would shift the investment curve to the right.
g) What is the relationship between the price level and the nominal money supply? What is the relationship between inflation and the growth rate of the nominal money supply?
h) How are consumption and saving affected by increases in current income, expected future income, and wealth?
An economy has the following AD and AS curves.
AD Curve:- Y = 300 + 30(M⁄P)
AS Curve:- Y =Y‾+ 10(P − Pe)
Here, Y‾= 500 and M = 400.
a) Suppose that Pe = 60. What are the equilibrium values of the price level, P, and output, Y? (Hint: The solution for P in this Part and in Part (b) below are multiples of 10.
b) An unanticipated increase raises the money supply to M = 700. Because the increase is unanticipated, Pe remains at 60. What are the equilibrium values of the price level, P, and output, Y?
c) Central bank of Kenya announces that the money supply will be increased to M = 700, which the public believes. Now what are the equilibrium values of the price level, P, the expected price level, Pe, and output, Y?