Economics 102 Introductory Macroeconomics - Spring 2005, Professor J. Wissink
Problem Set 4 – DUE at the start of class on Wednesday March 16, 2005
Boxes will be removed ten minutes after the start of class.
Remember: We will NOT accept problem sets late. Period.
Thanks for minding this policy and not asking if you can hand it in late.
1) Consider the following information about a hypothetical open economy.
Y
C
Iplanned
G
Taxes
Exports
Imports
300
400
500
600
700
800
180
260
340
420
500
580
50
50
50
50
50
50
120
120
120
120
120
120
100
100
100
100
100
100
120
120
120
120
120
120
110
110
110
110
110
110
Note: all values are in billions of dollars
a)
b)
c)
d)
e)
f)
g)
What is the equilibrium level of national income, Y*?
Graph its determination.
What is the: marginal propensity to consume out of Y (mpc)?
What is the marginal propensity to invest out of Y (mpi)?
What is the marginal propensity to export out of Y (mpx)?
What is the marginal propensity to import of Y (mpm)?
In this open economy the general formula for the investment multiplier is:
KI = 1/(1-mpc-mpi-mpx+mpm) What is the numerical value of the multiplier given your
answers to c-f?
h) What does the multiplier tell us?
i) What would happen to the equilibrium level of national income if planned investment
exogenously increased by $2.5 Billion?
j) Is this economy’s budget balanced?
2. Multiple Choice:
1) If the “Keynesian” investment multiplier is 2.5 and if investment rises by $20 while government
spending falls by $10 (other things remaining constant), by how much will the equilibrium level of
income (Y*) rise?
a. 0.
b. 25.
c. 40.
d. 50.
e. By an indeterminate amount.
2) If income can only go to consumption and saving then the following must be true:
a.
b.
c.
d.
e.
the mpc+mps = 1
the mps = 0.
the apc+aps = 1
both a. and c.
none of the above
3) In a closed economy with no government, which one of the following will occur when the economy is
in equilibrium:
a.
b.
c.
d.
e.
S=C
Y=S
C=Y
I=C
none of the above
4) A reduction in the marginal propensity to consume will:
a. cause the AEd line to become flatter and a given change in investment to have a smaller effect on
output.
b. cause the AEd line to become flatter and a given change in investment to have a greater effect on
output.
c. cause the AEd line to become steeper and a given change in investment to have a smaller effect on
output.
d. cause the AEd line to become steeper and a given change in investment to have a great effect on
output.
e. cause the AEd line to shift up.
5) Refer to the figure depicting the relationship between income received (Y) and consumption spending
(C) for a given household. Assume there is no government spending and taxes. This household's saving
will be zero when income is:
a.
b.
c.
d.
e.
1,400.
1,200.
1,000.
800.
600.
Consumption function
C
440
370
100
200
Y
3. A good friend of yours gets a job working for the federal government of Isle de Cornell, a cold and
snowy island/country in the Finger Lakes. Because she knows that you are taking Econ 102, she
invites you over for spring break on the condition that you help her solve Isle de Cornell’s macro
problems. Because you love both economics and snow, you accept her deal. Upon arrival you are
given the following information about Isle de Cornell:
Consumption function: C = $300 + .6Yd
Investment: I = $500
Government spending: G = $200
Taxes: T = $200
Exports: EX = 0
Imports: IM = .2Y
a) Calculate Isle de Cornell’s equilibrium level of output/income Y*.
b) Draw a graph representing Isle de Cornell’s aggregate desired expenditure function. Clearly label the
expenditure equilibrium point.
c) Calculate the general multiplier for Isle de Cornell. (This is the multiplier that applies when
autonomous expenditure increases by one dollar.)
d) Calculate the balanced budget multiplier for Isle de Cornell. (This is the multiplier that applies when
both government spending and taxes increase by one dollar at the same time.)
Suppose that Isle de Cornell wishes to increase its level of output (stimulate economic growth). As part
of your assignment, you are asked to evaluate a number of different policy options. Assume that Isle de
Cornell has a substantial amount of unutilized resources. This means that an increase in expenditure
(aggregate demand) will lead to an increase in output without inflation. This will help Isle de Cornell
grow.
e) The first policy option is a lump-sum reduction of taxes by $50. What effect would this tax have on
the equilibrium level of national income? Is this a good policy given Isle de Cornell’s goal of
growth? Why or why not?
f) The second policy option is to increase government spending by $50. What effect would this have on
the equilibrium level of national income? Is this a good policy given Isle de Cornell’s goal? Why or
why not?
g) The third policy is to simultaneously increase government spending by $50 and finance it with a
lump-sum increase in taxes of $50. What effect would this have on the equilibrium level of national
income? Is this a good policy given Isle de Cornell’s goal? Why or why not?
h) The forth policy option is to begin to allow Finland at long last to sell wool socks to the Isle de
Cornell economy. The estimated increase in sock trade would shift up in the import function of $50.
What effect would this have on the equilibrium level of national income? Is this a good policy given
Isle de Cornell’s goal? Why or why not?