Question

Suppose the initial conditions of the economy are characterized by the following equations. In this problem, we assume that prices are fixed at 1 (the price index is 100 and when we deflate, we use 1.00) so that nominal wealth equals real wealth.

1) C = a₀ + a₁ (Y - T) + a₂ (WSM) + a3 (WRE) + a4 (CC) + a₅ (r)

1’) C = a₀ + a₁ (Y - 200) + a2 (10,000) + a3 (15,000) + a4 (100) + a₅ (3)

2) I = b₀ + b₁ AS + b₂ CF + b₃ (r)

2’) I = b₀ + b₁ (150) + b₂ (2000) + b₃ (3)

3) G = G

3’) G = 300

4) X - M = X - M

4’) X - M = - 100

Where: a₀ = 165 , a₁ = .75, a₂ = .05, a₃ = .10, a₄ = .8, a₅ = - 500, b₀ = 210, b₁ = .5, b₂ = .5, b₃ = - 200

We now let G rise to 400 as the Federal Government (fiscal policy) authorities are not happy with the level of GDP. Solve for the new equilibrium output and label as point B on all three of your diagrams. Please be sure to label your diagrams completely and show all work.

Answer 1

We've been given the values of many of the inputs needed in calculations. Now, we know that in equilibrium

AE=Y=C+I+G+NX

Where Y is the GDP/Output, C is consumption, I is investment, G is government spending and NX is net exports.

C is given as C = a₀ + a₁ (Y - 200) + a2 (10,000) + a3 (15,000) + a4 (100) + a₅ (3)

Putting the values given in the question, we get

C=165+.75(Y-200)+.05*10000+.10*15000+.8*100-500*3

C=.75Y+595

I is given as I = b₀ + b₁ (150) + b₂ (2000) + b₃ (3)

Putting values in, we get

I=210+.5*150+.5*2000-200*3

I=685.

G=400 is given. Please note that G was increased to 400, as the question states.

NX=X-M=-100 is given.

Putting all of these into Y=C+I+G+NX, we get

Y=.75Y+595+685+400-100, OR

.25Y=1580, OR

Y=6320. This is the new equilibrium output.

The earlier three diagrams were not posted so I am not able to label this as point B on those. But since we already have the value, labeling should be easy.