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In an open economy: C = 400 + 0.75Yd T = 0.2Y I = 600 G...

In an open economy:
C = 400 + 0.75Yd
T = 0.2Y
I = 600
G = 1000
X = 500
Z = 0.1Y

a.Calculate national income when the economy is at equilibrium. Use the injection-leakage approach to graph your results.

b.Full employment is achieved when income is 5500. How much should government expenditure increase to achieve full employment?

c.At full employment, what is the (i) budget? (ii) trade balance?

d.Based on your answers in (c), is it advisable for government expenditure to increase to achieve full employment? Suggest a better option/ alternative.

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Answer #1

d)

The result from c describes that the increase in government expenditure makes the budget to go deficit. If this is not desirable, then the government can take monetary policy to increase investment by the same amount as government expenditure. However, the effect of monetary policy on investment is not as predictable as the change in government expenditure or tax. Therefore, in this case the best policy is to change government expenditure.

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