Question

Here is another set of equations describing an economy:

C = 14,400 + 0.5(Y-T) – 40,000r

IP = 8000 – 20,000r

G = 7000

NX = -1,800

T = 8000

Y* = 40,000

a. Find a numerical equation relating planned aggregate expenditure to output and to the real interest rate. [i.e. write down the PAE equation]

b. At what value should the Fed set the real interest rate to eliminate any output gap? (Hint: Set output Y equal to the value of potential output given above in the equation you found in part (a). Then solve for the real interest rate that also sets planned aggregate expenditure equal to potential output.)

Answer 1