Finale Presentation Macroecons

8/10/2019 Finale Presentation Macroecons

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Comprehensive Quantitative Question


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Assumptions

! Assumption 1: There is no tax and assume the economyhas fixed exchange rate.Both consumption and importare increasing function of aggregate income. That is C= a+ MPC!Yand IM = f + MPM !Y, where aand f

are positive constants.

! Assumption 2:For every 1% increase (decrease) in theinterest rate, planned investment Idecreases (increases)by $0.2 billion.

! Assumption 3:For every $1 billion increase (decrease)in government spending G, the interest rate increases(decreases) by 1%.


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4.1

" What is thedefinition of equilibrium in the

goods market? Using this definition, derive

MPCand MPMmathematically according

to Figure 1 and Assumption 1. (8 marks)

At equilibrium,

AD (Y) = AE

AD = C + I + G + X - M


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Using this definition, derive MPC and MPM

mathematically according to Figure 1 and Assumption 1.

" AD = C + I + G + X - M

" MPC =

"

MPM =

!C

!Y

!M

!Y


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" In a closed economy,

"AE = C + I + G

"From assumption 1, C = a + MPC x Y

"

Using b = MPC"AE = (a+bY) + I + G

"At eqm, Y = AE = (a+bY) + I + G

Y=1

1!ba +

1

1!bI+

1

1!bG


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From the graph, when Y = 0, AE =20

AE = (a+bY) + I + G

20 = a + I + G

When Y =100, AE = 100

100 = a + b(100) + I + G

100 = 100b + a + I +G

100b = 80b = MPC = 0.8


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In an open economy,

AE = C+I+G+EX-IM

From assumption 1, IM = f + MPM x Y

Using d=MPM,

AE = (a+bY) + I +G + EX (f + dY)When Y =0 and AE =20,

20 = a + I + G + EX f

When AE=25 and Y =25

25 = a + 25b + I + G + EX f 25d

25 = a + I + G + EX + 25(0.8) 25d

25d = 20 + 20 25 = 15

d = MPM = 0.6


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4.2

" Holding money supply constant, according toAssumptions 2 and 3, when government spendingincreases by $3 billion, what happens to the interestrate and planned investment?

(2 marks)

! Assumption 2:For every 1% increase (decrease) in theinterest rate, planned investment Idecreases (increases)by $0.2 billion.

! Assumption 3:For every $1 billion increase (decrease)in government spending G, the interest rate increases(decreases) by 1%.


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4.2

" Government spending

increases by $3 billion.

" 3% increase in interest

rate

" Investment decrease by

$0.6billion


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4.3

! Taking this crowding-out effect into consideration, if

government spending increases by $3 billion, how

much will be the new equilibrium aggregate output if

this is a closed economy? And how much will it be ifthis is an open economy? (8 marks)


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4.3

Closed Economy Open Economy

!YG =

1

1!MPC

!G

!YG =

1

1!(MPC

!MPM)

!G

!Ynet =!YG +!YI

!Ynet =!YG +!YI

!YI =

1

1! (MPC! MPM)!I

!YI =

1

1! (MPC)!I


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4.3

! In a closed economy,

! When G increases by 3 billion and I decreases by

0.6 billion

Y=1

1! ba +

1

1! bI+

1

1! bG

!Y=1

1! 0.8(!0.6)+

1

1! 0.8(3)= 12

!Y=1

1! 0.8(!0.6)+

1

1! 0.8(3)= 12


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4.3

! In an open economy,

! When G increases by 3 billion and I decreases by

0.6 billion

Y=1

1! (MPC!MPM)a +

1

1! (MPC!MPM)I+

1

1! (MPC!MPM)G +

1

1! (MPC!MPM)EX!

1

1! (MPC!MPM)f

!Y=1

1!(0.8

!0.6)

(!0.6)+1

1!(0.8

!0.6)

(3)=3

!Y= 11! (MPC!MPM)

!a + 11! (MPC!MPM)

!I+ 11! (MPC!MPM)

!G + 11! (MPC!MPM)

!EX!

11! (MPC!MPM)

!f

!Y=1

1! (MPC! MPM)!I+

1

1! (MPC! MPM)!G


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4.4

! Why does the same increase in government

spending have a larger effect on equilibrium output

in a closed economy than in an open economy?

Explain intuitively. (4 marks)


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4.4


Increase in government spending will

increase the circular flow of income in

that particular economy.

Y = C + I +G

Increase in government spending by the

same amount will increase the circular

flow of income by a smaller amount.

Some of extra government spending

that results is on foreign products and

not on home produced goods and

services

This results in a smaller Y in

Y = C + I +G + X - M


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4.4


Multiplier: Multiplier:

Magnitude of the multiplierClosed economy > Open economy

1

1! MPC

11! (MPC! MPM)


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Finale Presentation Macroecons

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