Consider a closed economy with the following relationships: C = 1000+ 0.9 (Y - T) I...

 

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Consider a closed economy with the following relationships: C = 1000+ 0.9 (Y - T) I = 210 + 0.1 Y - 1000 r r=i-n² Consumption: Investment: Real interest rate: Government expenditure: Tax Revenue: Central bank policy rule: Inflation target: G = 150 + 0.08 Y T = 250+ 0.2 Y i = (n + n) + 0.5 (π - n¹) π = .025 Aggregate Supply Curve: Medium run level of output: Y₁ = 11,000 π = π² +0.0001 (Y - Y₁) a) Write down the equation for the IS curve, with Y on the left-hand side expressed as a linear function of the real interest rate, r. (2 marks) b) What is the value of the goods market multiplier for this economy? (1 mark) Now suppose the economy is in medium run equilibrium, so that inflation, π = ² = ¹ = .025 and Y = Y₁ = 11,000. c) Write down the equation for the medium run equilibrium of the goods market and solve it for the medium run real interest rate, T, and then find the nominal interest rate, in. (3 marks) d) Now solve for the medium run equilibrium values of tax revenue Tn, consumption Cn investment In, government expenditure, G₁, and the fiscal surplus, FSn = Tn-Gn (5 marks) Suppose suddenly, inflation expectations double to ² = .05 e) Now solve the model for the short run equilibrium values of Y, Z, and i. Also solve for T, C, I, G, and FS=T-G. Explain why and by how much these values differ from their medium run values calculated in d). (7 marks) Consider a closed economy with the following relationships: C = 1000+ 0.9 (Y - T) I = 210 + 0.1 Y - 1000 r r=i-n² Consumption: Investment: Real interest rate: Government expenditure: Tax Revenue: Central bank policy rule: Inflation target: G = 150 + 0.08 Y T = 250+ 0.2 Y i = (n + n) + 0.5 (π - n¹) π = .025 Aggregate Supply Curve: Medium run level of output: Y₁ = 11,000 π = π² +0.0001 (Y - Y₁) a) Write down the equation for the IS curve, with Y on the left-hand side expressed as a linear function of the real interest rate, r. (2 marks) b) What is the value of the goods market multiplier for this economy? (1 mark) Now suppose the economy is in medium run equilibrium, so that inflation, π = ² = ¹ = .025 and Y = Y₁ = 11,000. c) Write down the equation for the medium run equilibrium of the goods market and solve it for the medium run real interest rate, T, and then find the nominal interest rate, in. (3 marks) d) Now solve for the medium run equilibrium values of tax revenue Tn, consumption Cn investment In, government expenditure, G₁, and the fiscal surplus, FSn = Tn-Gn (5 marks) Suppose suddenly, inflation expectations double to ² = .05 e) Now solve the model for the short run equilibrium values of Y, Z, and i. Also solve for T, C, I, G, and FS=T-G. Explain why and by how much these values differ from their medium run values calculated in d). (7 marks)