You are given the following model that describes the economy of Hypothetica. (1) Consumption function: C =
Question:
You are given the following model that describes the economy of Hypothetica.
(1) Consumption function: C = 80 + 0.75Yd
(2) Planned investment: I = 49
(3) Government spending: G = 60
(4) Exports: EX = 20
(5) Imports: IM = 0.05Yd
(6) Disposable income: Yd = Y - T
(7) Taxes: T = 20
(8) Planned aggregate expenditure: AE = C = I + G + EX - IM
(9) Definition of equilibrium income: Y = AE
a. What is equilibrium income in Hypothetica? What is the government deficit? What is the current account balance?
b. If government spending is increased to G = 75, what happens to equilibrium income? Explain using the government spending multiplier. What happens to imports?
c. Now suppose the amount of imports is limited to IM = 25 by a quota on imports. If government spending is again increased from 60 to 75, what happens to equilibrium income? Explain why the same increase in G has a bigger effect on income in the second case. What is it about the presence of imports that changes the value of the multiplier?
Step by Step Answer:
Principles of Macroeconomics
ISBN: 978-0134078809
12th edition
Authors: Karl E. Case, Ray C. Fair, Sharon E. Oster