Review of open economy IS-LM: Suppose you are given the following information about a very simple...

 

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Review of open economy IS-LM: Suppose you are given the following information about a very simple small open economy: Ct=c0c1 (Yt-Tt) (1) It = 10 + 11 (Yt-It) (2) Gt = 50 (3) Tt = 50 (4) Xt = 100 (5) IMt = m0+ m1 (Yt-Tt) (6) a) Describe in words what each equation and each variable from (1) to (6) represents. What do the parameters c0, 10, m0 represent? What do the parameters c1, il, ml represent? b) Let autonomous consumption spending be 20, autonomous investment spending be 20, and autonomous import spending be 10. In addition, assume that c1 = t1 = m1 = 0.8 Combine and solve equations (1) through (6) to find and compute equilibrium income (here, GDP), Yt, for this economy. c) Suppose the government attempts to stimulate the economy by increasing government spending by a factor of three, from 50 to 150. Compute the effect of this policy for equilibrium income. Compare the magnitude of this effect to the magnitude of the initial increase in government spending and explain any differences you find. d) Would the magnitude of the equilibrium output effect of higher government spending be larger or smaller if the economy were closed to trade? Explain your answer. e) Compute the effect of the increased government spending for consumption, private saving, investment, imports, the government budget deficit, and the trade balance. f) Suppose, instead, the government maintains its spending at 50 but cuts taxes to one third, from 50 to 16.66. Compute the effects of the tax cut for equilibrium income, consumption, private saving, investment, imports, the government budget deficit, and the trade balance. Compare your answers to those you obtained in c), d), and e) and explain. Review of open economy IS-LM: Suppose you are given the following information about a very simple small open economy: Ct=c0c1 (Yt-Tt) (1) It = 10 + 11 (Yt-It) (2) Gt = 50 (3) Tt = 50 (4) Xt = 100 (5) IMt = m0+ m1 (Yt-Tt) (6) a) Describe in words what each equation and each variable from (1) to (6) represents. What do the parameters c0, 10, m0 represent? What do the parameters c1, il, ml represent? b) Let autonomous consumption spending be 20, autonomous investment spending be 20, and autonomous import spending be 10. In addition, assume that c1 = t1 = m1 = 0.8 Combine and solve equations (1) through (6) to find and compute equilibrium income (here, GDP), Yt, for this economy. c) Suppose the government attempts to stimulate the economy by increasing government spending by a factor of three, from 50 to 150. Compute the effect of this policy for equilibrium income. Compare the magnitude of this effect to the magnitude of the initial increase in government spending and explain any differences you find. d) Would the magnitude of the equilibrium output effect of higher government spending be larger or smaller if the economy were closed to trade? Explain your answer. e) Compute the effect of the increased government spending for consumption, private saving, investment, imports, the government budget deficit, and the trade balance. f) Suppose, instead, the government maintains its spending at 50 but cuts taxes to one third, from 50 to 16.66. Compute the effects of the tax cut for equilibrium income, consumption, private saving, investment, imports, the government budget deficit, and the trade balance. Compare your answers to those you obtained in c), d), and e) and explain.

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a The given equations and variables represent the following 1 Consumption function C Co c1Y T where C is current consumption Co is autonomous consumption spending c1 is the marginal propensity to cons... View the full answer