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##### Economics 576 project 2

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solution

**Question**

Economics 576.01W-02W;Summer I, 2014;Project II;Given the basic Keynesian three-sector model;Y = C + I + G i = interest rates;where C = a + bYd Y = aggregate income;and I = f (i ?) but I? f (Y f = is a function of;with G = Go;and Tx = Txo;1. Assume: C = 22.3 +.75Yd;Now assume that government spending is increased by $22 billion. That would;(increase/decrease) the level of income by how much?;2. Assume: S = -35.1 +.25Yd;Now assume that taxes are cut by $15 billion. That would (increase/decrease) the;level of income by how much?;3. Assume: C = 42 +.8Yd;Now increase taxes and government spending (simultaneously) by $33 billion.;That would lead to a (decrease/increase) of __________ billion in the level of;income;4. Assume: C = 20 +.7 Yd;Now cut taxes by $20 billion. This would have the effect of shifting the consumption function (upward/downward) by _________ billion. (Think Keynesian cross model);5. Assume that the current level of income in the economy is $700 billion. It is determined that in order to reduce the unemployment rate to the desired level, it will be necessary to increase the level of aggregate income to $760 billion. Assume that S = -25 +.2Yd. How much would government spending have to be increased in order to accomplish the desired outcome?;6. Assume that the current level of income in the economy is $700 billion. It is determined that in order to reduce the unemployment rate to the desired level, it will be necessary to increase the level of aggregate income to $760 billion. Assume that S = -25 +.2Yd. How much would taxes have to be cut in order to accomplish the desired outcome?;7. Given a saving function of S = -25 +.2Yd, a $10 billion increase in government spending will bring about how many dollars of change in consumption?;8. Now, let?s modify our model a bit. Let?s add a fourth sector of spending so that Y = C + I + G + Xn with X = Xo and M = f (Y). Will this change, by itself, increase, decrease or not affect the magnitude of the government spending multiplier? Explain!;9. Thinking about modifications in the model again: Go back to the original model again, but add a marginal propensity to invest, this is, assume that;I = f (i and Y). The MPI is defined as?I/?Y and has a positive value. Will this increase, decrease or not affect the value of the government expenditures multiplier? Explain!;10. Now if we assume (more realistically) that tax collections are related to the level of income, that is, rather than assuming Tx = Txo, we assume that;Tx = To + tY where t is the tax rate, what will that change do to the magnitude of the investment multiplier? Explain!;11. In plain English, how is it (according to Keynesian theory) that a $1 increase in government spending can increase the level of aggregate income by more than $1? (Assume that the MPC is 0.8);12. Rather than the initial (top of first page) model, now assume a three sector economy with a tax rate (assume it is both average and marginal rate) of t and a marginal propensity to invest of f. Will this new model yield larger multipliers (say, government expenditures multiplier), smaller, or the same size as the initial model? Explain!;This is Project 2. The project is worth 50 points, with each question being worth 5 points. You may try all 12 if you wish, but can receive no more than 50 points.

Paper#35467 | Written in 18-Jul-2015

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