Econ 1020

Winter 2019

Assignment 4

Due date: March 15

Please do not simply indicate results, but show the formulas that you use

Exercise 1 

You are given the following data concerning a certain economy:

1) Consumption function: C = 80 + 0.6 Y

2) Investment function: I = 200

3) AE º C + I

4) AE º Y

(a) Graph equations 3) and 4), solve for equilibrium income (or output), and show it on your graph. 

(b) What is the relationship between planned investment and actual investment in correspondence of the equilibrium level of income (or output)? Explain. 

(c) Suppose equation 2) is changed to 2’) I = 150. What is the new equilibrium level of income (or output)? 

(d) Represent the effect of (c) on the graph you obtained in (a). 

(e) Why is the decrease in output greater than the change in investment? Explain the economic process behind this result. 

Exercise 2 

You are given the following data concerning a certain country:

1) Consumption function: C = 100 + 0.7 (Y-T)

2) Investment function: I = 50

3) G =70

4) T =20

5) AE º C + I + G

6) Y º AE

(a) What is the equilibrium level of output (or income)?

(b) Graph the AE and Y curves and show the equilibrium level of income on your graph.

(c) What is the effect on the equilibrium level of output (or income) of an increase of government spending by 30 (which means G’=100)? Calculate your answer numerically and show it on it on the graph you drew in (b). 

(d) How does the surplus/deficit of the government changes after an increase in government spending by 30?

(e) What is the effect on the equilibrium level of income (or output) of an increase in taxes by 20 (which means T’=40)?

Exercise 3 

Given the following model of an economy:

C = 6,000 + 0.75 (Y-T)

I = 11,000

G = 20,000

T = 16, 000

a) Calculate the equilibrium level of output (or income);

Assume estimations calculate that the full-employment level of output is $150,000:

b) If the government wanted to use G to achieve the full employment level of output, by how much should G increase/decrease? 

c) If the government wanted to use T to achieve the full employment level of output, by how much should T increase/decrease? 

d) Why G and T change by a different amount to achieve the same goal of moving the economy to the full-employment level of output of $150,000?