Module 8: Problem Set

Assume the following to answer the following questions: 

• C= 1000+ .9 (Y-T)

• Tax rate = 0.1Y

• Imports = 0.1(Y-T)

• Government spending = 200

• Investment = 300

• Exports = 600

• Potential Output = $8000

What is the current GDP in this economy?  Show your work.

The current GDP in this economy is $7500.

WORK

• C= 1000+ .9 (Y-T)

• Tax rate = 0.1Y

• Imports = 0.1(Y-T)

• Government spending = 200

• Investment = 300

• Exports = 600

• Potential Output = $8000

GDP = Y

GDP= C + I + G + X - M

Y = (1000 + 0.9(Y- 0.1Y)) + 300 + 200 + (600 - 0.1(Y-0.09Y))

Y = 1000 + 0.81Y + 500 + 600 - 0.09Y

Y = 2100 + 0.72Y

Y - 0.72Y = 2100

0.28Y = 2100

Y = 7500

By how much must government spending increase or decrease to close this gap and bring the economy to Potential Output? Show your work

The equilibrium GDP should increase by $500 to close the gap from the current equilibrium GDP of $7500 and the potential output of $8000.

The value of dG is a positive value of $140, showing that the government spending should increase by $140 to close this gap and bring the economy to Potential Output.

 

Government expenditure multiplier

dY/dG = 1/ (1-c(1-t) + m(1-t))

WORK

C = 1000 + 0.9 (Y-T)

c = 0.9

T=0.1(Y-T)

t=0.1

M=0.1(Y-T)

m=0.1

 

dY/dG= 1/(1-0.9(1-0.1) + 0,1 (1-0.1))

dY/dG = 1/(1-0.9*0.9+0.1*-.09)

dY/dG = 1/ (1-0.81 +0.09)

dY/dG = 1/0.28

 

500/dG = 1/0.28

dG = 140

Is the economy described above in an inflationary or recessionary gap of the AD/AS Model?

The economy described above is in the recessionary gap of the AD/AS Model.

Flashcard 4 Question - Mod 8 Set

Flashcard 4 Answer - Mod 8 Set