Class Notes (834,991)
MGEA06H3 (157)
Iris Au (146)
Lecture

# ECMA06_Tutorial_3_Solution.doc

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Department
Economics for Management Studies
Course
MGEA06H3
Professor
Iris Au
Semester
Summer

Description
ECMA06 Tutorial #3 Answer Key Question 1 Part (a) • The AE function: AE = C + I AE = [60 + 0.75Y] + [100 – 10(r – 0.05)] = [60 + 0.75Y] + [100 – 10(0.05 – 0.05)] AE = 160 + 0.75Y • Equilibrium output/income: In equilibrium, Y = AE: Y = 160 + 0.75Y 0.25Y = 160 Y* = 640 Part (b) Suppose that output is set accidentally at 600 (i.e., Y = 600): • The level of AE when Y = 600: AE = 160 + 0.75(600) = 610 Mechanism that brings output back to equilibrium: • Since Y = 600 & AE = 610, the economy is trying to purchase more output than is being produce; i.e., we have excess demand. • Prices are fixed (by assumption) at their current level, firms try to satisfy the excess demand by depleting their inventories that leaves inventories below their desired levels. • To replenish inventories to their desired levels, firms would increase their current level of output. • This pressure will continue until output increases to its equilibrium level of 640. If Y = 600, how will GDP be measured using the final products approach? • If Y = 600, C = 60 + 0.75(600) = 510 & I = 100 • In terms of GDP accounting, C = 510 & investment = 600 – 510 = 90. • Note: Investment = 90 because investment includes both I (= 100), which is intended investment, and changes in inventories, which is – 10 (90 – 100). Part (c) Suppose that output is set accidentally at 700 (i.e., Y = 700): • The level of AE when Y = 700: AE = 160 + 0.75(700) = 685 Mechanism that brings output back to equilibrium: • Since Y = 700 & AE = 685, the economy is producing more output than can be sold; i.e., we have excess supply. • Prices are fixed (by assumption) at their current level, firms find that their inventories pile up unexpectedly, as they are producing more than they are selling. ECMA06 Tutorial #3 Answer Key 1 • To lower inventories to their desired levels, firms would decrease their current level of output. • This pressure will continue until output decreases to its equilibrium level of 640. If Y = 600, how will GDP be measured using the final products approach? • If Y = 600, C = 60 + 0.75(700) = 585 & I = 100 • In terms of GDP accounting, C = 585 & investment = 700 – 585 = 115. • Note: Investment = 115 because investment includes both I (=100), which is intended investment, and changes in inventories, which is 15 (115 – 100). Part (d) dY • The multiplier, : dI In equilibrium: Y = AE = 60 + 0
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