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MGEA06H3 (157)
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Lecture

# ECMA06_Tutorial_5_Solution.doc

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

Description
ECMA06 Tutorial #5 Answer Key If r is held fixed at 0.06 & E is held fixed at 0.85 US\$ per C\$, then I = 40 – 4.5(0.06 – 0.06) = 40 X = 180 – 2(0.85 – 0.85) = 180 IM = (1/4)Y + 2(0.85 – 0.85) = (1/4)Y Part (a) • Disposable income, DI: DI = Y – T + TR DI = Y – (5/11)Y + [120 – (1/11)Y] = 120 + (5/11)Y • C = C(Y): C = 10 + (11/12)[120 + (5/11)Y] C = 120 + (5/12)Y • The AE function: AE = C + I + G + X – IM AE = [120 + (5/12)Y] + 40 + 320 + 180 – (1/4)Y AE = 660 + (1/6)Y • Equilibrium output: In equilibrium, Y = AE: Y = 660 + (1/6)Y Y* = 792 • Government (budget) deficit: GBB = T – TR – G GBB = (5/11)Y – [120 – (1/11)Y] – 320 = (6/11)Y – 440 GBB = (6/11)(792) – 440 = – 8 ⇒ The government runs a budget deficit of 8. Part (b) Suppose government spending increases by 55, i.e., G = 375: • The new AE function: AE = [120 + (5/12)Y] + 40 + 375 + 180 – (1/4)Y AE = 715 + (1/6)Y • New equilibrium output: In equilibrium, Y = AE: Y = 715 + (1/6)Y Y* = 858 • Government (budget) deficit: GBB = (5/11)Y – [120 – (1/11)Y] – 375 GBB = – 27 ⇒ The government budget deficit increases by 19 to 27. • The (government expenditure) multiplier: dY * ΔY * 858 - 792 dG = ΔG = 55 = 1.2 ECMA06 Tutorial #5 Answer Key 1 Part (c) • In part (b), we showed that an increase in G by 55 will increase (autonomous) AE by 55. • In order for a tax cut to have the same effect on Y*, we need a tax cut such that (autonomous) AE will increase by 55 as well. • Given a tax cut enters the AE function indirectly (through a change in DI and then the consumption), and the marginal propensity to consume out of DI is 11/12, this implies the amount of tax cut, α, is: (11/12)α = 55 α = 60 • A tax cut of 60 would achieve the same result on Y* as shown in part (b). • Note: You can check the result by finding the new AE function after a tax cut of 60 and then find the new Y*. Part (d) Suppose exports fall by 55, i.e., X = 125: • The new AE function: AE = [120 + (5/12)Y] + 40 + 320 + 125 – (1/4)Y AE = 605 + (1/6)Y • New equilibrium output: In equilibrium, Y = AE: Y = 605 + (1/6)Y Y* = 726 • Government (budget) deficit: GBB = (5/11)Y – [120 – (1/11)Y] – 320 GBB = – 44 ⇒ The government budget deficit
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